Flip Flop and You Don’t Stop

ATTOM Data Solutions recently released its First Quarter US Home Flipping Report, revealing post-recession peaks in home flips across the United States.  North Carolina is home to 3 of the top 10 home markets in US, with flip volumes in the Charlotte-Gastonia-Concord (8th), Raleigh (7th) and Durham/Chapel Hill (6th) regions representing rates of over 10% of all home sales. Interestingly, the data showed investment returns on flips continue to fall and the length of time of complete flips continues to increase.

While the typical home-flip transaction involves a distressed home purchased for a bargain, repair and modernization over several weeks or months, and then hopefully a sale at a profit, at LM Title we have seen a significant uptick in the number of calls where flippers already have an agreement to dispose of the residence prior to going on title.  These transactions are ethical mine fields, and recent activity by State Bar counsel reveal our regulator is currently investigating attorneys participating in these transactions.

It should be noted, there is nothing wrong conceptually with a flip transaction, even if the flipper never goes on title or is on title until the recording of the next instrument at the local Register of Deeds office.  Buying low and selling high is a goal in free-market capitalism - I hope to do it in the stock market, and I hope to do it with my personal real estate investing. The problem is instantaneous flip transactions have a great deal of potential for fraud, and therefore they are exceptionally disfavored by institutional participants.  If the fraudulent transactions do blow up, frequently the closing attorney is the only party around to answer to the institutional losers and the US Attorney.

Below are portions of a recent email I sent an attorney being pressured by a long-time client to close the transaction.

Dear X,

You asked I provide advice on a flip transaction you are being asked to participate.  Here are a few things you should consider before participating. 

1. Everyone must know what is going on.  Everyone.  In a typical A -> B -> C transaction, it is common for A, B, and C to be on board, but it is absolutely necessary for C’s lender to be aware of the flip transaction and informed in writing.  With traditional lenders, the closing instructions will have something buried in the 100 pages saying this cannot be done. Preventing these types of deals is the very reason 24-month chains of title are commonplace.  Even if your local mortgage guy states he is on board, you can imagine his boss is not.   If the boss is, see if you can get a change in closing instructions removing the prohibition.  I have never seen a deal completed with C using an informed institutional lender.  Never.  The deals I have seen involve cash or the extortion rate private loans.
2. If A is engaging through a short-sale, A’s lender must be aware.  Assuming it is an institutional lender, the short-selling lender almost certainly will not consent.
3. If everyone is aware, and has been informed in writing, the reality of the transaction must be reflected in the recorded instruments, settlement statements, title opinions to the title agent and trust accounting records. 

There are two and only two ways to do this: (1) an assignment or (2) a flip.  There is no hybrid of the two, and attorneys are subject to discipline for allowing the merger of these types of closings:

• For Assignments: One deed from A -> C
  1. One payment of Excise tax reflects the consideration C paid to A.
  2. One settlement statement, A is seller, C is buyer.
  3. B receives an assignment fee which is FULLY DISCLOSED ON THE SETTLEMENT STATEMENT.
  4. The only source of funds is from C. 
  5. Title opinion lists A on title and C as the new owner.

• For flips: 
  1. Two deeds, A ->B and B->C
  2. Two payments of excise tax.
  3. Two settlement statements.
  4. Two proceeds checks from the attorney trust account.
  5. Two separate sources of funds.  If B is not going to bring enough cash to complete the deal, the deal cannot close as a flip. B must have his/her own source of funds.
  6. The Preliminary Title Opinion lists A on title, states clearly B is going to acquire and dispose of an interest, and states C will be the ultimate owner.  Ideally, B gets his or her own title policy. 

4. In these deals, ‘B’ very likely is violating real estate broker licensing laws.  If you peel away all of the complications of the transaction, B is getting paid a fee for bringing A and C together, and that requires either a broker’s license or an exception. 

This is especially the case if B doesn’t have the ability to complete the transaction without using C’s funds.  This is near conclusive evidence the instantaneous sale wasn’t a fortuitus turn of events for B, it was clearly intended for him to market the property to a 3^rd party.  

5. Knowing this, if C still demands you go forward, you likely can still ethically participate in the deal, but understand you are dealing with people knowingly violating the law.  If things blow-up, these are the type of people very likely to start pointing the finger at you.  
   

6. Lastly, while mentioned above, I want to emphasize the need to make sure your title opinion is clear to the current state of title and that the flip will happen.  I know you would never be deceptive on purpose, but this is one of the situations where using your closing software to generate the forms will likely result in them being inaccurate (it will list B as the current owner).  I had multiple claims when working for a title insurance underwriter and while at Lawyers Mutual where this happened. Several times complaints were filed with the State Bar.