A prior version of this article was presented at an IADC Professional Liability Roundtable meeting in New York, New York in May 2007.
What is Real Estate Flipping?
THERE are two types of Real Estate Flipping: the legal and the illegal type of real property flipping. Illegal flipping is when one buys a house at a low price and then resells it at a higher price within a short time frame, often after making only cosmetic improvements to the property. Legal real estate flipping has been the subject of a number of television programs, including "Flip This House" on A&E or "Property Ladder" on the TLC Channel.
Illegal flipping is "a predatory lending practice whereby a recently acquired property is resold for a considerable profit with an artificially inflated value within a short period of time." (1) The legal flip transforms into an illegal flip when fraud, misrepresentation or deceit become an integral part of the transaction. (2) Illegal flipping is accomplished by "mortgage industry insiders using 'straw buyers' to defraud lending institutions, public and private investment firms and the United States Department of Housing and Urban Development (HUD) by submitting false information in mortgage applications." (3) "Straw buyers" are provided with fraudulent documentation (i.e., W-2 forms, tax forms, false appraisals, etc.)." (4) The property is "then sold at up to 500% of its true appraised value." (5) "Risk of default on these properties is significant." (6) "Lending institutions, investors, HUD, and private insurers often suffer substantial losses." (7) Consequently, flipping is a type of mortgage fraud, which is "one of the fastest growing white-collar crimes in the United States." (8) Mortgage fraud is defined as "a material misstatement, misrepresentation, or omission relied upon by an underwriter or lender to fund, purchase, or insure a loan." (9)
A quintessential example of an illegal property flipping/mortgage fraud case involved a New Jersey attorney, Stanley Yacker. In January 2002, Yacker admitted to "his role in a scheme to defraud purchasers of over-valued and fraudulently mortgaged homes in Monmouth County, New Jersey and elsewhere and to engaging in more than 200 'land flip' transactions with straw buyers." (10) Yacker stated "that those property transactions involved straw buyers who were paid for the use of their names and credit histories to obtain fraudulent mortgages for the properties." (11)
Yacker admitted "he acted with [realtors Irene] DiFeo and [Donna] Pepsny, among others, to engage in a scheme to defraud and to obtain money and property by means of false and fraudulent pretenses, representations, and promises, involving persons he represented in connection with their purchases of homes in 1995 and 1996." (12) Specifically, Yacker committed a variety of fraudulent acts, including:
* misrepresenting the nature and interest rate of the mortgage loan for which the purchaser had qualified - by failing to adequately explain the nature and consequences of the balloon first mortgage and the fact that tax payments were not included in the first mortgage payment--and the amount of the resulting monthly payment;
* failing to disclose to purchasers that, as a result of the purchaser's minimal down payment and the fraudulent increase of the purchase price, the seller would require the purchaser to execute at closing and become responsible for a second mortgage, thereby increasing the purchaser's monthly mortgage obligations;
* concealing the fact that some purchasers received funds out of closing to make repairs, by issuing checks to the purchasers in the names of other persons or entities;
* causing the falsification of numerous documents related to the transaction, including HUD-1/RESPA settlement statements which disguised the true nature and details of the transaction;
* failing to advise his purchaser-clients to abandon the closing when it was in their best interest to do so, and in fact encouraging or pressuring them to complete the closing under those circumstances, even after acknowledging in at least one instance that the purchasers' signatures on a contract of sale had apparently been forged or falsified;
* in one instance creating a fictitious sale of a property to a purchaser's relative who would then convey the property to the actual purchaser, in order to justify a false increase in the final purchase price of the home and to inflate the amount of the mortgage loan available for the transaction;
* creating the false appearance in the mortgage loan file that the debts of the purchasers were paid off as part of the closing, as required by a lender, by photocopying checks written by the purchasers which ... then [were] returned to them;
* failing to record deeds to establish and protect the purchasers' interests in their properties. (13)
Yacker also admitted that in 1996 and 1997, "Gary Grieser and others solicited and located persons willing to act as straw buyers in numerous transactions, whereby mortgage loans would be obtained and the properties acquired in the names of the straw buyers, even though those individuals had no interest in obtaining such loans or purchasing such properties." (14) "After the closing on those properties, each straw buyer conveyed a 60-percent interest in the given property to Grieser's entity, Capital Assets, in a joint venture arrangement which left the straw buyer holding a 40-percent interest as co-owner with Capital Assets." (15)
Yacker "prepared the joint venture agreement used in those transactions." (16) "Yacker also acknowledged that he knew that each of the straw buyers was being paid for the use of their names and credit histories in obtaining the subject mortgage loans and in acquiring the subject properties." (17) Yacker also committed various fraudulent acts to further the straw buyer scheme, including:
* issuing false letters regarding nonexistent deposits of funds by purchaser-borrowers, which funds he claimed to be holding in escrow;
* closing title on the resale portion of flip transactions knowing that the original purchase of the property had not yet closed; and
* signing and causing straw buyers to sign false and fraudulent closing documents, including HUD-1/RESPA settlement statements which did not truthfully describe receipts and disbursements of funds, and affidavits that falsely asserted that the straw buyer would be residing in the subject property. (18)
Yacker pleaded guilty "to all 10 counts of an Indictment, which charged him with conspiracy to commit wire fraud and nine counts of wire fraud." (19) In 2003, Yacker was sentenced to "18 months in prison and ordered ... to pay an unspecified portion of $787,985.00 in restitution." (20) Unfortunately, the claims against Yacker are not unique or limited to New Jersey. Illegal flipping schemes are taking place nationwide:
In Atlanta, Georgia, "Chalana McFarland was an attorney who operated her own law firm." (21) McFarland acted as both the "title agent for a title insurance company as well as the closing attorney for various lenders." (22) She then "used the stolen identity of numerous victims to submit false fraudulent loan applications." (23) The appraisals were "inflated and straw buyers were used to complete the fraudulent sales of over 100 properties." (24) "McFarland paid her identity thief $10,000 per stolen identity, as well as paying the appraiser who inflated property values over $400,000." (25) The fraudulently obtained mortgages valued in excess of $20 million with losses in excess of $12 million. (26) "McFarland and 16 other subjects were indicted" and "[f]ifteen have been sentenced, with McFarland receiving 30 years in prison... " (27)
In Fort Lauderdale, Florida, a federal grand jury "returned an 11 count indictment charging seven individuals with conspiracy to commit bank fraud, HUD fraud and false statements on more than 120 loan applications," totaling more than $15 million dollars. (28) The mortgage fraud was "predicated on a flipping scheme" where a "real estate investor would purchase homes and, on the same day, resell them at inflated prices to unqualified buyers he had recruited." (29) The buyers were almost always "first time homebuyers and/or recent immigrants" who "did not have sufficient income or assets to pay the required down payment and closing costs so, the real estate investor would illegally provide funds to them and incorporate these costs into the price of the over-inflated loans." (30)
In Baltimore, Maryland, a "property speculator, two loan originators, an appraiser, and a settlement attorney were indicted for engaging" in a scheme to "acquire inexpensive homes and fraudulently qualify buyers to purchase the properties at much higher prices." (31) The "majority of over 100 settlement statements contained false information about the buyers' and sellers' monetary contributions to the transactions." (32) Appraisers "overstated [the] property values and misrepresented ownership at the time of the sale." (33)
In Newark, New Jersey, Thomas Fauntleroy and David Bowie admitted to inducing the FHA to "insure mortgage loans valued over $1 million, made by Neighborhood Mortgage (owned by Bowie) to unqualified buyers." (34) "In support of the FHA loan applications, the defendants allegedly created and submitted false and fictitious bank statements, leases, IRS Forms W-2, verifications of past mortgage payments, pay stubs, attorney escrow letters, gift letters, verifications of employment, deposit checks, and fraudulent property appraisals." (35) Fauntleroy was sentenced to 21 months in prison and ordered to pay $524,000.00 in restitution. (36) Bowie was sentenced to 12 months in prison and ordered to pay $500,000,00 in restitution. (37) Another of Fauntleroy's coconspirators, attorney Peter Port was sentenced to five months in prison. (38) Port, who "served as the title agent on many of the properties involved in Fauntleroy's schemes...