Flipping: Dangerous Maneuvers for Appraisers

You may already be aware of one of the fastest-growing areas of appraiser litigation today—real estate flipping schemes. Armed with false paperwork and deceptive sales pitches, flippers are exploiting some of the country`s most fragile neighborhoods and gullible citizens. Posing as real estate investors, these "flippers" purchase rundown houses and resell them, sometimes within hours, to unsuspecting buyers at significantly higher prices. Typically, the flipper, with the aid of a broker, prepares a package of documents that includes a falsified application and other papers designed to legitimize the deal and make the buyer appear creditworthy. Such documents usually misrepresent the buyer`s down payment, employment, income, and assets.

Unfortunately, the transaction cannot take place without an appraisal. In order for the lender to make the loan, the appraisal must substantiate the higher purchase price. After the sale is complete and the buyer realizes he/she paid much more than the house is worth. Often the buyer is unable to fulfill the terms of the loan. In the event of a lawsuit, the appraiser may be named as a co-defendant for fraudulently inflating the value of the property.

Sometimes appraisers knowingly fail to disclose in the appraisal report that the property had been acquired by the flipper days, weeks, or months earlier—for a substantially lower price. In one case, the appraiser stated that he failed to disclose this information because he did not believe it to be relevant. Another appraiser did not disclose the lower purchase price because his client asked him not to. In other cases, the appraisers also fall victim to the scheme since comparable market sales have been created by a series of flipped transactions. Appraisers need to recognize a potential flip and take measures to protect themselves against litigation. The following scenario will illustrate a typical flip and how you may avoid being drawn into this type of situation.

Ms. Buyer was a single mom living in a subsidized housing project, making $300 per week as a bus driver, and had poor credit. She heard through the grapevine about an "investor", Mr. Flip, who could help her buy her own home for a $500 down payment. She contacted Mr. Flip, who proceeded to show her several homes in the mid-city area. Eventually, Ms. Buyer found a home she liked. Unbeknownst to Ms. Buyer, Mr. Flip had purchased this home a few weeks earlier for $10,000.

Initially, Ms. Buyer was concerned about the condition of the home. It had old and stained carpeting, dirty walls, and missing or damaged fixtures and appliances. Mr. Flip immediately eased her concerns by telling her he intended to completely renovate the home with new carpeting, fixtures, appliances, and a complete paint job. Mr. Flip offered to sell the property to Ms. Buyer for $50,000, with a down payment of $500. Ms. Buyer thought this was a great deal and agreed to purchase the home.

Mr. Flip proceeded to contact an out-of-town appraiser who valued the home at $80,000—after completion of the promised renovations. Mr. Flip convinced the appraiser that the home would be worth $80,000 by showing the appraiser a list of comparable sales, all located within the same neighborhood and reflecting values of $70,000 – 90,000. The appraiser knew that Mr. Flip had purchased the property a short time earlier for $10,000. However, Mr. Flip explained that he was an investor who bought packets of rundown homes, fixed them up, and resold them for a profit. Mr. Flip was concerned that the loan underwriter might be "misled" by the prior purchase price and would not approve the loan. The appraiser agreed to omit the lower purchase price from the report. Mr. Flip appeared to be an honest guy, and, since he was a big-time investor, the appraiser hoped to get more assignments from him in the future.

Additionally, Mr. Flip took Ms. Buyer to his friend, a mortgage broker, to help her secure financing. The broker and Mr. Flip prepared a falsified loan package designed to mislead the lender. The documents indicated the property was being sold for $80,000, instead of the actual $50,000 he promised Ms. Buyer. The package sought a first-trust deed of $64,000 (80% of the purchase price). A false loan application was prepared which significantly over-stated Ms. Buyer`s income, assets, and the down payment. When the broker asked Ms. Buyer to sign the documents, they were placed in a neat stack with arrows and clips indicating where she should sign. He told Ms. Buyer the documents were in order and that she did not need to read all that legal jargon. Mr. Flip explained they would let her know as soon as her loan came through so she could make arrangements to move.

Shortly after moving in to her new home, Ms. Buyer received a packet of loan documents. In all the confusion of unpacking, she did not actually read the paperwork, and filed it away to review later. Ms. Buyer`s first surprise came when she received her mortgage statement. The monthly payment was much higher than she expected and the statement indicated she had a mortgage of $64,000. Unfortunately for Ms. Buyer, the lender verified that the statement was correct. Ms. Buyer immediately made several telephone calls to Mr. Flip and the mortgage broker. As you may expect, her calls were not returned. The next call Ms. Buyer made was to a lawyer.

Mr. Flip initially paid $10,000 for the property. His repairs were of poor quality and workmanship, and cost him around $4,000. Mr. Flip also paid $300 for the appraisal and a few thousand dollars in closing costs. As the seller, Mr. Flip received $64,000 in loan proceeds and a $500 down payment. Not a bad profit! Unfortunately for Ms. Buyer, she was unable to make her mortgage payments and defaulted on her loan—damaging her already poor credit. The lender foreclosed on a property with a $64,000 loan that has an actual value of less than $20,000.

Despite the fact that Mr. Flip engaged in well over 100 similar transactions, he has filed a petition for bankruptcy, claiming his liabilities exceed his total assets. The misled appraiser is being sued for more than $100,000. Consequently, there are many lessons to be learned from the conduct of the real estate appraiser in this situation:

Be wary of information provided by the client—especially when the client says you do not need to verify it.

The appraiser in this situation should never have relied upon the comparables provided to him by Mr. Flip. Aside from verifying that the figures were accurate, some additional investigation was warranted, in light of the lower purchase price. Had the appraiser done so, he/she would have noted the other sales of similar properties in that neighborhood were significantly lower values than those offered by Mr. Flip. In fact, the comparables provided by Mr. Flip were sales of other flipped properties.

Take care when accepting assignments outside your geographical area of expertise.

If the appraiser had been familiar with the local market, he/she would have immediately recognized that the property value being sought was unusually high. Appraisers performing inspections outside their customary area should always take steps to become familiar with the local market. It is advisable to consult with local appraisers or realtors to ensure that accurate and complete information has been gathered.

Always analyze the listing and sales history of the subject property when it is available.

Often second or third-time flips can be discovered at this stage of the investigation. If the property has been bought and sold a number of times over the past year, or if the seller in the sales agreement is not the owner on record, then you may be dealing with a flipped property. A large discrepancy in the purchase and sales price of a property—held only a short time—is also a big clue.

Never intentionally omit prior sales history on the appraisal report.

The appraiser made a huge mistake by excluding this information from the appraisal—even if it was at the client`s request. By failing to disclose the prior sales history, the appraiser provided a report that was misleading. It is difficult to defend an appraiser in a lawsuit whose actions so clearly indicate culpability.

Legitimate investors are buying and selling real estate property every day at a profit. There is nothing illegal about that and appraisers do flourish in a healthy real estate market. However, there are individuals out there who attempt to defraud buyers and lenders through a series of misrepresentations and falsified documents. Often the appraiser is unwittingly caught in the crossfire when the fraud is discovered. By conducting a thorough investigation (and using a good dose of common sense), you can help to avoid being Mr. Flip`s next victim.

Copyright 2001. LIA Administrators and Insurance Services. All rights reserved.