Fraud and Prevention

The New Flipping Is a Flop

Perspectives by Ann Fulmer
August 5, 2009

Back in the day, I used to watch A&E's "Flip This House" with a mixture of amusement and apprehension. I was amused that so many wannabe real estate magnates woefully underestimated the work involved and overestimated the return. I was apprehensive because it contributed to the "get rich quick in real estate" mind-set and mania, and created armies of zombie investors who didn't recognize the fraud-for-profit schemes that they, wittingly or not, enabled.

Fast-forward to today. The liar loan programs are no more. Banks are scrutinizing loans more closely in pre-funding and are requiring fully documented applications. Loans take longer to get because of the added scrutiny, and tightened underwriting guidelines mean fewer borrowers qualify. Rising interest rates have dampened demand and foreclosures continue to depress house prices. In those circumstances, it's no wonder that so many people think that flipping - and fraud generally - must have gone the way of the dodo bird.

News flash: they haven't.

It's a cliché that one's ultimate profit in a real estate transaction is determined by the purchase price, and that the goal is to buy low and sell high. During the boom, properties were acquired at or above market value and then "flipped" at a fraudulently inflated value. In the latest scheme, which we at Interthinx have dubbed "flopping," the fraudsters artificially deflate the purchase price in a negotiated short sale and then flip it at or above market value in a compressed timeframe.

In the for-profit version, distressed homeowners are contacted by the perps or the real estate licensees they're working with. The perps, frequently using the legal anonymity of an LLC, may negotiate directly with the bank or they may delegate that task to the collaborating licensee. The licensee can help deflate the price in a couple of ways.

The simplest is to tell legitimate buyers that the property is under contract, thus keeping the property on ice until the lender cries "uncle" and lowers the price. Or, the licensee may intentionally withhold all but the low-ball offer from a perp, a friend, or the licensee's own investment company, in order to force a price reduction. Once the property is under contract and the price is agreed on, it is sold.

Using the compressed timeframe that prevents the lower deflated value from being documented in public records, the property is sold again in a simultaneous or a reverse closing, with the proceeds from the inflated sale used to fund the actual short sale. The second buyer is usually a straw buyer (often a naïve investor), a person using a stolen identity, or another collaborator.

In order to further cover their tracks, more than one closing agency may be used. And in the most egregious cases, no payments are ever made and the perps lather, rinse and repeat when the property is foreclosed again.

Not all of these schemes involve international fraud rings or homegrown crooks masquerading as property investment gurus. Some of the flopping schemes involve distressed borrowers who recruit friends or family to buy the property at a deflated value, and then transfer the property back to the original borrower. In such cases, the "flop" is used to effect a forced modification and debt reduction.

In addition to robbing the lender of its right to mitigate its losses and receive fair market value on the sale (depressed as that may actually be), artificially deflated sales prices have a tremendously negative effect on the values of surrounding properties, local tax bases, and the ability of local government to provide essential services.

To counter these schemes, all short sale offers should be closely scrutinized for signs of collusion between the parties and for price manipulation. It might not hurt to have the buyer and the seller certify that all offers were presented for review and to state whether the property will be flipped.

Because the "flop" may not appear in the public records or be mentioned in the appraisal, "flops" are nearly invisible. Therefore all lenders should closely examine their proposed settlement statements to look for unusual disbursements or wire transfer orders directing the payment to an escrow or closing agent that is not involved in the lender's current transaction.

Of course none of these steps will deter the really determined fraudsters, but at least there will be an additional misrepresentation upon which to base a lawsuit or a criminal action if it turns out they lied about a "flopping" flip.

Ann Fulmer is vice president, business relations at Interthinx. For more information, visit http://www.interthinx.com.