Is It a "Win Win" or a Scam?

March 16, 2009

Nash & Lodge, PLLP

Lately we have reviewed a number of transactions that real estate agents or real estate companies were concerned about. On one hand, they looked at the transaction as a “win win” for everyone, on the other hand, something concerned them enough to contact us. The truth is it is hard to say no to a transaction that will put money in your pocket and food on the table. Everyone has to be careful that this truth does not blind them from seeing the transaction for what it may be: a high risk transaction that may be construed as fraud which will expose you to lawsuits, regulatory sanctions and criminal charges.

A homeowner is attempting to sell their home but is upside down, I.e., they need a short sale approval for any sale. An investor makes an offer on the property. The structure of the transaction is either the investor offers to purchase an option to purchase for a nominal amount (i.e., $100) or offers a normal purchase but with the same extremely low earnest money payment. The offer normally has the investor negotiate the short sale. Once the short sale is approved, the investor tries to flip the property by finding a buyer that will pay more than the short sale price. If the investor cannot find such a buyer, he/she will walk away from the deal.

A "Win Win" Deal?

How is this considered a “win win” type of deal? Sellers are finding it becoming more difficult to find a buyer who is willing to wait for the short sale approval. The time frame to get the short sale approval continues to lengthen frustrating everyone involved. The seller will not receive any money for the transaction, so the argument is that the seller does not care if the investor made money as long as the seller got their short sale.

The Problems

So what's the problem? The first problem is that the investor is only going to go through with the deal if he/she can immediately flip the property for a profit. If the investor backs away from the deal the seller may have lost his/her only opportunity to sell the property before the period of redemption expires.

Even if the investor closes on the transaction there may be a problem for the seller since the investor negotiated the short sale – did the lender/s agree in writing to satisfy the underlying debt or will there be money still owing to the lender/s after the short sale closing? The investor only cares about the lender approving the purchase price so getting the seller out from under the entire debt owed to the lender/s is not a concern they share with the seller.

By the vary nature of the deal, the investor is trying to convince the lender/s that the purchase price offered by the investor is the fair market value of the property; however, the investor really believes the property is worth substantially more which will allow them to then immediately flip the property. Some would argue that the value of the property is lower if subject to short sale approval. If the investor is going to rely on this argument they had better have actual data to prove that the immediate profit they made on the flip is equal or close to equal to the fair market difference between a sale subject to a short sale and one that isn't.

The biggest problem with the transaction is that the investor is taking no risk. They put the minimum amount down, often use an option so they cannot be forced to go forward with the transaction, and will only close with the seller if the investor finds a buyer that will agree to a higher purchase price and a simultaneous closing. In other words, the investor will only close if he/she knows that there will be a profit without ever putting any significant money into the transaction. The Department of Commerce and Attorney General's Office rarely looks favorably at transactions that are structured so that the investor takes little or no risk and the homeowner is totally at risk.

In many cases the investor requires the seller to use the investors' title company and, often, that title company is located outside of Minnesota. Why? Because most local title companies will look at these transactions as possible flips and do not want the liability. This practice puts both the seller and buyer at risk because how can a title company located in another state held accountable in Minnesota for any mistakes they may make?

This type of transaction is similar to the transactions that were sweeping the market a couple of years ago when the investor would buy the homeowners interest in the property with a promise to “save” the property from foreclosure. The investor would pay a nominal payment to the homeowner, buy out the mortgage and then enter into a rental agreement with the homeowner that would allow them to eventually be able to buy back the title to their home. The transaction would be set-up so that it was unlikely the homeowner would be able to actually buy back their home, the investor would then sell the property for a profit to a third party.

In response to this type of transaction the Minnesota Attorney General's Office pushed for new legislation that ultimately came to be known as the “Foreclosure Consultant” statute. I believe that the investors in these new type transactions clearly fall into this statute and must follow all of it's requirements. The investor transactions that I have reviewed did not meet a number of the statutory requirements.

Another possible concern is how the investors are marketing their properties. Are they using a licensed real estate broker? Are they marketing themselves? Do they have real estate licenses?

 Conclusion: Beware

It is not illegal for an investor to purchase property for re-sale and sell at a profit, but there are limitations to what an investor can do. A number of people are sitting in prison today because they participated in flipping. Be extremely careful before you become a part of such a transaction and make sure you are not violating a law or regulation, or that you are not allowing someone else to violate a law or regulation. Make sure that you are protecting your client's interests and document your files to protect yourself if future claims arise.