Appraisal Scoop

Real Estate Purchase Contract Scams - Tricking Appraisers To "Hit The Target"

GUEST AUTHOR: Vernon Martin, the founding principal of American Property Research, performs paid research, due diligence and valuations regarding commercial real estate
throughout the world. He has 28 years of commercial appraisal experience and has
worked in 20 countries, 39 U.S. states, and four Canadian provinces. He was  previously the chief commercial appraiser at 3 national (U.S.) lending institutions, formerly taught Real Estate Valuation at California State University, Los Angeles and has authored many professional journal articles and two books.

The appraisal textbooks don’t mention these, so I will.  Real estate purchase contracts are often
constructed to mislead lenders and appraisers.  Various ruses are used to inflate stated purchase prices above market  value, with the hope of tricking an appraiser into valuing a property at above market value and tricking a lender into offering a loan at an imprudent loan-to-value ratio.  

What the buyer and seller are counting on is a phenomenon known as “anchor bias”, the tendency of appraisers to offer an appraised value identical to the purchase price. Various academic studies have indicated that this happens about 96 to 97% of the time, although some appraisers seem to have been getting wiser lately.  Some ruses that I have recently seen include the following:

1. The “soft second” mortgage loan – forgivable seller financing used to inflate the contract purchase price.  

My last appraisal assignment presented such a possibility. It was an $8 million purchase contract which was contingent upon $4 million in first mortgage financing, supplemented by seller financing of $4 million. The buyer would have no equity in the property, a situation that presents a high risk for loan default.

I suspected that the seller financing was a “soft second”, a seller concession disguised as a fake loan. My suspicion was well supported by a contract purchase price which was $1.6 million above the listing price for a property that had been marketed for almost 3 years. I found the listing on the Internet.  

Normally, the term “soft second” in the real estate industry refers to a legitimate second mortgage loan made at a below-market rate, perhaps subsidized by a government agency or a nonprofit entity. In some cases, though, the seller financing is not meant to be paid back. It is a price concession in disguise, meant to inflate a contract purchase price.

An appraiser cannot be sure the second mortgage is real or fake, so he must look for clues, the most obvious of which is that the purchase price is not supported by comparable sales or the purchase price is above the asking price. The lack of equity contributed by the buyer should also make lenders and appraisers think twice.     One would think that some government agency or appraiser association would issue an “all points bulletin” on this deception, but this scam continues to this day.

2. Unsigned purchase agreements in draft form.

 

I have seen a proliferation of this trick in the last 2 years, and am currently witnessing it happen on a
transaction in Puerto Rico.  The buyer just says that the purchase contract has not yet been finalized and submits his own version, usually in MSWord, with a different price.  Very simple, but these deceivers are counting on appraisers or lenders who will believe anything.  

 

Normally, an application for a purchase mortgage loan comes with an already-signed purchase agreement with contingencies for financing. Why and how could there be a closing without a definitive purchase agreement? An agreement that is not written is commonly known as not worth the paper it is written on. There is no reason for an appraiser to accept an unsigned, draft purchase agreement as a reliable indication of value.

 

3. The double escrow
 
This is when there are two purchase contracts for the same property.  The first purchase contract is the legitimate one, and once closed, the buyer can then sell at a higher price to an entity he controls in a different purchase contract that he will submit to lenders and appraisers.  The latter transaction, however, is a sham "pocket-to-pocket" transaction.

 
4. Secret partnerships and "transaction facilitators"
 
In one instance I met with the owners/sellers of swampland intended for development of a marina residential community. The buyer and sellers were old friends. I was presented with three conflicting purchase contracts, and whenever the story keeps on changing, that is a good sign of deception. After four hours I asked Mr. Seller where he would  be moving to. He seemed surprised and responded, "I'm staying here, of course.  I've got a lot of work to do!" which made it clear that he was part of the development team. I looked at his wife, whose facial expression said "How can my husband be so stupid?"

I discovered  one company in Arizona that advertised "transaction facilitation" services. Step 1 is that the buyer forms a joint venture partnership with the transaction facilitator in buying the property in the guise of an LLC or Limited Partnership. Step 2 is the shell company (the LLC or LP) sells to the buyer
again at a higher price in a sham transaction designed to trick a lender and maximize financing.
 
Another type of "transaction facilitation" is those services which "rent" cash down payment money overnight to buyers while the purchase price is inflated to cover the amount of the phony down payment.  Law enforcement has been shutting down such operations in the United States.

Other purchase contract deceptions 

 

It is risky, any way, for an appraiser to automatically assume that a contract purchase price is identical to market value.  I have seen fake purchase contracts and purchase contracts which disguise the fact that the buyer and seller are one and the same. I have seen purchase prices inflated by real estate
syndicators who are compensated as a percentage of the transaction price.

 

Many appraisers are so convinced that the purchase price is real that they make the mistake of making
unconventional adjustments to sales data to support the stated purchase price. They may choose much newer properties or much smaller properties as comparable sales and fail to make adjustments for age or size.
 
Questions to ask
 
The first thing I do in analyzing the purchase transaction is to peruse the Internet to try to find the property listed for sale. LoopNet and realtor.com are good sources, but sometimes if you just google the address of the property, you can find a more obscure listing. When I find the property listed at a price below the contract purchase price, and the property has already spent a substantial time on the market, that is cause for suspicion.

The next question I ask the buyer and the seller, separately if possible, is "who were the listing broker and the buyer's broker on this transaction?" The reason why I ask is that I see so many purchase loan applications which are not represented by a broker, begging the question of how the buyer and seller found each other in a market with so many properties listed for sale. 

If there was no broker, there was most likely no listing or advertising, meaning the buyer already knew the seller, increasing the odds that the purchase transaction is not arm's length or even a
"pocket-to-pocket" transaction with the owner buying the property from himself with my client's financing. Past experience has shown me that this is a way to make the lender the unintentional buyer of a hard-to-sell property.

One tell-tale sign of a fraudulent purchase is when the buyer complains that the value is too low. In legitimate purchases, the buyer often uses a low appraisal to negotiate a better price, and they sometimes even thank me, but when a buyer starts making phony excuses as to why the appraised
value should be higher, it is a signal to me that the buyer is either already affiliated with the seller or else the buyer and seller have negotiated a separate purchase agreement and the contract I was given was
phony.

Recent adverse publicity for the appraisal profession
 
The National Association of Realtors (U.S.) has recently unleashed their well-funded publicity machine to criticize appraisers for failing to "hit" purchase prices. They publicize sob stories of realtors whose purchase deals fell apart.  "I had a bona fide purchase contract and the incompetent appraiser appraised it too low!" Such things could be said about me, too, but nothing is being said about the epidemic of deceptive purchase contracts nowadays.
 
To appraisers who think they must "hit" the purchase price:

If it was really true that the market value of a property is always the same as the purchase price, there would be no need for appraisals, would there be?

 

AUTHOR: Vernon Martin, the founding principal of American Property Research, performs paid research, due diligence and valuations regarding commercial real estate throughout the world. He has 28 years of commercial appraisal experience and has worked in 20 countries, 39 U.S. states, and four Canadian provinces. He was previously the chief commercial appraiser at 3 national (U.S.) lending institutions.  Full profile: click here

Runt Rants - A Tale of Two Loans - "It was the best of cases . . it was the worst of cases."

Tired of Sub Prime news yet?  Well, it's a story that's three years in the making.  Hope you're not bored by it yet!  We’ve discussed the Sub Prime Crisis several times since August. We’ll continue that theme as it seems appropriate.

Today we have two actual case examples . . Best and Worst Case scenarios.

THE BEST CASE

Michael Gordon a Florida Appraiser provided this example of a Florida ARM set to increase payments by 37% for a borrower who had also experienced a business reversal related to the real estate crunch. The borrowers contacted the lender, explained the situation, and a few days later received a Fed Ex delivered letter informing them the ARM portion of the loan contract was rescinded, and converted to a fixed rate at the original rate. Crisis resolved.

The homeowners contacted Countrywide per my suggestion. As far as the situation with Countrywide, they were very excited to get the great news that Countrywide was going to drop their interest rate back down to 6.5% which is what it was at the origination of the loan. They had unfortunately chosen an adjustable rate that went up after 2 years.

In June 2007 (the 2 year anniversary of the loan) their rate jumped up to 8.5%. Their mortgage jumped from approximately $1,750.00 up to $2,400.00 (these figures include escrow numbers as well). That was really hard on them because the homeowner just had a situation happen with a Painting Contractor he had been subbing work that did not pay on $30,000 in work and he lost that business as a source of income as well.

Several months later, they fell behind on the mortgage. The homeowners called Countrywide and asked for help. They forwarded the call to the Relief and Recovery Department of Countrywide. The representative told the homeowners that they would have to gather paperwork (bank info and debt info) to prove their situation before Countrywide could help them.

Before the homeowners had time to gather all the paperwork, they got a letter from Countrywide via Fed Ex and it basically said they were going to drop their interest rate back down to 6.55 percent and they didn't have to do one single thing to make that happen. They said the new mortgage rate and payment would go into effect Jan 1, 2008.

In this situation both the borrower and the lender are better off. Exactly what Runt Rants suggested in the Thought Experiment. There are many, many circumstances where this solution could be adopted for the benefit of the borrower, the lender, the community, the economy.  Well done Countrywide!

Click here for the WORST CASE . . .

'Flip This House' star accused of fraud

What if you found out an American Idol contestant was lip-synching? What if the Bachelor was really married? How real is reality TV? 

On an episode of A&E's popular reality series "Flip This House," Atlanta businessman sits in front of a run-down house and calls buying and selling real estate his passion. 

But according to Business Week, "Now authorities and legal filings claim that Leccima's true passion was a series of scams that included faking the home renovations shown on the cable TV show and claiming to have sold houses he never owned."   

Sam Leccima has some major serious fraud allegations on his hands today!  The Atlanta FOX 5 I-Team has done an investigative report on Flip This House , one of America's favorite reality shows, and their "star" flipper in Atlanta. 

You can learn more by reading about Samuel P. Leccima’s Real Estate License Revocation, or watching part one and part two of Dale Russell’s Fox 5 I-Team Report.

Mortgage Fraud: Six convicted in case that cost banks more than $5 million

The 12/28/2006 Inman News Story (Click Here) "Ex-mortgage loan officer to do heavy time for fraud" says: "A federal judge has sentenced a former mortgage loan officer convicted of organizing a Washington, D.C., house-flipping scheme involving mortgage fraud to more than 24 years in prison."

Five others charged in the scheme have also entered guilty pleas.

I've listed Brad Geary's, “Universal Truths of Mortgage Fraud” in the Appraisal Scoop many times. According to Mr. Geary "Virtually all mortgage fraud combines at least two of the "Universal Truths" of mortgage fraud. This case is no different!

As usual, an appraiser was needed to seal the deal. 

BUT . . .this time they didn't even use a "licensed" appraiser!

"Robbie Colwell, who was paid to write appraisals that inflated the values of the properties, pleaded guilty to conspiracy to commit bank fraud. Prosecutors said Colwell was not a licensed appraiser but used other appraisers' names and licenses to write "completely fabricated reports on the value of the houses."

"Nearly all of the appraisals claimed the homes had undergone complete rehabilitation and remodeling, when in fact none had renovated kitchens or bathrooms, many had crumbling walls and ceilings, and one was merely a shell, with no interior walls or floors at all."

Buy it. Fix it. Sell it…..That’s flipping

In the tradition of mockumentaries like “Best in Show” and “Waiting for Guffman,” Flipper Nation is a hilarious new series about a couple of ill-fated guys trying to cash in by “flipping” houses, and in the process debunking the myth that anyone can getting rich quick in the real estate game. From the promo:

Flipper Nation: a country of people getting rich on real estate. Then the bubble bursts. That’s when David Kimball and Richie Tatum have chosen to get into real estate. A day late and a dollar short, they’re trying to make it to a million dollars. Follow their path to fortune at FlipperNation.com!

Head on over to FlipperNation.com to see the first episode, get real estate tips (to be taken with a grain of salt of course), and even print your own masks of the show’s personalities!

Cash Back at Closing Strictly Illegal!

Ralph R. Roberts writes in his article: Cash Back at Closing? Strictly Illegal! - Cash-back deals are stitched into the fabric of the U.S. economy. manufacturers promote products with cash rebates. Credit card companies offer cash back on purchases. Even banks dangle cash-back deals to attract new customers. Now real estate con artists have jumped on the cash-back bandwagon, and plenty of home buyers--and even some real estate professionals--are falling for these schemes. Click here for an example.

On first glance, cash back at closing looks like a win-win situation. The buyer pays a little more for a property than it’s worth, and the seller agrees to return the surplus cash to the buyer, who can then use it to pay off outstanding debt or renovate the property. The seller gets close to or better than the asking price, the real estate agent gets a bigger commission, the loan officer chalks up another successful loan, and the lender scores a larger loan and stands to earn more interest over the life of the loan.

Unfortunately, cash back at closing schemes are illegal and potentially damaging to the lender, who is fooled into making a risky loan. “And lenders aren't the only losers,” warns real estate and mortgage fraud expert Ralph R. Roberts. “Buyers can be tricked into buying more house than they can afford. Click below to read on . . .

Sales of 14 upscale homes at well-above-market prices raise suspicions of flipping in Ohio

Geoff Dutton of The Columburs Dispatch reports:  "The peculiar but tempting offers sometimes came a year or more after homeowners planted for-sale signs in their front yards."

"Interested buyers suddenly appeared, proposing to pay hundreds of thousands of dollars more than the asking price for houses in some of central Ohio’s elite neighborhoods, including Muirfield Village and Tartan Fields."

"The catch: the sellers must agree to immediately refund the difference between the asking price and the sale price. "  Click here for the complete article.

Additionl Resource: Are kickbacks at closing illegal?  Read Ralph R. Robert's article - click here.

FSI: Fraud Scheme Investigation

Interthinx™ and leading mortgage professionals have teamed up across competitive boundaries to develop a fraud prevention training video that will help the industry thwart the expansion of mortgage fraud schemes nationwide.

Frederick Cabanes aka "Appraiser Dennis Outlaw" (pictured above) is just one of the characters in the FSI: Fraud Scheme Investigation project sponsored by Interthinx™

Click below for more information on ordering a free DVD . . .

What NOT To Do In Real Estate - 24 Years Old, $2.2 Million in the Hole

I'm a 24-year-old aspiring real estate investor from Sacramento CA. After going to few seminars I bought 8 houses in 8 months across 4 states with no money down. I fixed and sold 2 and then ran out of cash. I am now facing foreclosure on 6 5 houses. I'm learning my lessons, finding solutions and blogging about it. Comments appreciated!  - Casey Serin

That's the way that the I am Facing Foreclosure.com blog site starts out!  This guy's story has been picked up by the news media, blogs like The Motley Fool, and even NPR Radio.  If there's a poster child for everything that went wrong in the real estate boom, it just might be Casey Serin.

In one year, the 24-year-old website-designer-turned-real estate-flipper bought eight homes in four states — and in every case but one, he put no money down. At his peak, in April, Serin had $93,000 he'd taken out of the homes as he bought them. By July, he was broke, desperate for one last deal.

In a nutshell, click below to find out what the "10 Mistakes That Made Flipping A Flop" are.

Red flags preceded home-fraud lawsuit

All levels of government received grievances about the lawsuit's key figure, Robert Penn, according to the IndyStar.com news story about homes being sold at inflated prices, defrauding lenders out of tens of millions of dollars and leaving investors on the brink of financial ruin.

"Federal, state and local authorities received warnings, some dating back two years, about the Fishers man at the heart of a mortgage fraud lawsuit involving the foreclosure of scores of Indianapolis-area homes."

According to the full article (click here) - Suspicions that something was wrong were so widespread in the real estate community that two title companies sent out notices warning other title companies to be wary about any deals involving Fishers businessman Robert Penn.

CLICK BELOW FOR HIGHLIGHTS. . .