Wednesday, September 7, 2011

What is "Flopping" and when is it illegal?

The term "flopping" in real estate transactions is an offshoot of the term "flip." Anyone who watches late night TV knows that "flipping" a property usually means to buy a fixer-upper, fix it up, and then sell it. Ideally this occurs in a relatively short time period (to reduce the holding costs to the buyer/fixer/seller).

"Flopping" typically refers to a flip in which the purchase occurs at a short sale and in which the buyer may already have a subsequent purchaser lined up for a higher price. A lender agrees to sell the property for less than is owed on the mortgage note, the buyer then acquires and quickly resells the property.

Buy low, sell high. What could be wrong with that? The problem occurs if there is fraud. Lenders, and their guarantors such as Fannie Mae, do not have the resources to conduct due diligence on the properties on which they hold mortgages. So, Fannie Mae relies upon the short-sale buyer to provide it with information about the property?!? The buyer obviously has an incentive to overestimate needed repair costs and to underestimate the value of the property.

Once the buyer resells the property, Fannie Mae may complain that it was given fraudulent information by the buyer (or by the real estate agent, or by the seller) as to the value of the property and/or the existence of other interested parties.

Shelley Poland, a vice president at Freddie Mae, and Robert Hagberg, the associate director of fraud investigations, said in a blog post that they believe such fraud is on the rise.  Freddie is requiring buyers to sign an affidavit that the transaction is "arms-length." 

What can a short-sale buyer, particularly an investor looking to flip, do to avoid an allegation of fraudulent "flopping?"  1)  Have nothing to do with the listing agent or broker's price opinion as to the value.  2) Use reasonable estimates for repair costs or any other information submitted to the seller's lender when seeking short sale approval. 3) Do not exchange anything with the seller that is not reflected on the HUD1 settlement statement.
Also, beware.  Freddie, and its fraud prevention unit, claim that it is fraud if a buyer/investor enters into a short sale purchase contract, identifes and contracts with a subsequent purchaser, and closes on the short-sale purchase without identifying the subsequent purchaser to the lender.  see

Real estate attorney James N. Graham