Flipping Real Estate, Legal or Illegal?

A couple of weeks ago I had several readers ask about flipping and why it was illegal.  I told them "Flipping is legal unless there is fraud", but promised I would try to make some sense of what’s going on with the “flipping trials” that have been on the front pages of the local papers. As the testimony unwinds, the local press has painted legal and illegal flipping with the same brush, and cast a shadow across the concept of buying and reselling homes for profit, implying that it was illegal.

Any time you buy and sell a house (usually without intending to live there)—that’s called a flip. It’s either a fast flip or a slow flip, but it’s still a flip no matter how you look at it.  The media in cases where an investor bought a property and sold it a short time later uses the term “flipping”.  That’s just doing business.  It’s legal.  And it happens every week, even in depressed markets.

But an illegal flip is just like a legal flip except it includes some mis-statments of fact (the fraudulent step) in one of the many documents that buyers and sellers have to sign.  The guys who are on trial right now made a practice of moving properties (often with a little fraud) and got away with it, over and over.  What they were doing at the time might have seemed like everyday business, but once they got caught their illegal short-cuts became a news story.

Again, flipping houses is not illegal. Fraud is illegal. So what kind of fraud did these guys get in trouble over? Here are a few possibilities:

1. Getting appraisers to raise the appraised value of a property, often double or triple the value, resulting in the lender (being duped into) making larger loans for the flipper or their buyers.  This step allows the buyer to overpay for property (and maybe pocket the difference).

2. Arranging down payments for a buyer, often from a third party—sometimes from a loan company or maybe even from the seller—resulting in an unqualified buyer buying a house that they couldn’t afford and shouldn’t be approved for.  This works best when the value of real estate is escalating rapidly.  The buyer can live there, or sell the house and the seller and flipper (might fraudulently) split the profits.

3. Falsifying loan documents required by banks to get a buyer approved, documents such as pay stubs, social security numbers, verification of employment, personal tax returns, verification of funds on deposit, etc. Resulting in a fraudulent application.  This may even include stolen identification numbers buying homes, and dumping them to a “flipper”.  When the stolen ID numbers are those of a dead person, the county discovers the default when the taxes come due, and the flipper has resold the home long before any of this is discovered.

4. Using straw men (people who appear to be buyers, but are standing in for the buyer) is legal and often done in real estate, especially if the actual buyer is a celebrity or high profile sports star, who might have to overpay if his identity were known to the seller.  But flippers occasionally use “straw men” who are paid to use their ID's, and sign the documents; but once the sale is made to the straw man, he immediately resells the property to the “flipper” for a profit.  The flipper pays off the straw man and keeps the profit.  This “launders the chain of title, and is a frequently abused type of fraud; which once discovered leads to an FBI investigation.  A straw man can be a stranger, an illegal alien (with phony papers) or even a relative of the flipper.  Flippers may also be illegal aliens, and probably will use fraudulent tax and social security numbers.

5. Back dating lease agreements to prove a track record of the tenant making payments on time and a year or more occupancy, even though that tenant just moved in. This is very common. Closing companies and banks/mortgage companies want the loan to go through and the sale to happen.  They used to say, “We do it all the time” but they don’t say that anymore.

A few years ago the FBI was following several (bald faced fraudulent) deals on broken-down commercial buildings in which the flipper makes a fair offer to purchase, and the seller accepts; then the flipper gets a fraudulent high appraisal on the property and a high dollar loan for the appraised price, at closing the flipper pays the seller the agreed amount and keeps the excess of the money from the bank (this can be millions). This requires the closing company to aid and abet the swindle.  Sometimes really bold flippers will do a second deal on that same property, with new very high appraisals.  Once they have the money, these guys usually leave the area, with the loan in default.  Some of the more brazen might burn the building for the insurance and to eliminate the evidence.

Illegal flipping occurs anytime the deal is different than what is represented on the contract presented to the lender. Each loan is based on the stated facts, so if even one fact is misrepresented, it’s fraud.  Regardless of how many people participate in the process.  If you are thinking all this makes sense, just remember, fraud against a bank or lending company is investigated and enforced by the FBI.

Legal flipping occurs when you buy a house, and either fix it up or simply choose to resell it.  If you’re buying and rehabbing houses, document all the work you do.  Keep a file on what you’ve done and spent to make a case on how you raised the value so quickly. You should also document your work using before and after photos.  Good records will help with everyone you deal with from other contractors to bankers to the IRS.

Dane Hahn is a real estate professional practicing in the Englewood, Florida Area.  Reach him at 941-681-0312, or by email at dane.hahn@gmail.com.  See him on the web at http://www.danesellsflorida.com/