Fraudulent Short Sale Flips: Tell-Tale Signs Without the Bias

There appears to be a buzz going around about small-sale flipping and the FBI adding this genre to its list of mortgage fraud.  But, not all small-sale flips are fraudulent.  This bears repeating: NOT ALL SMALL SALE FLIPS ARE FRAUDULENT.  There are many real estate professionals out there closing back to back transactions in a perfectly legitimate way. It is often how they get paid for the long, arduous task of negotiating a small sale as many small sale lenders refuse to pay a loss mitigation fee.  If the investor does not have a real estate license, they are out of luck.  Further, there is nothing inherently illegal about flipping properties.  It is the fraudulent activities that often accompany flip transactions that are problematic.

The first tale I saw on small sale flipping yesterday was reported by the Sarasota Herald Tribune.  In typical fashion, using strong words such as “schemes” and “scams” (I despise those words by the way) which clearly demonstrate the bias of the author, theyappear to  imply that small sale flips, in and of themselves, are fraudulent.  I believe the Home Equity Theft Reporter has a better take on the subject, as indicated by their post title: “Small Sale Flipping Fraud: Use of Inflated Appraisals, Straw Buyers, Sale Terms Undisclosed to Lenders All Indicate that Scammers Are Still At It“. I recommend reading it.  I would also add to that small list of fraudulent activities, non-arms length transactions and realtor fraud.  Also, read the FBI Press Release on Operation Terrible Deeds and more specifically, the US v. Bills case (page 4-5 of the Press Release) for a description of small sale fraud.  Note the use of straw buyers, the lies to the homeowners etc.

There is nothing incorrect with flipping properties as long as you do not engage in the fraudulent activities enumerated above.  If you tell, in writing, in your Contract of Sale that 1) you are a real estate investor and 2) you intend to immediately resell the property for profit, you have satisfied the disclosure requirement.  As far as the allegations that investors are “fooling” or “tricking” the small sale bank in accepting a “low-ball” offer, that is pure rubbish.  The small sale lender is free (and usually does) to order an independent appraisal or BPO to determine value and based upon that report, among other information, makes a business choice as to what it will accept as a small payoff. This is a business choice based purely on economics.

Personally, I reckon inflated appraisals is a non-issue in this age of the Home Valuation Code of Conduct (HVCC).  Mortgage brokers can no longer order their own appraisals and as such, the sphere of influence is greatly reduced if not eliminated. The other fraudulent activities have been discussed ad nauseum throughout the blogosphere and if you don’t know by now you shouldn’t include straw buyers in the mix, or have side  agreements, well, you should stay far away from real estate investing.

As for non-arms length transactions, this one is simple: 1) Don’t involve yourself in any sort of transaction whereby the homeowner is going to keep possession of the property and 2) Realtors: if you are the listing agent you cannot be the investor.  These two roles are diametrically opposed.  Your fiduciary duty is to get the highest price possible for your client, the homeowner.  If you make a low offer and set up a second transaction at a higher price, that is prima facie proof that you have violated your duty.

Some other suggestions: Structure your transaction so that every document you submit is legitimate.  No back dating deeds or title, no fake HUD-1s, etc. If you are going to sign a HUD-1, there had better be a real estate transaction to support it.  Make sure each transaction can stand on it own – use transactional funding and do not fund the first transaction with funds from the 2nd.  In my opinion, this is an issue of “appearances” not law, but in the current market, a wise choice. Make sure that you have a excellent team behind you with experience and a working knowledge of the law in this area.

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