Flop houses: six appraisal experts discuss the unethical practice of property flopping.

YOU'VE HEARD OF PROPERTY FLIPPING, but the hottest new word in the lexicon of real estate jargon is "flopping." We asked a panel of Appraisal Institute members and industry leaders to explain what flopping is, how it works and how it's impacting the marketplace.

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Weighing in are John Bredemeyer, SRA, president of Realcorp Inc. in Omaha, Neb.; Ann Fulmer, vice president of business relations for Agoura Hills, Calif.-based Interthinx; Joni Herndon, SRA, president of Real Property Analysts/GulfCoast in Tampa, Fla.; Debbie Huber, SRA, owner of Huber Appraisal Inc. in Las Vegas; Sara Schwarzentraub, SRA, president of Inter-State Appraisal Service in La Mesa, Calif.; and Danny Wiley, SRA, owner of The Wiley Group in Nashville, Tenn.

WHAT IS FLOPPING?

According to Fulmer, flopping occurs when parties to a short sale (or an attempted debt-reduction loan modification) collude to deflate the value of the collateral property. She says real estate agents are frequently involved; they either work with the "investor" to create a low-ball broker price opinion by concealing higher offers from the seller's lender and putting a low-ball price in the Multiple Listing Service (MLS), or by marking the property in the MLS as being under contract when in reality it's only under an "option purchase contract," which gives the investor exclusive rights to buy the home for a year at a specific price.

Huber agrees, saying that flopping is "a form of property flipping for profit that involves a real estate agent engaged in the listing process who (directly or indirectly) purchases the property for less than market value in order to make a quick sale to someone for a profit."

"Like flipping, (flopping) is happening for quick money. The object of both flipping and flopping is to create equity or a spread, which represents the investor's profit margin," Fulmer adds. "Flopping is happening because we're in a declining market. It works because the price manipulation is not seen by the lenders, and since the sale to the end buyer is at or near actual market value, that transaction doesn't raise any eyebrows either."

Huber says another contributing factor is the fact that many lending institutions holding "toxic" assets are willing to sell their foreclosing properties for less than the mortgage--and they are relying on BPOs to determine value before the short sale. "In many cases, however, the BPOs coming back to the banks are completed by parties that may have a bias about what the property should initially sell for," she notes.

Bredemeyer adds that at a banking level, flopping is occurring due to the demands of the banking system. "Banks want to eliminate nonperforming loans as quickly as possible in order to avoid the headache of having federal auditors list 'exception items' in their audit reports," he says. "To hold nonperforming or REO on their books, banks must address these with the auditor, and the banks' presidents must disclose these to their boards. In some ways, it's just easier to let a property sell low and take a known hit rather than keep nonperforming loans and REO properties."

THE EFFECT ON NEIGHBORHOODS

Fulmer believes that flopping puts additional downward pressure on the value of surrounding properties. "When a low price is recorded in the MLS, it creates additional uncertainty as to the actual market values for the area," she says, emphasizing that the instability of local markets allows fraud to flourish.

Schwarzentraub echoes those sentiments. "I'd say that with any flop, the short-sale process creates confusion about a property's value," she says. "The initial (short) sale comes in extremely low, followed by a flopped sale, which is much higher and gives the false impression of market value increase--so it confuses just about everyone.

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"No wonder some lenders won't make loans these days!" she adds.

Herndon sees the practice of flopping affecting both neighborhoods and the broader economy, with perhaps its greatest impact being on the American consumer. "Remember," she says, "the American taxpayers are the ones who footed the bill to bail out many of the nation's banks. For these same banks to be receiving under market value for their assets is detrimental to their long-term recovery and the recovery of the financial sector in general," she cautions.

OTHER CONCERNS

How can an appraiser know if a property was flopped or not? "It's simple: Investigate!" Schwarzentraub says.

"Call the seller's and buyer's agent to get the details of the transaction, property condition, etc.," she explains. "Also, look at public records and the MLS for any prior sales in a short duration of time."

Fulmer lists red flags that indicate when a property may have been flopped and says appraisers specifically should watch out for a short-sale price that is low compared to actual market value and in comparison to other comparables in the area. Other warning signs she points out are an MLS listing history that shows signs of manipulation (a very low MLS price that is withdrawn, followed quickly by a "new" listing with the same real estate agent at the higher "retail price") and an indication that the seller on the higher-priced transaction was not the owner of record at the time of the listing or the sale.

"Appraisers also need to be aware that an agent may try to manipulate them," Fulmer notes. "Watch out for pressure to low-ball the price opinion; property titles that have recently been transferred to a land trust, a common ruse to evade a lender's anti-flipping requirements; and corporate entities with whom you are unfamiliar appearing on the scene to buy a property, among other common-sense signs."

What can banks do to avoid getting flopped? "First, let me say that there is certainly nothing wrong with an investor making profits by buying and selling wisely," Wiley explains. "The controversy around flopping centers on those who do it unethically: They mislead the lender or take advantage of the fact that the lender is not local.

"Therefore, one of the best defenses for the lender is the use of competent local appraisers. Appraisers who can analyze complicated markets, appraisers who can provide different types of value opinions (market value and liquidation value), and appraisers who can write concise and meaningful reports are one of the lenders' best defenses against a fraudulent flop," Wiley advises.

Bredemeyer believes banks must decide if they want to take the "risk" of holding a property to see if they can get more value, or short selling just to get the property off their books. "Either way," he says, "the best thing the bank can do is to employ knowledgeable appraisers who can give them an accurate opinion of value."

According to Bredemeyer, what isn't in a bank's best interest is spending $50 on a broker price opinion, which is typically performed by an agent with minimal valuation education or sometimes with a vested interest in the property, and then expect to receive reliable information.

"So often in life, you do get what you pay for," he says.

Huber agrees, reminding bankers that by law an appraiser must be unbiased.

Fulmer believes that one of the biggest dangers for banks is when the person preparing the BPO has an undisclosed interest in the transaction. "The perpetrators frequently use corporate vehicles--such as LLCs--to disguise their interests," she explains. "So it's very difficult to spot those conflicts of interest. That's why it's so important for banks to pay close attention to values."

Fulmer says she is encouraged to see that more lenders are requiring appraisals instead of BPOs and getting review appraisals, because it shows they "get it."

"Fraudsters are always adapting their techniques to current market conditions," she notes. "As long as there are underwater borrowers and high default/foreclosure rates, banks will be vulnerable to flopping schemes. My advice to lenders out there: Use available tools and technology, work with trusted professionals and be careful!"

Aaron Hultgren is a communications specialist for Appraisal Institute as well as a staff writer for the organization's Appraiser News Online e-newsletter. He can be reached at [e-mail].

There are various outlets to which appraisers can report fraudulent activity. Here are a few:

State Attorney General--www.consumerfraudreporting.org/stateattorneygenerallist.php

HUD--www.hud.gov/offices/oig/hotline/index.cfm

Fannie Mae--www.efanniemae.com/utility/legal/antifraud.jsp

FBI--www.fbi.gov/hq/mortgage_fraud.htm

THE FLOP COPS

Our panel of experts:

John Bredemeyer, SRA

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Ann Fulmer

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Joni Herndon, SRA

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Debbie Huber, SRA

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Danny Wiley, SRA

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RAISE THE ALARM!

How can you tell that a property has been flopped? Here are some of the top red flags:

1 A short-sale price that is low compared to actual market value

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2 An MLS listing history that shows signs of manipulation (i.e., a low listing that is quickly withdrawn in favor of a higher price)

3 Any sign that the seller on the higher-priced transaction was not the owner of record at the time of sale

By Aaron Hultgren, Appraisal Institute communications specialist