Phoenix real estate strategy of 'flopping' examined

As more houses in metro Phoenix go on the market for short sales, some investors have begun buying and reselling them quickly for a profit, using strategies that some in the housing industry say could be unethical or worse.

The deals work in a variety of ways, but all involve the same basic strategy. An investor persuades a lender to agree to a short sale, buying a house for less than what the lender is owed. But the investor has another buyer lined up who is willing to pay more.

The bank, usually unaware of the other waiting buyer, accepts a lower price from the investor, who then quickly resells the home - for a higher price - to the waiting buyer.

The deals, which have become more common as short sales have increased, are now drawing the attention of real-estate and financial regulators.

Most lenders object to such deal-making because, had they been aware of the other waiting buyer, they would have taken the higher price. Banks take a loss on short sales, and the deals can make their losses greater.

Real-estate professionals disagree over the nature of the deals. Some insist they are a smart way to make a profit in a tough market. Others call them unethical at best and question whether investors violate the law if they conceal information from a lender.

Many real-estate market watchers agree that the deals have negative impacts. Neighborhood housing values suffer because, while the second sale might be for the home's true market value, the first sale represents an artificially low price.

In the industry, the deals have been dubbed "flops."

In a rising market, investors "flip" houses, buying them and then reselling for a profit as overall values rise.

"Flopping is the opposite of flipping," said Amy Swaney, regional Arizona sales managers for Citywide Home Loans and a past president of the Arizona Mortgage Lenders Association. "It is the art of profiting off the devaluation of property rather than an increase in value of a property."

It is impossible to know how many homes have been "flopped" since short sales began to be widely accepted by lenders in the past year.

But a key indicator is how quickly short-sale homes are resold. An owner who buys in a short sale and sells the home again within a few days most likely had the second buyer lined up in advance.

In the past year, nearly 20,000 short sales closed in metro Phoenix. Of those, at least 1,000 were flops, according to an analysis by Tom Ruff of the real-estate research firm Information Market. A few examples: a Tolleson home sold for $90,000 through a short sale and then was flopped within 20 days for $106,000; a northwest Phoenix home was purchased first through a short sale for $28,500 and then resold through a flop within two weeks for $50,000; and a Scottsdale house sold via short sale for $90,000 and then for $122,000 through a subsequent flop less than a month later.

The Arizona Department of Real Estate, mortgage giants Fannie Mae and Freddie Mac and the FBI are all investigating flopping deals.

"Short-sale flopping is one of our real-estate industry's biggest issues right now," said Judy Lowe, Arizona Department of Real Estate commissioner. "We are all looking at the legality and ethics of these deals. And it varies by flop because it appears every deal is done a little differently."
The art of the deal

Short sales slowly have grown more common as more homeowners in the region face losing their homes to foreclosure.

In some ways they are more attractive to lenders and sellers. A short sale does less damage to the seller's credit record than a foreclosure. And a lender typically is paid more money in a short sale than it could make on the home after foreclosing, partly because it has to incur costs related to taking back the home before reselling it.

But as short sales have expanded, so have the strategies some investors appear to use to make a profit. Investigators and industry professionals describe several common approaches.

- Price high, then sell low: A real-estate agent lists a home for a short sale but knowingly prices the house too high so it sits on the market for several months. As the homeowner edges closer to foreclosure, the agent recommends reducing the offering price. A buyer appears who is willing to pay less than the reduced price. The lender is persuaded to accept the deal, arguing that the home has been on the market for so long because it is overpriced and that foreclosure is imminent. The lender agrees, and the short sale is completed.

But the new buyer already has a plan to resell the house and often already has a second buyer lined up ready to pay more. The key to the arrangement is the price-setting. The high price keeps other potential buyers away and sets the lender up to be more agreeable to a low offer at the end.

The agent can receive a quick two commissions on the same property.

The lender gets less for the house than it otherwise might, and the seller may be damaged, too. The more time that passes before the sale, the more damage is done to the seller's credit from missing monthly payments.

- Steering the deal: A third party working with the seller to help facilitate the deal or a real-estate agent representing the seller ignores higher offers for a short sale. An investor buys the property without the lender ever knowing what other offers the home might have drawn. The investor then quickly resells the property for a higher price.

If a third party was in on the flop to steer the deal away from the open market and to the investor, the agent often doesn't know. If the agent was in on the flop, the agent may have received an additional payment from the investor.

The deals rely on finding a second buyer, usually another investor, willing to pay more after the short sale. In some cases, the second buyer doesn't even know that an investor is orchestrating a short sale before reselling. In other cases, buyers are looking for deals but are reluctant to deal with the paperwork hassle and uncertainty of a short sale. A flop allows them to pay a low price for the home, while the interim buyer deals with the short-sale technicalities.

The deals also require people to coordinate the arrangement and sometimes conceal information. Arizona regulators are concerned that loan officers, appraisers and real-estate and escrow agents could be acting unethically and even illegally, and some may be getting caught up in these deals without realizing it.

Many in Arizona's real-estate and lending industries are against flopping.

"I hate flop deals," said Kevin Kaufmann, a Phoenix real-estate agent specializing in short sales with Keller Williams Realty. "The deals look like a great way to make fast money, but they aren't usually in the best interest of the seller who is dealing with financial hardships and facing foreclosures."

Investigators also are watching for another type of short-sale deal that is a short-sale version of a fraud scheme used in boom times.

A buyer or buyers use a "straw buyer" to purchase a home. The buyer uses fake identification and financial information to obtain a mortgage and then never makes payments, triggering foreclosure proceedings. Immediately before foreclosure, the people running the scheme offer to buy the home in a short sale. The lender isn't aware of the connection between the original buyer and the short-sale buyer. The people in on the deal buy the house for a low price and can resell it.

A pair of Connecticut real-estate agents were convicted on fraud charges for a flopping scheme earlier this year. Both agents admitted to providing their own appraisals for the homes, acting as straw buyers to purchase homes through short sales and then reselling the homes at higher prices.
Industry concerns

Homes listed for short sale are at a record high in metro Phoenix, so the potential for more flops is significant.

In an effort to stop potential short-sale fraud, Fannie Mae and Freddie Mac recently issued warnings that homes it approves for short sale can't be resold within at least 30 days.

Mortgage research firm CoreLogic estimates that lenders will lose at least $50 million from the deals nationally this year.

The FBI has identified the deals as one of the nation's top mortgage scams now, but they are difficult to investigate and prove.

State regulators talked to the real-estate industry about foreclosure and short-sale schemes at a conference held by the Arizona Real Estate School in September.

Lauren Kingry, superintendent of the Arizona Department of Financial Institutions, said because there are so many different ways flops are handled, it's difficult to determine if the deals are illegal.

"Though many Valley attorneys say flopping is completely legal as long as it's disclosed, it's still a growing problem for the real-estate market and lenders," Swaney said. "Some deals may skirt the law, but that doesn't make them ethical. We as professionals in the industry have to watch out for our clients, whether they are homeowners, buyers or lenders."

She said some Valley escrow agents are turning away deals that require them to process the documents on a short sale and then a second sale of the same home for a higher price within days of each other.

Some groups involved in the deals say they disclose the planned resale up front so they aren't defrauding the lender or acting unethically. Some mortgage servicers may be agreeing to the deals to avoid a foreclosure. But big lenders say they are opposed to flopping.

"I am telling people flopping homes they must give full disclosure to lenders," said Phoenix real-estate attorney Scott Zwillinger. "If banks don't know about all the deals involved, then a flopper is committing fraud. That's the bottom line."

Even if deals do take advantage of lenders, public sentiment is not necessarily on the banks' side. With banks awash in criticism of how they have handled foreclosures and refused to modify loans for many needy homeowners, consumers are less likely to be outraged at a deal that takes advantage of a lender.

But in some deals, taxpayers - not lenders - may be the ones taking a loss.

For mortgages that are federally backed, lenders can seek some federal funds to cover their losses on short sales.

So if a flopping deal drives down the selling price, the lender may seek more money from the federal backer to cover the loss. It is unclear how much money lenders have been paid to recover losses in short sales.

"Flopping may be legal if all the deals are disclosed to everyone involved, but they make me furious," said Ruff, the real-estate analyst. "The money flopping deals are costing lenders ultimately is money the taxpayers are going to have to cover on mortgages that are government- backed."

More on this topic

Versions of the 'flop'

Price high, then sell low

A house is originally listed for $200,000 but doesn't sell for six months. The real-estate agent lowers the price to $150,000 and provides appraisals showing that the amount is the property's current market value. An investor then makes an offer of $100,000 for the house, which the lender is persuaded to accept. The house is then resold by the investor for $120,000 to make a quick profit of $20,000.

Steering the deal

A real-estate agent is hired by a homeowner to handle a short sale. Rather than seek offers from other buyers, the agent presents the home to an investor who is interested in buying short sales. The investor makes an offer and handles the paperwork. The agent may even ignore other offers that come in from potential buyers. The investor pays the real-estate agent a fee or commission for steering the home to the investor. The investor then quickly resells the home at a higher price for a profit.


by Catherine Reagor The Arizona Republic November 14, 2010


Phoenix real estate strategy of 'flopping' examined