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Fannie Mae, by way of its October 2010 Mortgage Fraud News update, defined flopping as a process “wherein the perpetrator influences the loss mitigation process by deflating value so the servicer will accept an artificially low short sale offer.  The perpetrator then profits by selling the home to an end buyer at the home’s true market value or at an inflated value.”  The FBI’s 2009 Mortgage Fraud Report similarly defines flopping as a practice in which “the perpetrators collude with appraisers or real estate agents to undervalue the property using an appraisal or a broker price opinion to further manipulate the price down (the flop) to increase their profit margin when they later flip the property.”  While any such practice would undoubtedly constitute fraud, the question that exists is how prevalent is flopping in today’s marketplace.

While the FBI is clearly concerned with fraudulently deflated pricing, its 2009 and 2010 Mortgage Fraud Reports lack any meaningful explanation as to how flopping is effectively perpetrated in today’s environment in which lending institutions are keenly focused on not falling victim to any such scams.  As listing agents in today’s short sale market can attest, lenders utilize a variety of valuation tools that make it extremely difficult for a fraudulently deflated sales price to be approved.  Even assuming that a dishonest seller and/or real estate agent seeks to undervalue a home’s worth, lenders virtually always order an appraisal or broker price opinion (BPO), both of which are performed by licensed and independent third-party  professionals.  Most lenders will additionally utilize a computerized automated valuation model (AVM) to confirm the results of the appraisal or BPO.  Discrepancies between the AVM and the bank’s valuation often trigger a second BPO or appraisal from yet another licensed and independent third-party professional.

In most instances, a successful flop will, at a minimum, require the involvement of a buyer, real estate agent and two separate BPO agents or appraisers, all of whom must be willing to provide inaccurate or falsified data to the loan servicer.  Furthermore, the scheme to defraud would likely have to involve the assigned bank negotiator as well.  Because more than one bank negotiator is typically assigned to a short sale throughout the life of a file, and because these individuals are closely monitored by supervisors, manipulating the bank’s valuation is extremely difficult, and it is hard to imagine a scenario in which so many individuals successfully conspire to commit criminal activity.

Unlike flopping, in which the sales price is artificially manipulated, the practice of flipping is often a legitimate business venture when performed outside of the short sale context.  Freddie Mac defines property flipping as “the process by which an investor purchases a home and then resells it at a higher price a short period of time later.”  For example, an investor may purchase a home for $100,000, make $20,000 worth of upgrades and then sell the home months later for an increased price that reflects the home’s fair market value.  Such is a legitimate business practice.  With that said, flipping a short sale often constitutes fraud and is far more common than flopping and substantially easier to perpetrate.

Flipping in conjunction with a short sale is typically consummated pursuant to a scenario in which an investor purchases a property via a short sale and, prior to close of escrow, secures a third party to whom the property will be immediately sold for a higher amount.  In such a scenario, the perpetrator deceives the lender into approving the short payoff by concealing the existence of a pre-arranged end buyer who intends to purchase the property for substantially more money than the approved short sale price.  The problem lies in the fact that the short sale lender is not informed that the buyer is immediately flipping the property for thousands more than that same lender has been told the property is worth.

While it may be assumed that such transactions are difficult to achieve because the short sale buyer must secure a purchaser willing to buy the property for more than the approved short sale price, the reality is that several market factors enable the practice of flipping.  Loans in default and scheduled to be foreclosed create a distressed sale in which the seller is often unable to secure a top-dollar offer.  By removing the property from foreclosure and eliminating the distressed sale, all while the market continues to improve, the short sale buyer is able to flip the property for a profit.  Authorities nonetheless view flipping of short sales as mortgage fraud because the perpetrator fraudulently induces the lender to approve the short sale by hiding the fact that there is a second buyer willing to pay more than the offer presented to the lender for short sale approval.

Short sales are viewed as a critical part of our real estate market recovery. These transactions enable distressed homeowners to get out from under huge debts and allow banks to avoid the expense of a trustee’s sale while recovering more money than they would likely receive following a trustee’s sale.  While flopping is more myth than reality in today’s market, the practice of flipping threatens the banks’ willingness to effectuate short sales and exposes real estate licensees to great risk and liability.

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The property is worth less than is owed.
Establish this by doing a careful CMA or BPO, taking into account that the market may be declining. Pay special attention to similar properties that did not sell. The lender will need to see clearly that there is no chance that the property will sell for enough to cover all liens and closing costs. Short sales are considered by buyers to be distressed properties, and will typically command somewhat less than a non-distressed price. Remember that the lender may be thousands of miles away and not at all familiar with your market. Incorporate local newspaper articles about the local market and MLS statistics to strengthen your analysis.

The seller has some hardship that makes it impossible or extremely impractical for the seller to keep the property.
What are hardships as defined by most lenders? Most lenders focus on and require “changed financial circumstances”. Loss of job, unusual medical costs, death of an owner, natural disasters, even extended military service for reservists, can be hardships. There should be a nexus between the hardship and the need to sell. A job loss leading to a problem paying the mortgage is obvious, but an illness might require a family to move closer to specialized medical help, so even without an unbearable financial hardship, the homeowner simply cannot stay. Lenders do not consider a decline in value alone to be a hardship.

The seller is cooperative and willing to work with a real estate broker to package the short sale.
Is the seller cooperative and willing to sell? You will need the seller to help write a narrative of the hardship involved. The seller will be asked by the creditor to reveal all details of the seller’s financial situation. If there is a formal short sale application, the seller will have to complete it. This can be embarrassing, and some sellers simply won’t do it. Prepare them and make sure they are willing to do what is required. If they are uncooperative, you will not be able to help them.

Important Note:  Many troubled loans today are “subprime loans” and/or “stated income loans”. Be especially careful to explain in writing to all sellers that any representations of the seller’s financial status that were made on the initial loan application will be scrutinized in the short sale application process. Sellers may expose themselves to charges of loan fraud if the short sale application information they provide is inconsistent with the material provided on the initial loan application. In other words, if the seller represented on the original loan application that his income was $10,000/month, but on the short sale application represents that his income recently dropped from a high of $5,000/month to $3,000/month, this will raise the question of loan fraud. If the seller is concerned or has questions, it is advisable for the seller to consult with an attorney before completing a short sale application.

The lender is contacted and expresses willingness to entertain a short sale.
Contact the lender’s “loss mitigation” department. Ask for the person who will be responsible for processing the short sale application. Try to speak with the same person each time you call. You will need an authorization letter from the seller verifying that you have permission to speak with the lender on the seller’s behalf. Let the lender know the situation and your proposed short sale solution. Ask for a list of documents that the lender will require. This may vary with each lender. Ask for copies of any proprietary documents the lender specifically wants to see, such as a particular short sale application form or an income and assets sheet. These also will vary by lender. The lender may ask you and other area brokers to do a Broker Price Opinion (BPO) to verify your evaluation. If there is more than one loan subject to a shortfall, you will need to contact multiple lenders and go through the same process. Some lenders are proactive and will immediately send the short sale requirements to you. Others will be non-committal. Even institutions go into denial when faced with bad news. Unless the lender indicates that it will categorically refuse a short sale under any circumstance (a rare occurrence), you can proceed with the next steps.

The property is listed with appropriate caveats and protections for the seller, properly priced, and effectively marketed.

• Seller Protections: When you list the property it is important to have a record of the discussion you have had regarding the short sale with the seller. The listing agreement should state that the seller’s acceptance of any offer will be subject to the lender’s approval of the offer without requiring that the seller bring cash to close escrow, and an agreement by the listing broker to accept the commission as approved by the lender. Offers to purchase the property would need the same caveat regarding lender approval. This protects the seller against agreeing unconditionally to sell the home, only to have the lender disapprove the short sale. In such a case, the seller could be sued for specific performance or damages by a frustrated buyer. The seller should also explicitly acknowledge that the seller will receive no proceeds, that there are significant tax, credit, and legal ramifications to a short sale, and that the seller has been strongly urged to consult with an attorney and a tax advisor before signing the listing.
  AAR produces a Short Sale Addendum to the Listing Contract. For more information regarding this form, go to AARonline. www.aaronline.com/2008/08/short-sales-revised-forms-and-new-resources/
• Pricing: It makes no sense in a short sale setting to start with an unreasonably high price. Some sellers will ask that you price the property at a “break-even” price for them initially. Use your best judgment, and follow your broker’s policies and procedures, but know that a price that attracts no offers will hurt your seller. If the foreclosure clock is already running, you may run out of time. Price the home at a realistic market price today. Adjust the price quickly if you see no activity or if you have no offers. To make the short sale work, you will need to get an offer to the lender quickly.
• Commissions: Short sales present a special problem with conditional compensation being offered to a cooperating broker. As a listing agent, you are not entirely sure what your commission will be until the terms of a short sale are approved by the lender. Your MLS may have adopted NAR-approved language such as the following based upon changes adopted by NAR at the May 2008 meeting:

Lender Approval Listings
Multiple Listing Services must give participants the ability to disclose to other participants any potential for a short sale. As used in these rules, short sales are defined as a transaction where title transfers; where the sale price is insufficient to pay the total of all liens and costs of sale; and where the seller does not bring sufficient liquid assets to the closing to cure all deficiencies. Multiple Listing Services may, as a matter of local discretion, require participants to disclose potential short sales when participants know a transaction is a potential short sale. In any instance where a participant discloses a potential short sale, they must also be permitted to communicate to other participants how any reduction in the gross commission established in the listing contract required by the lender as a condition of approving the sale will be apportioned between listing and cooperating participants. All confidential disclosures and confidential information related to short sales must be communicated through dedicated fields or confidential “remarks” available only to participants and subscribers.

Multiple Listing Services that permit, but do not require participants to disclose potential short sales should adopt the following rule:

Section 5.0.1: Participants may, but are not required to, disclose potential short sales to other participants and subscribers. When disclosed, participants may, at their discretion, advise other participants whether and how any reduction in the gross commission established in the listing contract, required by the lender as a condition of approving the sale, will be apportioned between listing and cooperating participants.

Alternatively, Multiple Listing Services that require participants to disclose potential short sales should adopt the following rule:

Section 5.0.1: Participants must disclose potential short sales when reasonably known to the listing participants. When disclosed, participants may, at their discretion, advise other participants whether and how any reduction in the gross commission established in the listing agreement, required by the lender as a condition of approving the sale, will be apportioned between listing and cooperating participants.

• Marketing: Both for the seller’s sake and to generate lender confidence, your short sale listings should be aggressively marketed. Whatever you would do for an ordinary listing, you should do for a short sale listing. Use multiple pictures, virtual tours, websites, and advertising as appropriate. You may want to accelerate the marketing if there is a foreclosure deadline looming. The lender will need to understand that you have done everything possible to sell the property at the highest price. The lender is not your client. You represent the seller, but everybody should understand that the lender is the true decision-maker. You will want to include the marketing history in the short sale package. Once again, if you have no offers within a reasonable time, adjust the price.

The lender is presented with an offer, accepted by the seller, along with a completed short sale package, hardship letter, and narrative explaining why the short sale is necessary and desirable.

• The Offer
  1. The ideal offer should be from a prequalified or preapproved buyer, with no unusual contingencies, such as the sale of the buyer’s existing residence. It should be flexible in terms of closing. The ideal offer might provide “The close of escrow to occur 30 days after buyer’s receipt of acceptance of the short sale by the lender”. The ideal buyer is willing to be patient. Of course, not all offers will be ideal. If you receive a very low offer, you may wish to attempt to negotiate it between the seller and the buyer as in an ordinary sale setting. Certainly you should counter terms that affect the seller in a negative way, such as early possession without compensation or inclusion of seller’s personal property. Remember that it is the seller who “accepts” the offer. Once the offer is fully negotiated between buyer and seller, it should be signed by both, subject to the approval by the lender as discussed elsewhere in this document. Recognize that lenders will want to see “as-is” offers without credits for repair or closing costs paid to buyers. Policies regarding short sale counter offers vary widely around the country, and also between brokers. Experience suggests that if you receive an offer on the low side of “reasonable” from a qualified buyer, you may still want to pass the offer along to the lender. In a short sale it is more important to get the lender a bona fide offer than it is to negotiate the perfect sale price. The very fact that an offer is presented to the lender for approval may persuade the lender to put the foreclosure process on hold, at least temporarily. The lender will have every opportunity to disapprove the offer and request a different price. Of course, just as in a traditional sale, all offers you receive must be presented to the seller throughout the course of your agency agreement.
  2. AAR produces a Short Sale Addendum to the Residential Resale Real Estate Purchase Contract. For more information regarding the use of this form, go to AARonline.https://www.aaronline.com/law-ethics/risk-management/Aug08.aspx
  • The Completed Hardship Letter, Short Sale Package, and Narrative
    Every lender is different, and each short sale package can be different as well. You may choose to submit most of the package to the lender when you obtain the listing, and then pass along the offer, or you may wait until you have an offer to submit a complete package. The following are the most common elements. Some will be required, and some are advisable because they help you explain to the lender why the short sale is a good alternative to foreclosure:
    1.  A hardship letter written by the seller describing the seller’s circumstances.
       The seller should be as persuasive as possible in describing why the seller is in no position to continue with his or her financial obligations to the lender. This letter can make or break the short sale. The reasons given by the seller should be compelling and the seller should be both honest and frank in their disclosures to the lender. Include corroborating material. If the seller was fired, include the termination letter. If the seller has medical bills, summarize them. If the seller is ill or disabled, the seller should explain how that has made it impossible for the seller to keep the property. If there are tax problems, the seller should describe and document them. If the property was damaged and not covered by insurance, as in several recent natural disasters, the seller should document the damage and the denial of the claim.
    2. A copy of the purchase contract and all supporting documents signed by both the buyer and seller.
    3. Written proof of the buyer’s ability to purchase the property, i.e., a completed loan application, pre-approval by a lender or evidence of cash on hand (a current bank statement).
    4. A copy of the certified escrow instructions.
    5. A preliminary title report.
    6. An estimated net/closing statement (HUD-1) certified by an escrow officer who is acceptable to the lender. It is very important that this estimate be as complete and accurate as possible.
       Many lenders will reference the closing statement in their acceptance or rejection. You may receive an approval that states “Lender will accept net proceeds of no less than $273,565 no later than November 30, 2009.” If the estimate of net proceeds is wrong for any reason, you may have to attempt to renegotiate with the lender.
    7. A completed and signed IRS Form 4506, “Request for Copy of Tax Form”.
    8. A completed and signed personal financial worksheet. This will include assets such as other real estate, stocks, bonds, 401Ks, etc.
    9. Tax returns for the previous two years.
    10. Employment paycheck stubs for the past two months.
    11. Profit and Loss statement (if the seller is self-employed)
    12. Bank statements for the past two to three months.
    13. A completed Short Sale Application if the lender provides one. Many don’t.
    14. Your CMA/BPO with supporting sales data. You want to show that the offer you are presenting is the best market price offer the lender is likely to receive.
    15. A short narrative, written by you, about the market and market trends in the immediate area of the property being sold. Highlight such data as average time on the market, number of short sale and REO listings in the MLS and price trends. Support your conclusions with material such as recent economic data and newspaper articles. The decision maker may well be in another state and will not necessarily understand why the property is suddenly worth less than the loan.
    16. Your marketing history, showings, and feedback. Here again, you need to show the lender that you have made a real effort to get the highest price. They must understand that you have done a better job than they would have and that you have presented them with a quick and attractive solution to a deteriorating situation.
    17. A formal request signed by the seller that the short sale be approved as submitted.
  • *Important Note: If there are multiple loans, you will repeat this process for each lender. It can be especially difficult to obtain a short sale approval from a second trust deed holder or other junior lienholder that is “wiped out” in a short sale. You will probably need to request that the first trust deed or mortgage holder offer at least a symbolic sum to the second trust deed holder to secure an approval. Anecdotally, second trust deed holders have recently been accepting partial payments as low as $5,000 on trust deeds of $100,000 or more.
  • Following Up. Once you have submitted the short sale package, stay in touch with the lender every day if possible. Make sure they acknowledge that the package is complete. Try to talk to the same person in the Loss Mitigation Department each time and document your conversations. This is not a happy decision for the lender. It will get shoved to the bottom of the to-do list over and over again. Lenders are infamous for “losing” short sale paperwork. Keep the seller and the buyer’s agent up to date. If there is a drop-dead time limit to the offer, remind the lender of it often.
  • Subsequent Offers.
    1. There are different opinions and practices concerning whether to submit all offers received to the lender, or whether to limit the submission to the first offer the seller accepts. Many lenders will require in writing that all offers be submitted, as a condition of reviewing the short sale package. Consult with your broker concerning the broker’s policy regarding subsequent offers. Remember, once again, that all offers must be submitted to the seller, even if they are not then submitted to the lender.
    2. In some areas, agents are simply submitting all offers to the lender without having the seller negotiate or accept any particular offer. Recognize that, without an accepted offer signed by both buyer and seller, you will not have a contract even if the lender approves. This approach presents certain practical and risk management issues. Consult with your broker about this practice if it appears to be common in your area, or if you are inclined to follow the practice.

Reprinted with permission from Realtor.org.

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