Real Estate Scams: Don't Be the Next Victim!

Sound too good to be true? To most of us, this newspaper ad is a sure sign of a real estate scam. But to the unsophisticated, first-time homebuyer, it seems more like a dream come true. When these types of scams are eventually uncovered, the dream can become a nightmare not only for the buyers, but for real estate appraisers as well.

The real estate scam perpetrated by Mr. Smith is typical of such schemes. Mr. Smith, a real estate speculator, purchases dilapidated homes in depressed neighborhoods, performs a few cosmetic repairs, then looks for a suitable buyer. Since he targets renters with low incomes and poor credit, Mr. Smith also enlists a local mortgage broker for help with truly "creative" financing.

Smith`s newspaper ad attracts the attention of Mr. and Mrs. Jones. The Jones family has a modest income and never thought they could own their own home. When Jones calls the number listed in the ad, Smith assures him that only a $500 downpayment is necessary and offers to show him a property that same day.

Although located in a run-down neighborhood, the home itself looks nice, with new paint, carpeting and appliances. Jones immediately accepts Smith`s offer to sell the house for $40,000, not knowing that Smith purchased the property for $15,000 a few weeks ago and put only $3,500 into repairs.

As promised, Smith and the mortgage broker take care of all the paperwork. To both increase their profit margin and make the loan package more attractive to prospective lenders, they falsify virtually all the information on the sales contract, settlement papers and loan application. The purchase price is listed as $80,000, not the $40,000 that Jones agreed to. Instead of the $500 which he paid Smith, Jones is shown as making a downpayment of $8,000. Smith falsely indicates he will hold a second deed of trust for $28,000. Smith also prepares fraudulent W-2 forms and income tax returns. Before submitting the loan package to lenders, Smith orders an appraisal from an independent fee appraiser. The report estimates the value of the property to be $80,000.

When escrow is ready to close, Smith asks Jones to meet him at the title company to sign the papers. Jones wants to review the documents, but it is late in the afternoon and Smith is in a hurry to get back to his office. Smith assures him that everything is in order and there is nothing to worry about. Jones hurriedly signs the documents and is not even given a copy.

Having realized a tidy profit of nearly $25,000 on this transaction, Smith congratulates himself on another "job" well done and starts looking for his next hapless victim. However, Smith`s luck is about to change.

Just a few months after escrow closes, Jones has financial problems and stops making his mortgage payments. When the loan goes into default, the lender requests a broker price opinion to determine the property value at foreclosure. The lender is shocked when the price opinion comes in at only $20,000! As the dominoes start to fall and details of the transaction are discovered, both Jones and the lender realize they were hoodwinked by Smith and his cohorts into investing in a property worth significantly less than they were led to believe. When Jones learns that Smith also swindled other homeowners, he files a class action lawsuit against all participants in these real estate transactions, including the real estate appraisers.

In the past few months, our office has learned of similar real estate scams being perpetrated across the country. Several appraisers in California have been named in a lawsuit in which a lender claims damages of over $40,000,000. In New Jersey, a similar suit alleges damages of over $21,000,000.

Most real estate scams involve the use of "flipped" properties and/or "created markets." Properties are repeatedly purchased and sold at continually increasing prices within a short period of time. When the perpetrator of a scam flips properties in a close proximity, a market of artificially high values is created.

As was true in our Smith/Jones scenario, most appraisers who find themselves involved in real estate scams are innocent participants. How then did they appraise the properties at such overly inflated prices? The usual problem is deficient market research. Many of these appraisers simply relied on comparables given to them by the seller without doing any independent verification. Not surprisingly, most of these comparables were other flipped properties. The appraisers either did not notice or were not concerned that these properties had been sold several times in the last few months, oftentimes by the same seller!

How can legitimate appraisers avoid becoming involved in real estate scams?

1. Appraise your clients as carefully as you appraise properties. Avoid doing business with people who have questionable reputations.

2. Be objective and base your estimates of value on genuine data. Never arrive at the value your client requests unless data supports that conclusion. Be wary of a client who provides you with supporting figures but discourages you from verifying that information.

3. Be alert to the possibility of "created" or "flipped" markets. If a property seems to be overpriced for its condition and neighborhood, don`t simply assume that all information provided to you is legitimate. Some basic research might disclose the fact that the property may be involved in a scam. For example, in researching comparables, look to see if the same party was the seller in several of the transactions. Check to see how many times the property was transferred in the last year or so and if the prior sales were for an amount significantly lower than the recent sale.

In today`s booming real estate market, it may be tempting to spend less time in research and verification. In doing so, however, you may face the possibility of being named as an alleged conspirator in a real estate scam.

Copyright 1998. LIA Administrators and Insurance Services. All rights reserved.