Land Flips, Fraud and Double Escrows

Land flips are hot right now in Minnesota. Florida, California and maybe Arkansas come to mind when thinking about real estate fraud. However, this one has made it to the frigid upper Midwest. State real estate licensing officials estimate there have been 250 land flips involving low-end properties, other estimates are higher.



land flip involves a fair market sale from a usually honest seller to a speculator and then a sale by the speculator to a co-conspirator or an unsophisticated buyer. Here the ultimate buyer is often a single low-income mother who understandably wants to raise her children away from the gunfire and drug deals in rental properties.



To put numbers on it, the first purchase agreement is for $25,000, the true market value of the marginally habitable property as reflected by the property tax value. The speculator then makes a second purchase agreement for $75,000 with the unsophisticated buyer, supported by an appraisal that uses erroneous comparable sales to support the $75,000 price. Oftentimes the second purchase agreement includes overvalued repair and improvement allowances.



The speculator (often a real estate broker or mortgage broker) assists the unsophisticated buyer in qualifying for an asset based, sub-prime loan, because the buyer has a bad credit history. A title insurance agent issues a title commitment showing the speculator in title, when the first purchase agreement has not closed. The speculator needs to show good title so the loan to the buyer will close. There are often simultaneous closings of the first and second purchase agreement.



The speculator takes a "carry-back" mortgage for the spread between the $55,000 asset based loan and the second purchase agreement price. The speculator often funds the buyer's "cash needed to close" outside the closing by an alleged gift of the closing costs. The speculator usually gets that cash back at closing. The sub-prime, secondary market lender probably does not know it is taking a $55,000 mortgage on a $25,000 property, but I wonder if some secondary market lenders want to book the loans and sell them. Perhaps they plan to be in the Bahamas when the economy turns and these loans shake out.



The speculator usually does not try to collect monthly payments on the carry-back mortgage, hoping to make a second killing when the buyer refinances or sells.



Where do you draw the line between an aggressive business deal and a fraud? The US Attorney, the FBI, the Minnesota Attorney General and the Commerce Department are looking into these transactions, but what is their statutory or common law basis for nailing the speculators? Some appraisers are losing their licenses, and presumably, some real estate brokers and mortgage brokers will lose their licenses, but what are the standards?



Who should bear the risk of loss: the sub-prime lender, the unsophisticated buyer, the secondary market, the speculator, the real estate broker, the mortgage broker and/or the title company? Where is the line between a title company taking the business risk that the first deal will not close, and insuring the speculator in title, when the speculator has only equitable title under a purchase agreement and not actual fee title under a deed? When is the title company, buyer and/or sub-prime lender a dupe or duplicitous? Clearly, the speculator should bear the risk of loss, but people who have no honesty are difficult to collect from because they have no qualms against using false identities and they may not stick around for the fallout.



I think its important to note that the terms "speculator" and "land flip" should not necessary be viewed in the perjorative. There is nothing inherently illegal, unethical or immoral about entering into a contract to sell an asset before you have closed the transaction to acquire the asset, as long as all the necessary and proper contingencies are observed and disclosures made. If this were stock, I think they would call it selling short. In California we would probably call this a double escrow. But there are also many legitimate uses of such devices. I just want to make sure we don't paint all "speculators" with one brush.



In the 1980's land flips were found to be a primary factor in the failures of many S&L's. The worst of these often involved large parcels of vacant land--such as along Interstate 30 between Dallas and Fort Worth--achieving astronomic (false) values in "flips" done in rapid succession between parties acting in collusion. Many of these folks went to prison for bank fraud--so they got "painted" pretty good.