Flipping is simply buying a house at a discount, adding value in some way, and selling quickly for a higher price. There is nothing illegal or wrong about it, and flippers can do a real estate market a lot of good. But although flipping is perfectly legal, there are illegal flipping schemes out there, and there is a subset of property flippers that is giving good, honest business people a bad name.
Like flippers, floppers look to buy property at a discount. Unlike real flippers, though, who actually add real value to properties, floppers rely on fraudulent representation for their profits – and that’s worse than being illegal: It’s also wrong.
During the housing boom in the 2000s, appraisers – nearly all independent contractors — were under tremendous pressure from real estate agents and lenders alike to come up with whatever numbers would make the deal go through. The banks didn’t care whether the numbers were accurate: They were selling the loans upstream anyway, to Fannie, Freddie, and any suckers who would take them.
The appraisers who were willing to play ball got lots of business. The honest ones soon found out that their opinion on a deal wasn’t welcome. The lenders stopped calling them, and their business dried up. Only the crooked and spineless – the ones telling the banks and agents only what they wanted to hear, were successful.
Here’s how a typical flop scheme works: A homeowner finds himself significantly underwater on his mortgage and falls behind on payments. The lender eventually initiates foreclosure procedures. Meanwhile the homeowner hooks up with an “investor” (I use the quotes ironically, because floppers aren’t investors – they’re crooks), who offers to put together a short-sale package. Meanwhile, the second crook is in cahoots with a crooked appraiser, who comes up with a low-ball appraisal of the house’s market value.
The lender, relying on information from the crooked appraisal, agrees to the short sale, and the crook buys the house at a sharp discount from market value.
This causes substantial economic harm to the owners of surrounding homes, because the low-ball sales price becomes part of the “comps” that get pulled for the neighborhood. The low-balling therefore causes neighborhood values to drop. It may also make the difference between some surrounding homeowners having to pay extra private mortgage insurance premiums (PMI) and being able to keep that money. This is an important issue to them.
The crook owns the house for a brief period – perhaps a few days, perhaps as long as a year – and then sells the house at the full market value. He may even have gotten a new appraisal by another crooked appraiser at an artificially high price. At the end of the transaction, the flopper and the original seller split the difference between the short-sale price and the final sale: something they planned to do all along.
This eventually mitigates the damage done to neighbors by low comps (though the PMI payments on properties that should have poked above the 80 percent loan-to-value ratio it takes to cancel PMI cannot be gotten back). But it costs lenders as much as $375 million per year, according to CoreLogic, a real estate data clearinghouse that tracks home sale prices and transactions across the country.
What makes a transaction like this an illegal “flop” instead of a flip?
Understandably, mortgage lenders are getting pretty fed up with this practice, which is becoming all too common. They are getting wise to it, and they are tracking instances where homes are sold very shortly after a short-sale at considerable profit. Simply selling a home after a short-sale at a profit is not in itself illegal – but it is a possible indicator of fraud. According to the CoreLogic study linked to above, the data show that 1 in 6 short-sales are resold within a day, and the the average profit on same-day short-sales is 34 percent, according to the CoreLogic study linked above.
Lenders know that floppers aren’t adding value with a remodeled bathroom and kitchen between sales just minutes apart. Mortgage lenders and their consultants are looking for evidence of fraud – and they’ll start with these cases. If you’re involved in one of these transactions, don’t be surprised if private investigators or law enforcement agents start sniffing around the deal – talking to your counterparties, and ultimately issuing subpoenas for documents.
What, precisely, raises red flags for mortgage companies? CoreLogic defines “suspicious” short-sales as follows:
The scam was common during the run-up, and reached epidemic proportions in the late 2000s, becoming a favorite tactic of real estate crooks by the end of the decade. Consider: According to data from the Mortgage Asset Research Institute, valuation fraud represented just 16 percent of all mortgage fraud cases. That number rose to 22 percent by 2008, and 33 percent by 2009.
There’s nothing wrong with buying low and selling high. It’s the American way. But if you rely on fraud to do it, that’s a felony, and the FBI will come after you if they find out. That’s what happened to Sergio Natera and Anna McElany, two real estate agents in Bridgeport, Connecticut.
Here’s how the scam worked, verbatim from the FBI release:
According to court documents and statements made in court, Natera and Anna McElaney, both real estate agents, defrauded Regions Bank, which held two mortgages on a residential property in Bridgeport. On December 5, 2007, McElaney, who was a listing agent for the property, received an offer to purchase the property for a price of $132,500. However, Natera and McElaney informed Regions Bank that the highest offer to purchase the property was for $102,375 and that it was made by BOS Asset Management LLC. Natera and McElaney concealed from Regions Bank that there was a higher offer by another bidder, that Natera owned BOS Asset Management LLC, and that Natera and McElaney planned to keep the difference between the two prices. Based on the false and incomplete information provided to it, Regions Bank agreed to the short sale for the lower price and released its mortgages on the property.
On June 9, 2008, Natera and McElaney arranged for two sales of the property to occur on the same day. The first sale was from the owner of the property to BOS Asset Management LLC for $102,375; the second sale was from BOS Asset Management LLC to the original bidder on the property for $132,500. Natera and McElaney retained the difference between the two sale prices.
In February 2010, Natera and McElaney each pleaded guilty to one count of bank fraud. On July 25, 2011, McElaney was sentenced to eight months of imprisonment and six months of home confinement. [Emphasis added – JVS]
The postscript: Natera received his sentence in April – two months of imprisonment, followed by three years of supervised release, the first six months of which Natera must spend in home confinement.
The best way to defend yourself:
“… I want employees to ask themselves whether they are willing to have any contemplated act appear the next day on the front page of their local paper – to be read by their spouses, children and friends – with the reporting done by an informed and critical reporter.”
Colluding to deceive your business partners and counterparties is never on this list.
A great chess player never hopes his opponent does not see the best move available to him. The best chess players assume their opponents always see the best move on the board, and play accordingly.
So it is with the ethical flipper. The ethical flipper does not rely on his buyer’s ignorance, never lies, never deceives and never colludes with others to do so. When he buys a home, he is doing a service to a seller who needs to sell quickly. Both parties benefit. When he holds a property, he adds real value. He does not rely on deception to add value, but works in such a way that the more informed the buyer becomes, the more valuable the home is. The value the true flipper adds, whether from repairs, renovations, financing arrangements, or simply doing a great job finding the right buyer for the property, is not dependent on concealment or deceit, but is there even if the buyer knows every detail about how the property was acquired. The true flipper benefits his sellers and buyers alike – and turns them into missionaries for his own business, looking out for opportunities for the flipper to serve their own friends, family, neighbors and co-workers.
Jason Van Steenwyk is a veteran financial industry journalist who has been fighting to make the world safe for the retail investor since 1999. He lives at Ground Zero of the real estate bubble in Fort Lauderdale, Florida.
No, forget it, they are NOT going to fix anything. That Dodd – Crank bill won’t do anything, it is too long and complicated to be enforceable and the state agencies that do the “enforcing” are impotent. I WAS a Texas State Certified Real Estate appraiser. I have worked for over 200 lenders and I have NOT found even ONE yet that would NOT fire me the first time I gave them an appraisal that didn’t “make value”. I have NOT been fired by ALL of them just every single one of them I gave an appraisal to that didn’t make VALUE. You folks have got to understand this is all driven by the GOVERNMENT, They WANT to start another PHONY Housing boom as quickly as they CAN. They artificially squash interest rates by a “dictator” instead of having them set by Supply and Demand like they are SUPPOSED to be in a Capitalist system. I did my last appraisal in 2004. I did not even LOOK at an appraisal for 6 years. Then a real estate agent sent me a copy of one done in Red River County Texas in 2010 that was a PACK of LIES from beginning to end. I filed a complaint on the guy. I waited for TWO YEARS for them to “get around to it, it was a $50,000 LIE at least. It was loaded with Gross misrepresentations of material FACT and Gross OMISSIONS of Material FACT. I waited TWO YEARS for them to DO something and all they did was send him a WARNING LETTER< not even a FINE!!! Somebody's Grandmother can get caught driving and forgetting to fasten her seat belt and the fine will be $65 to several hundred dollars depending on the jurisdiction. But for a LIAR for HIRE, no fine at all!!!
The Texas Appraiser Licensing and Certification Board is made up of APPRAISERS still working in the RACKET and Public Members that do not know BS from Wild Honey. When you CATCH somebody they make it as hard as they can for you to file a complaint, if you call to try to find out if they have FORGOTTEN your complaint, they jump all over you for "harassing them". They SUCK, they are inept and crooked. It is a Good ole Boy system. "I'll go easy on YOU and next time when I get caught YOU go easy on me." That is all there is too it, and most appraisers cannot appraise anything if somebody does NOT give them a CLUE to start with. When I was a young man, I worked in Horse Racing, I have had every job on the Race Track and I can tell you Horse Racing is MUCH better policed and is MORE HONEST that APPRAISING or BANKING. And we EXPECT horse racing to be crooked. But let me tell you, the WORST ADVICE anybody ever gave me was to get in that sorry RACKET, real estate. I almost never even MET a real estate appraiser until I became one. Man, it is the SORRIEST thing I have ever done and I will NEVER do it again. It is all about PRINT more phony fiat currency and Loan, loan loan and loan and anybody that gets in the way of THAT is going to be RUN OVER. That is the way BOTH PARTIES are, no matter who you vote for you will get that because BOTH PARTIES Practice Keynesian Economics. KE is so deeply embedded in the WORLD SYSTEM there is no turning back until they run it in the ditch FOREVER. Remember I told you so, I predicted the crash and told my Congressman and my state Rep, nobody would lift a finger. It is just like everything else really, the government has TWO POLICIES for EVERYTHING, the ONE for public Consumption and the one they ACTUALLY CARRY OUT. It will NEVER CHANGE. Real Estate Appraisers are lower than used car salesmen, Tattoo parlor operators and their patrons and topless bar owners and their patrons. They are just thieves pimps and crooks. Bob Burnitt Ellis County Texas
There is another scheme where The Flipper or Flopper only works with a specific lender, who looks the other way. The Flopper knows the crooked appraiser who is on the take. The Real estate agent also on the take is involved. They work together the Real estate agent tells the buyer that the seller only works with their lender and there appraiser. “Out Side Appraisers dont Know the area”? The Home is posted at the correct appraised price. The Real estate agent encourages the buyer to pay 10,000 to 20,000 more, ”To Secure the bid’ and if the buyer does not agree the buyer is not considered. When the buyer agrees to pay extra cost, the crooked appraiser is brought in and it is reappraised at the higher cost. This does not work with VA so Veterans like myself really don’t stand a chance.