The Ramblings of a Title Man

          When is a flip an illegal flip?

  We have all heard and seen flipping stories play out in the real estate industry. One story out of Fort Myers, Florida, happened before the housing crash of 2008. Large condominium complexes were being built by developers and pre-sold. A $300,000 condo could be put under contract before it was built for 10 percent down and a signature. The high-rise complex would take two to three years to build, and years later when the condo was finished and the developer was ready to consummate the final closing and hand over the keys, the condo would be worth $450,000. The contract holder would then have a choice: Buy the condo at the set $300,000; or sell the contract and pocket $150,000 profit. As you can imagine, many took the profit and sold their contract rights to a new buyer. Is this type of flip an illegal flip? The answer depends on how the transaction is put together and if there is information hidden or concealed from the buyer’s lender. 

Buying low and selling high is a centuries-old business strategy used to grow income and profit. We’ve all seen the HGTV? shows where a young couple buys foreclosed homes, fixes them up in 90 days and sells them for profit. That is the American way, right? But what if your title company is being asked to handle a complex situation where multiple sales are contemplated simultaneously? Such transactions could spell legal trouble for you and your agency.

There are generally three types of flips:

·        Contract assignment. Like the Fort Myers example above, a buyer has a contract to buy real estate at a certain price. A second buyer wants to pay more. The first buyer can sell their interest in the contract for the difference in price, and a sale takes place from the original seller direct to the second buyer.

·        Flip with no funding. This is known as the typical “A to B, B to C” transaction. The seller (A) sells to buyer 1 (B), and buyer 1 (B) does minimal repairs during the contract period and finds a new buyer, buyer 2 (C) to sell to. The transactions happen simultaneously, and most importantly, the buyer 1 (B) does not risk their own money. The money from buyer 2 (C) is needed to contemplate the sale from the seller (A) to buyer 1 (B). 

·        Flip with funding. Like the above “A to B, B to C” transaction, the only difference in flipping with funding is that the “B” party has sufficient cash to fund the A to B transaction and the two transactions can stand alone. Many people who engage in this type of transaction hold the property for a short period of time (90 days perhaps) before finishing the B to C deal. The HGTV? example above would fall into this category.

If we examine these three types of transactions, we can come up with some general rules to guide us when these transactions are presented. The first type, contract assignment, is legal in most states. Rules exist on the proper disclosure by licensed real estate agents in all states on how they have to disclose the dual agency or multiple agency conditions of this type of sale. The one caveat that title agents should always remember is when dealing with this type of transaction, disclosure and clear understanding by the end buyer’s lender is paramount. Making sure the lender has the full real estate contract, with all addendums and contract assignment is a first step. Having the lender acknowledge in writing the way the deal is constructed is a very good best practice to ensure you are not accused later of mortgage fraud. Remember, when a title insurance underwriter issues a Closing Protection Letter on your deal, you are responsible to adhere to the written instructions from the lender. Standard lender instructions usually say something like, “you must notify the lender if the property is being transferred immediately prior to the lender’s financing.” Lastly, before engaging in this type of transaction, be sure to consult your underwriter for any company-specific rules and requirements. 

The “flip with no funding” transaction is the most problematic. If the end buyer (the C party) is getting a loan, this type of transaction is almost always considered mortgage fraud and illegal. If we think of it from the lender’s perspective, they are making a loan on a property that has an inflated value. In our example, when party A sells to party B for $75,000, and then party B sells to party C for $150,000, the price has been inflated and the lender is not loaning on the real value of the property. The first rule on these types of deals is, no amount of disclosure eliminates mortgage fraud. If party C has a lender, this type of transaction is illegal. But what if party C is paying cash? Then you are in a category of transaction that carries a great deal of risk but may not be illegal. In title theory, when A contracts with B to sell, B immediately gets the equitable title to the land and may sell that title. If party B finds a buyer for more, theoretically stating, that is a transaction some underwriters may be willing to insure. The title agent best practice is, never insure or conduct such a closing without specific underwriter approval. 

Our third type of transaction is the flip with funding. This type of deal is easier to insure, especially if party B holds the property for 90 days or more while repairs are being done. Lenders today typically ask for a 24-month chain of title so they can see the history of recent transfers. States where sales prices are recorded with real estate records allow lenders to see the recent sales price. In a similar example, party A sells to party B for $75,000, party B uses their own money to buy from party A and then initiates repairs on the property. Next, party B sells to party C for $150,000 after a 90-day repair period. In most states, as long as there is disclosure of the recent sale from A to B, this type of transaction is not illegal. Moreover, a title agent’s best practice is to make sure the ultimate buyer’s lender is aware of the recent transfer and that improvements have been done on the property. And, as always with this type of transaction, title agents should consult their underwriter for any specific state rules and guidance. 

               Our example from Fort Myers at the beginning had a tragic ending. During the housing crash of 2008, many contract holders of those condos saw the value of the condo go from $450,000 to $150,000 or less. They were faced with the option to buy their condo at the set $300,000 price, knowing it would only be worth half, or walk away from the deal and forfeit their 10 percent down payment. Most chose to walk away and forfeit the down payment. This resulted in lenders for builders being left holding the bag when builders couldn’t sell their inventory and went bankrupt. Buying low and selling high doesn’t always work out. 

 "Be greedy when others are fearful. It is a gross oversimplification to say that the key to investing is to buy low and sell high." - Warren Buffett, 1930 - living, American investor, business tycoon and philanthropist, who is the chairman and CEO of Berkshire Hathaway.