The Reality of the “Flip,” the Myth of the “Flop” and the Dangers of Both

Posted on September 1, 2012 by Scott M. Drucker

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As real estate professionals navigate the choppy waters created by the nation’s real estate crisis, they are undoubtedly exposed to a number of schemes to defraud centered around the practice of short sales.  Even the most ethical real estate agents will undoubtedly be impacted in some manner by two such schemes, short sale “flipping” and the closely related practice of “flopping.”  While real estate professionals should unquestionably steer clear of both, upon closer inspection it appears that while flipping is a somewhat common practice that frequently exposes agents to significant liability, flopping has largely been eliminated by the extensive due diligence performed by lenders evaluating short sales.

Fannie Mae, by way of its October 2010 Mortgage Fraud News update, defined flopping as a process “wherein the perpetrator influences the loss mitigation process by deflating value so the servicer will accept an artificially low short sale offer.  The perpetrator then profits by selling the home to an end buyer at the home’s true market value or at an inflated value.”  The FBI’s 2009 Mortgage Fraud Report similarly defines flopping as a practice in which “the perpetrators collude with appraisers or real estate agents to undervalue the property using an appraisal or a broker price opinion to further manipulate the price down (the flop) to increase their profit margin when they later flip the property.”  While any such practice would undoubtedly constitute fraud, the question that exists is how prevalent is flopping in today’s marketplace.

While the FBI is clearly concerned with fraudulently deflated pricing, its 2009 and 2010 Mortgage Fraud Reports lack any meaningful explanation as to how flopping is effectively perpetrated in today’s environment in which lending institutions are keenly focused on not falling victim to any such scams.  As listing agents in today’s short sale market can attest, lenders utilize a variety of valuation tools that make it extremely difficult for a fraudulently deflated sales price to be approved.  Even assuming that a dishonest seller and/or real estate agent seeks to undervalue a home’s worth, lenders virtually always order an appraisal or broker price opinion (BPO), both of which are performed by licensed and independent third-party  professionals.  Most lenders will additionally utilize a computerized automated valuation model (AVM) to confirm the results of the appraisal or BPO.  Discrepancies between the AVM and the bank’s valuation often trigger a second BPO or appraisal from yet another licensed and independent third-party professional.

In most instances, a successful flop will, at a minimum, require the involvement of a buyer, real estate agent and two separate BPO agents or appraisers, all of whom must be willing to provide inaccurate or falsified data to the loan servicer.  Furthermore, the scheme to defraud would likely have to involve the assigned bank negotiator as well.  Because more than one bank negotiator is typically assigned to a short sale throughout the life of a file, and because these individuals are closely monitored by supervisors, manipulating the bank’s valuation is extremely difficult, and it is hard to imagine a scenario in which so many individuals successfully conspire to commit criminal activity.

Unlike flopping, in which the sales price is artificially manipulated, the practice of flipping is often a legitimate business venture when performed outside of the short sale context.  Freddie Mac defines property flipping as “the process by which an investor purchases a home and then resells it at a higher price a short period of time later.”  For example, an investor may purchase a home for $100,000, make $20,000 worth of upgrades and then sell the home months later for an increased price that reflects the home’s fair market value.  Such is a legitimate business practice.  With that said, flipping a short sale often constitutes fraud and is far more common than flopping and substantially easier to perpetrate.

Flipping in conjunction with a short sale is typically consummated pursuant to a scenario in which an investor purchases a property via a short sale and, prior to close of escrow, secures a third party to whom the property will be immediately sold for a higher amount.  In such a scenario, the perpetrator deceives the lender into approving the short payoff by concealing the existence of a pre-arranged end buyer who intends to purchase the property for substantially more money than the approved short sale price.  The problem lies in the fact that the short sale lender is not informed that the buyer is immediately flipping the property for thousands more than that same lender has been told the property is worth.

While it may be assumed that such transactions are difficult to achieve because the short sale buyer must secure a purchaser willing to buy the property for more than the approved short sale price, the reality is that several market factors enable the practice of flipping.  Loans in default and scheduled to be foreclosed create a distressed sale in which the seller is often unable to secure a top-dollar offer.  By removing the property from foreclosure and eliminating the distressed sale, all while the market continues to improve, the short sale buyer is able to flip the property for a profit.  Authorities nonetheless view flipping of short sales as mortgage fraud because the perpetrator fraudulently induces the lender to approve the short sale by hiding the fact that there is a second buyer willing to pay more than the offer presented to the lender for short sale approval.

Short sales are viewed as a critical part of our real estate market recovery. These transactions enable distressed homeowners to get out from under huge debts and allow banks to avoid the expense of a trustee’s sale while recovering more money than they would likely receive following a trustee’s sale.  While flopping is more myth than reality in today’s market, the practice of flipping threatens the banks’ willingness to effectuate short sales and exposes real estate licensees to great risk and liability.

Scott Drucker

Bio:

Scott M. Drucker, a shareholder and founding partner of Mack Drucker & Watson, PLC, focuses his practice in civil litigation, with an emphasis on real estate litigation, commercial litigation and construction law. His clients range from individuals to large corporations, which he represents in both federal and state courts, mediation, arbitration and appellate practice.

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