Since 2007, fraud involving distressed properties has increased greatly, none more aggressively than short sale flips. A growing trend of short sale flipping has Freddie Mac and the FBI investigating various cases where lenders, distressed homeowners, and/or end-buyers are being defrauded. Everyone should be aware of this trend, and how Realtors and clients can avoid becoming a victim of or party to fraudulent transactions. 

What Constitutes Short Sale Flip Fraud?

Freddie Mac’s definition of short sale flip fraud is:  “Any misrepresentation or deliberate omission of fact that would induce the lender, investor, or insurer to agree to the terms of a short payoff that it would not approve had all facts been known.”

 Short sale flip fraud usually involves an original short sale homeowner, an investor and an end-buyer, and is often referred to as an “A-to-B/B-to-C” transaction. In this example, the short sale homeowner (A) sells to an investor (B), who simultaneously or quickly sells at a higher price to an end-buyer (C). Often, the investor creates a disproportionately advantageous position by presenting an option contract. Option contracts are agreements where the buyer has purchased (usually for a nominal fee) the right to buy a property for a specified amount of time. If the lender approves the option contract, the seller is contractually bound to sell to the investor without any real obligation from the investor to buy. The investor already has or will secure a buyer who will pay a higher sales price before exercising the option. The investor does not disclose the buyer’s higher purchase price because most servicers would not approve such an offer. This process also clouds title until the property in the “A-to-B” transaction closes, which has prompted many title companies to stop insuring title in these types of transactions.

 Although many types of short sale flip fraud have been committed, the following is an example where the agent is committing fraud:

A seller (delinquent borrower) owes $200,000 on a property with a market value of $180,000. The listing agent negotiates with the lender to accept a $170,000 offer to purchase the property made by another investor client (In several instances, Freddie Mac has seen that this offer will be made directly by the listing agent or through an entity under his/her control). The lender accepts the offer for $170,000.

The listing agent neglects to disclose to the lender that there is another offer on the property for $195,000. The listing agent negotiates and accepts the second, higher offer on behalf of his investor client, who is now acting as the seller. Both transactions close on the same day with the net difference being pocketed by the facilitator and increasing the lender/investor’s net losses, and the list agent receiving commissions of $21,900 for both transactions.

Here, the agent has acted as dual agent and violated the fiduciary responsibility he had for his distressed client It is important to note that not all short sale flips are fraudulent, or even unethical. In some instances, all parties to the transaction provide full disclosure, and the transaction is in accordance with local laws and loan servicer requirements. These transactions most often involve an investor making material changes or improvements to the property before selling. 

It is estimated that lenders—the majority of which are Government Sponsored Enterprises (GSEs)—stand to lose $310,000,000 in 2010 because of short sale flip fraud.  When GSEs lose money, so do American taxpayers. Neighborhoods already decimated are losing further value due to these transactions, pushing more and more homeowners into a negative equity status. In addition to risking one’s license, an agent who commits fraud affects the lives of individuals and communities across the nation.

Nancy Robinson  Certified Distressed Property Expert ( C.D.P.E)