House Flipping and Fraud: What’s Illegal (And How to Protect Yourself)

If you aim to be a professional property flipper, it pays to acquire a professional’s understanding of the law. Property flipping is, of course, totally legal. There’s nothing wrong, ethically, morally or legally, with finding a motivated seller, fixing up a property, and quickly selling at a higher price to someone who wants the house. Indeed, adding value for the end user and benefiting everyone on both ends of the transaction is exactly what commerce is all about!

You’ll run into trouble, though, if you attempt to use deception to trick a seller, financer, or buyer into the deal. Yes, real estate markets in some areas have taken on some “wild west” qualities. But state DAs are still rigorously enforcing applicable laws – especially laws against various forms of fraud.

What is Fraud?

Let’s begin at the beginning: At common law – the vast legal tradition of court rulings and precedents we inherited from antiquity – fraud has three basic elements:

1. A false statement
2. Reliance on that false statement
3. Damages

Basically, for someone to commit fraud against you, they must tell you something that is intentionally false or misleading. As the plaintiff, you must demonstrate that the information was false, that the false statement was material to the decision (that is, not irrelevant), and that you depended on that information to make a decision. And then that decision must have harmed you in some way.

Note that this is just from British common law. Each state sets its own specific definitions. For example, some states, like Arizona, Montana, Oregon and Washington, define as many as nine separate elements of fraud. And some states treat omissions of relevant, material information differently from others. So it’s important that you also seek the services of an attorney licensed in your particular jurisdiction to answer questions specific to your case.

Special Real Estate Considerations – Duty to Disclose

In addition to the above elements of the crime of fraud, real estate brokers and sellers also have, in most jurisdictions, a duty to disclose all known property defects. There’s generally no obligation to conduct a full and detailed inspection of the property, but some states do impose a checklist of features that the seller is expected to be familiar with prior to the sale. If you deliberately omit material information concerning property defects, the buyer may come after you with a lawsuit later – and possibly have a case.

Burden of Proof and Available Defenses

The burden of establishing all three elements of fraud falls on the plaintiff. That means if you want to accuse someone of fraud in court, you need to be able to prove all three elements beyond reasonable doubt with evidence and testimony.

Likewise, if someone accuses you of fraud, your defense will be to destroy at least one or more of the elements of fraud, in the eyes of the jury.

Note: Remember our mail campaigns in earlier columns? If you use the mail to perpetuate a fraud, you don’t just have a problem under state statutes. You could get hit with a federal offense. That carries a potential sentence of 30 years in prison, or up to a $1 million fine. So be careful what you put in the mail – and make sure you can back up any claims that go in a direct mail campaign. The same applies to wire fraud. If you use interstate phone calls, or the Internet, to defraud people, you could likewise face up to 30 years in prison and a $1 million fine, per offense.

Fraud in Action

This isn’t just theoretical: The Department of Justice recently filed wire fraud charges against six individuals for using the Internet and telephone lines to perpetuate a property-flipping scam.

Their target: flippers. That’s you.

Specifically, the DOJ accused this group of people of selling REO property (bank-owned real estate) that could be quickly turned around for a profit. The problem: These properties did not have clear title, were uninhabitable or “simply worthless,” according to the DOJ.

This wasn’t just a bunch of local yokels. The DOJ arrested or arraigned individuals in Southern California, Tennessee and Florida in just this one case.

Never Skimp on Due Diligence

There’s a saying among old-school newspaper editors and reporters: “If your mother says she loves you, check it out.” The same goes for any counterparty in a real estate transaction: Don’t rely on what people tell you voluntarily. Check out the information for yourself. The stakes are too high for you to do anything else. A closer look at the details of this case underscores the importance of being disciplined about your due diligence procedures and safeguard mechanisms like escrow before you commit to a property. From the Department of Justice:

In some cases, victims did not receive the properties because they simply did not exist. In other cases, the properties were condemned or other issues with the titles meant victims were not able to take control of the properties. Of those victims who did receive titles, some found that the titles were encumbered by tax liens, fines or building code violations. Furthermore, the indictment alleges that investor funds were immediately disbursed upon receipt, rather than being held in escrow. [Emphasis added – Ed.]

If the DOJ’s characterization of the facts of the case is accurate, the flippers who got conned had an opportunity to head the danger off at the pass. Escrow could have protected the buyers. A drive-by would establish a property that doesn’t exist. And the encumbrances for tax liens, fines and code violations are a matter of public record – easily obtained by checking with the office of the county recorder, or simply checking with a title insurance company.

… And Speaking of Your Mother …

The FBI recently obtained an indictment of an Oklahoma man on four counts of wire fraud involving a property flipping scheme. His modus operandi? He would buy properties, own them for a couple of months, and then sell them to his mother and stepfather – without their knowledge or consent. He just worked the transactions out on paper. The Justice Department alleges that between 2005 and 2007, this 39-year old signed fraudulent mortgage applications on as many as 20 properties. The motive: He could obtain the mortgages himself and profit from their sale.

The stakes: This man faces up to 20 years in prison and up to $250,000 in fines, plus mandatory restitution … on each count.

Don’t even think about trying these schemes. They leave a paper trail, nearly by definition – and they are just plain wrong.

Self-Defense

As a property-flipping professional, you need to defend yourself against two possibilities:

1. Getting defrauded
2. Being accused (and convicted) of fraud

The best things to do on the first count seem obvious: Conduct a thorough due diligence at every step. People who take shortcuts and fly by the seat of their pants eventually get burned. Also, protect yourself through escrow – especially if you don’t know the counterparty well.

Defending against an accusation is trickier – because anyone can accuse anyone of anything. The best defenses are to conduct your business on the up and up, and document your moves – including any material disclosures. If you do disclose defects, do so in writing – and get the buyer to initial or sign off on the document.

Get Professional Advice

One of the differences between a hobby investor and a real estate professional is that the professional has a team of experts: One of those experts that you should be forming a relationship with – before the crisis – is an attorney. Arrange a meeting, and talk about preventing fraud and your responsibilities in your jurisdiction. And once you have that relationship established, you should have his or her number on speed-dial. Don’t wait for the FBI to come knocking on your door, though, or to get served by a processor with notification of a lawsuit against you. An ounce of prevention is far better than a pound of cure.

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.

Comments

Nancy - November 11, 2014 at 10:53 am

I a a victim of house flipping. I originally bought one House in 1984 of ca 1127M2 block. In 1992 I built other unit 74b and 1994 other unit 74a. In1998 I sold one unit to Daughter for cost of mortgage 60K,Same time 1998 I strata titled the block and finished building upstairs self contained apartment on my home, making now my front house a Townhouse, Lot 1 74 Drummond st Bedford 6052, and the middle unit lot 2 74a Drummond st bedford 6052.And the back unit 74b Drummond Street Bedford. I have suffered through broker and realestate and flipping and predatory lending and ID changes of the lots and unit numbers, and lots of fraud, and summary judgement. Now the realestate agents who once managed the back units, have sold all the units and even my home, which was paid off and with no encumberances, only last year in November. Now they are flipping it again. The structure is all mine, and the pool alone cost me 33K, the apartment on top was built by me. The flippers have renovated it and are flipping it again. I had a whole block , two units on the back, apartment on top. Realestate agents and brokers and financial institutions, and Settlement agents have taken all. Also through advising me to gift…The flippers, who are probably flipping for a group of three men, (I was mentioned), have probably bought it from them and after one year are reselling it. My property should be given back to me and if the flippers lost money, they should go and get it from the three men, who stole everything from me. This is all Genuine. I am 60 now. My family and grandchildre are all sad. Check it out on Ray White Realestate uxcel. The agent selling it again, was managing my properties before they were Taken. Respectfully and Genuinly: Nancy.

Jennifer - July 16, 2014 at 11:36 am

I bought my house in April of 2009. It was a flipped house by a non licensed/bonded contractor which I found out was illegal in the state of Washington and the City of Clarkston allowed this to happen! My house is falling apart One big issue is the cut the trusses out of part of the roof to put a furnance in the attic! My roof has dropped over a foot since I bought it. Insulation is not complete so I pulled all the reports from the city Inspector and found out They not only didnt inspect my house they falsified a report Im in the process of filing a claim against the city and trying to take my case to state level I have so many issues its not even funny and our city inspectors are suppose to inspect each step when someone is flipping a home or doing any type of remodel when a permit is pulled! I want these people held accountable I would love to get the flipper in trouble also. Did you know if you do your own electrial work and are not licensed electrician you have to live in the home for 2 years Well my flipper wasnt licensed in any way and only owned and flipped the home in 11 months What do you all think I think I have a case that cant lose!

Jennifer - July 16, 2014 at 11:29 am

A law was passed July 22nd 2007 in Washington state you have to be a licensed and bonded contractor to flip a home

Cee - February 28, 2014 at 7:51 pm

I still own an old property from when I was single. I got caught in the early 2000′s real estate bubble. I got BAD advice about “fixer-ups” from a Century 21 agent. She told me the house couldn’t be sold and it basically needed to be completely remodeled. I’ve slowly worked on it ever since. Unfortunately when everything feel apart and lost value, I decided to hang on to it and wait. I kept the property’s utilities on too. I know it needs some work, but it’s NOTHING like the DUMP that is on my old street that have gone through at least four sales over the last five years. The rest of the street’s houses are in nice shape. I know my old neighbors and have been inside their houses and they’ve been in mine. I have family members who were professionals in the buildings trades, so everything I’ve done has been checked out and confirmation of great work too. I am proud to show my completely remodeled bath and kitchen areas. They look like a professional did them. Anyway, my hubby and I got a letter from a flipper a while back, which I ignored, but decided two weeks ago out of curiosity to call and inquire… I wanted to know if I could just sell it with all of the construction materials I have ready to complete the remainder of the home >>> I wanted enough to cover the remaining mortgage with about $8-10,000 on top…($35,000 just to get rid of it) I already know for a fact via public real estate sales, three empty houses on my old street sold for $47,555 and $57,200 & $57,500 as recent as 12/2013. I have some drywall work have to finish the floors. I am just tired of this extra work at this point. I haven’t replaced the furnace or the windows, yet however, neither did any of these other homes. I inquired and even walked through the lowest selling one…it was a TOTAL DUMP…how they ever got $47,555, blows my mind. The week after they closed 10/2013, the new owners had a dumpster in the driveway and literally gutted the place. They left door open and the picture window uncovered so any driving/walking by could see right in at what they were doing…OMG… This “flipper” is also a licensed real estate agent too. I found that out as he toured the house with me. I quoted him a $40-45,000 asking price to him and he offered $35,000. It looked encouraging for the first week, I so worked my ass off two weekends and one week day, all day long, cleaning up and out. I removed all of my tools and supplies with the exception of building supplies which total close to $2,000 worth of materials plus a new dishwasher. I also have a stove that was hardly used when I lived there as well as a relatively newer washer & dryer that I have continued to use to wash up work clothes and rags when I worked over there…all appliances being left behind. I added a full bath in the basement as well as nice built in storage closet in the basement. All new doors and moulding trims throughout too. Soooo many improvements, I am losing track. I agreed to his offer and signed an “as is” preliminary contract agreement which wasn’t hard to understand…it clearly allowed him to vacate his offer…which was o.k. with us. I also communicated with him in email, which is where he clearly terminated the contract by wanting to lower the offer yesterday. We looked this document over carefully and didn’t see any thing bad on it. Anyway I allowed this guy to place a realtor’s key box on the front door, so he could take a look with his partner who helps do the flip work so they could do their own inspection. (I can not miss work at this time.). All that seems all well and good until he sent me an email a couple of days ago and started making excuses or whining. I didn’t get a good feeling at all and figured he was getting ready to lowball his signed offer…well that’s exactly what he did two days later with even more BULLSHIT lies after “his inspection”…NOT an official city inspection…when my hubby and I called him this morning, we heard the same BULLSHIT he’d put in email….asking if we’d be willing to “reduce” the price….my hubby said, then what are YOU offering now? He said, $30,000. My husband said, “How about $33,000???? This guy then him-hawed even more. I got another really SICK feeling…one that I have learned to TRUST…he’s supposed to call us back to let us know tomorrow… We remained nice the whole time. When we hung up, I told my hubby, “I’m driving over there and checking the place and removing the keys from that damned lock box….because I have a really bad feeling about this now. I had even gotten a payoff quote and put it in the house for this guy…that was what I worried about most at that point driving over there. When I arrived, I saw a strange car in front of my property. I parked in front of my neighbor’s house and went to go in to discover the lockbox hanging empty, but the door locked….OMG…I unlocked my door and left the front door open stepped inside and said, “There MUST be someone here…HELLLOOO?….HELLOOOOO???”. Which in hindsight was probably stupid as heck….anyway there was a old guy coming in my back door and asking me if I was the “owner”…my immediate thought was, How the hell do you think I got in without a key? Did they think I’d only have one set of fricken keys???? Bastards. When he started asking me questions, I kindly and wearily answered already knowing I don’t want anymore involvement with these clowns. I was totally under impression they were done looking the place over, this was unsettling, but what really irked me was when he asked me, “Oh, Why are you here????”. My response was, it’s my property and your partner didn’t seem interested this morning when we talked to him, which is fine, I understand he’s in the business of making money and that’s ok. I am now preparing to continue working on my property now. The really good thing about this was it motivated me to clean the place up so it’s not an overwhelming depressing mess to work around.”. The old guy kept saying, “You have a REALLY nice property.” I didn’t say anything. I just thought, yeah, I bet, you two are blinded by the dollar signs aren’t you…mofu’s… As he was leaving, I had the spare ring of keys that were in the kitchen drawer in my hand and put them into my coat pocket right in front of him. He went to put the front door keys back in the lockbox and when I reached out, he handed them to me, then I reached down and looked at the open lock box and immediately saw how to remove it and did just that too! I was nice the whole time too. I said, “How about I just give this to back to you now, cause I don’t want you guys to have to make anymore unnecessary trips out here, Thanks anyway. You should have seen the look on the guy’s face. I realized at that very moment that I had just reclaimed my power and upper hand. I will NEVER do that again unless it’s a real estate agent working FOR OUR interests. The guy actually said, “We might want to come back.”. I just smiled and have a good weekend” and closed my door and locked it. I went in to look at something that his business partner said was a “serious plumbing leak”. I shined a bright work light up in it and photographed it. I already KNEW he was LYING. I pulled out the DRY ancient insulation material and found nice dry clean SOLID wood behind it, just as I KNEW it was…telling me the cast iron sewer pipe was leaking was BULLSHIT too…there was still white powery drywall dust from my kitchen remodel work on the seal at the highest drain connection joint! The only place it could ever have gotten wet at any time was right in the base of kitchen floor as the highest drain opening from the kitchen drain, which HAS NOT BEEN OPERATIONAL SINCE 2001!!!!!! The drain below that point show natural aging, NO LEAKS…when he said the wall on both sides of that sewer drain had to be ripped out I KNEW he was a TOTAL LIAR. His first email about the “conditions” indicated to me he hadn’t heard anything I’d said at his viewing too. I have PLENTY of building trade experience/ knowledge even if I didn’t do it for a living. I was throwing BULLSHIT flags all day today. I immediately decided to contact a serious real estate agent and then go to the local Home Depot and arrange for window/gutter and furnace replacement estimate consultations >>> TOMORROW!!!! He fed also me BS line about the old furnace too. I wrote down the information from that too to look up it’s possible age….that was something else, HE “inspected” it too….he’s NOT an HVAC person!!!! It HAS been replaced at least ONCE!!! It’s old but NOT nearly as old as the house as attempted to convince!!!! From the moment he said, “Trust me…” during our phone cal this morning, I KNEW we were being scammed. Then he made BIG fricken deal out of water stains on the living room floor too! ….and that they couldn’t be sanded out….oh really now…I have a friend whose old house across town had MUCH worse water and pet stains on their oak floors and Mark sanded down 1/16″ down at a time to see if he could restore it…needless to say he successfully restored all the oak floors in their rehabbed bungalow!!!! Besides most people I know don’t like bare hardwood, they cover it with carpet!!! Do you REALLY think I believe he is going to “repair” any of the things he used to attempted screw us over???? NO! NO! NO!!!!!! ABSOLUTELY NOT!!! We might as well as invest $10-15,000 and then be able to sell it for what the REAL market value of the properties in that neighborhood are…which even after recovering our investment with money to cover selling costs and still have money to put back in the bank. I learned a lot. During my drive over there, the following thought came to me, “KNOW YOUR VALUE!!!!!”. This kept reoccurring all day long. I don’t feel down, I feel even more motivated to complete and sell this through a real estate agent. I just needed to realize that my own time is worth BIG money too and it’s time to pay others to help us get this house finished and FINALLY sold. I just should have done this years ago!!!! The up side, I learned a lot including a hell of a lot more respect for all the hard work my own Dad did while he was on this earth! RIP Dad, you helped me learn A LOT!!!! Every time I see something you helped me with or things you did at your own property…reminds me of how hard you worked to make everything look perfect!!!! When we finally sell that property, it will be like saying good-bye again. We miss you!!!! God’s speed!!!!

Glen - September 15, 2013 at 12:41 pm

Jason, is flipping following the gurus advice with no money and no credit legal in Oregon? Such as Options to Purchase real estate contracts and selling a house to another buyer without ever being on title?

Robert - July 12, 2013 at 6:06 pm

I am a disable veteran. I bought a house 9 months ago. I had a home inspection done and they inspector never gave me copy of the report. When I called him the number has been disconnected, the roof is falling down, the house never got fumigated, its loaded with insects. I called and tried to tell the real estate agent about what was happening, and he told me I bought the house “as is”. He pulled the Bate-and-switch on the document purchased as is. They put us in so much stress, I had a heart attack and to be taken to the hospital. The real estate agent threaten me, can somebody please help me.
Thank You
-Robert

Eric Berg - February 4, 2013 at 1:52 pm

My family just purchased a house in WI from flipers. The did not disclose many problems with the house that were disclosed in the past. The flipers covered up the problems with the house. They made a good profit from the sale of the house. They told us they know their is many issues with the house. They know the laws and their is not a thing we can do. The flipers purchase new house to flip 10 miles away.

Amie - July 21, 2012 at 5:04 pm

What do you do when you realize you bought a house in which all of the issues were masked by the flipper? And in which the inspector didn’t find these major issues? My husband and I are young but we managed to save enough to buy our first home just over a year ago. We are now having to pay an extra 30% of what we purchased our house for to fix/replace things that seemed to be in perfect condition when the house was sold to us. These issues were just bandaged and then we discovered them after being in the home for a short time. Do you know of any agencies/organizations that help people in our situation. Our insurance won’t cover us because they are proving to be pre-existing problems.

Jason Van Steenwyk - August 1, 2012 at 9:39 pm

Hello, Amie,

Thanks very much for writing!

That kind of issue would be very specific to state law, so there wouldn’t be a single answer I can give you other than to consult an attorney for specifics in your case.

Broadly, you MAY have a claim if you can 1.) Show that a reasonable inspector executing routine due diligence normally expected would have uncovered the issues, or 2.) The previous owner failed to make the required disclosures mandatory in your jurisdiction. Some jurisdictions actually have a checklist of specific items the seller has to address. So your case might be stronger if the issue you’re having was on the checklist. 3.) You need to establish that the failures of either the previous owner, the inspector or both contributed to you suffering economic harm, and 4.) you can peg a reasonable dollar amount on it.

Which brings us to 5.) Whether anything you might win in a judgment is actually collectible. If it’s not collectible, then you might not want to bother with it, because litigation is expensive, even for the winners, if the assets just aren’t there to collect against.

Now, most established inspectors would carry a special form of insurance called Errors and Omissions. This is sort of a type of malpractice insurance, which protects the inspector as well as the client. Anyone can make a mistake, and you don’t seem to be accusing deliberate fraud. So if you do have a case, the E&O company may be willing to come to a favorable settlement that works for both sides. If it goes to a trial, there should be assets on the table sufficient to make you whole.

I wouldn’t retain the services of an inspector or any other licensed professional ANYTHING unless they maintained at least some basic E&O coverage, and this is something you can verify at the outset of your relationship in the future. Not because I’m sue happy. I’ve never filed or threatened to file in my life, thank goodness.

Even assuming the best of everyone, insisting on E&O coverage is just prudent. It’s just a reasonable precaution to take so that I know I’m protected in case a well-meaning but maybe overworked professional makes an honest error. In that case, I know that I can be made whole in case someone messes up, and I won’t be driving a good person into bankruptcy by insisting on being made whole from damages resulting from someone else’s error.

Jason Van Steenwyk - July 16, 2012 at 8:10 pm

P.S., What state are you in, Christie?

Jason Van Steenwyk - July 16, 2012 at 8:09 pm

Hello, Christie, and thanks for writing!

I came across this particular misconception just the other day, as I was writing this column in a cafe. Two insurance agents came to share my table, and were making phone calls trying to put deals together.

I’m always anxious to add sources and perspectives, so I asked them if they worked at all with flippers. The younger agent immediately claimed that “house-flipping is illegal.” The older agent corrected him. House-flipping is not at all illegal. There is a such thing, however, as illegal flipping! But that has more to do with fraud law than flips.

I’ll be writing more on this in the future. I’m hesitant to write too deeply into scams, because the more detail I write about it, the more ideas I might give to dishonest people!

The practice mostly referred to as “illegal flipping” works like this: You start negotiating with a buyer. You bring in an appraiser who low-balls the appraisal… because he’s corrupt or on the take. The criminal may pay him off. You then fix up the house. The criminal then brings in an appraiser who comes up with appraisal that’s too high, again because he’s corrupt or on the take. The new buyer goes to the bank which lends him money based on the corrupt appraisal.

Another variant of the scheme is the deliberate inflating of an appraisal to trick the flipper’s bank into overlending. The flipper borrows the money… and then takes off to Brazil with the proceeds at the first whiff of trouble.

Banks may also impose “title seasoning” restrictions, meaning that they won’t lend unless the current owner has held the title for a specific amount of time – say, 3 to 6 months. The FHA won’t guarantee mortgages that haven’t met a title seasoning threshold. So you might have an illegal flip if the flipper committed fraud to hide the fact that the title didn’t meet the title seasoning requirements from a lender.

In each case, it’s the **FRAUD** that makes it illegal, not the flip. It’s not illegal to buy and sell houses at a profit, and even to do so very quickly. It’s done all the time, and it’s no different than your grocer selling produce (and letting you buy it with your credit card.)

I disagree with your instructor’s premise that flipping itself has hurt your state or caused the foreclosure crisis – though this canard is frequently trotted out by populists whenever markets reverse direction for a time and they blame “speculators” over everything from oil prices to stocks to houses.

These “speculators” serve a critical function in capital markets – they provide liquidity. I harp every chance I get on the importance of the flipper finding a “motivated buyer” who needs to sell quickly. Take the flipper out of the community, and it becomes much more difficult to sell when you need to. Well, any economics theory textbook will tell you that liquidity risk – the risk that you won’t be able to sell and convert your investment to cash quickly – depresses the price of assets. (Look up the term “liquidity premium” for more on this idea.) The presence of a healthy number of flippers competing for opportunities to buy houses INCREASES real estate prices, and is good for the community. Provided, of course, they are open and honest and comport themselves within the law.

There is no room in this business for shysters and fraudsters – nor any other industry.

As to your last question, “why do money hungry and scamming people still flip houses?” That reminds me of when someone asked Jesse James why he robbed banks. “Because that’s where the money is!”

Money hungry and scamming people flip houses for the same reason the honest people do: They think they can make money doing it.

Thanks for your question! More on these ideas in future columns. A good amount of information on ‘Title Seasoning’ has already been written and turned in to the good people at RealEstate.com, and will soon be appearing. Check back every tuesday!

Best of luck in all you do.

Jason Van Steenwyk
Fort Lauderdale, Florida

christie fox - July 15, 2012 at 7:38 pm

When I was in school for the post salesman’s course (after I passed my real estate state test) we in class asked the instructor if “house flipping” was illegal in our state and his response was “yes it is”. I was never able to find any reason to refute his comment nor could find anything that proved what he said was true, so I always thought flipping was illegal. These days, and especially in my state, foreclosures have abounded and during this abounding we’ve been told again that flipping houses is part of what has hurt our state. If flipping is so bad that it puts people in a bind plus continually raises the cost of living then why do money hungry and scamming people still flip houses?