Real Estate Purchase Contract Scams

The appraisal textbooks don’t mention these, so I will.  Real estate purchase contracts are often constructed to mislead lenders and appraisers.  Various ruses are used to inflate stated purchase prices above market value, with the hope of tricking an appraiser into valuing a property at above market value and tricking a lender into offering a loan at an unsafe loan-to-value ratio. Many borrowers don't want to inject cash equity into a deal if they have the ability to purchase with "no money down". Heads, the purchaser makes money; tails, the bank takes back the property with no loss of money to the buyer.

What the buyer and seller are counting on is a phenomenon known as “anchor bias”, the tendency of appraisers to offer an appraised value identical to the purchase price. Various academic studies have indicated that this happens about 86 to 87% of the time, but I notice that some appraisers have been getting wiser lately.

Some ruses that I have recently seen include the following:

1. The “soft second” mortgage loan – forgivable seller financing used to inflate the contract purchase price.

My last appraisal assignment presented such a possibility.  It was an $8 million purchase contract which was contingent upon $4 million in first mortgage financing, supplemented by seller financing of $4 million.  The buyer would have no equity in the property, a situation that presents a high risk for loan default.

I suspected that the seller financing was a “soft second”, a seller concession disguised as a fake loan.  My suspicion was well supported by a contract purchase price which was $1.6 million above the listing price for a property that had been marketed for almost 3 years on LoopNet and updated only 8 days before.

Normally, the term “soft second” in the real estate industry refers to a legitimate second mortgage loan made at a below-market rate, perhaps subsidized by a government agency or a nonprofit entity.  In some cases, though, the seller financing is not meant to be paid back.  It is a price concession in disguise, meant to inflate a contract purchase price.

An appraiser cannot be sure the second mortgage is real or fake, so he must look for clues, the most obvious of which is that the purchase price is not supported by comparable sales or the purchase price is above the asking price.  The lack of equity contributed by the buyer should also make lenders and appraisers think twice. Nothing casts more suspicion on a real estate purchase than that the price cannot be supported by comparable sales.

One would think that some government agency or appraiser association would issue an “all points bulletin” on this deception, but this scam continues to this day.

2. Unsigned purchase agreements in draft form.

I have seen a proliferation of this trick in the last 2 years, and am currently witnessing it happen on a transaction in Puerto Rico.  The buyer just says that the purchase contract has not yet been finalized and submits his own version, usually in MSWord, with a different price.  Very simple, but these deceivers are counting on appraisers or lenders who will believe anything. 

Normally, an application for a purchase mortgage loan comes with an already-signed purchase agreement with contingencies for financing. Why and how could there be a closing without a definitive purchase agreement? An agreement that is not written is not worth the paper it is written on. There is no reason for an appraiser to accept an unsigned, draft purchase agreement as a reliable indication of value.

3. The double escrow

This is when there are two purchase contracts for the same property.  The first purchase contract is the legitimate one, and once closed, the buyer can then sell at a higher price to an entity he controls in a different purchase contract that he will submit to lenders and appraisers.  The latter transaction, however, is a sham "pocket-to-pocket" transaction.

4. Secret partnerships and "transaction facilitators"

In one instance I met with the owners/sellers of swampland intended for development of a marina residential community. The buyer and sellers were old friends, but none had development experience. I was presented with three conflicting purchase contracts, and whenever the story keeps on changing, that is a good sign of deception. After four hours I asked Mr. Seller, who lived in a trailer on the property, where he would be moving to. He seemed surprised and responded, "I'm staying here, of course.  I've got a lot of work to do!" which made it clear that he was part of the development team and this was not an arm's length transaction. I looked at his wife, whose facial expression said "How can my husband be so stupid?"

I discovered one company in Arizona that advertised "transaction facilitation" services. Step 1 is that the buyer forms a joint venture partnership with the transaction facilitator in buying the property in the guise of an LLC or Limited Partnership. Step 2 is the shell company (the LLC or LP) sells to the buyer again at a higher price in a sham transaction designed to trick a lender and maximize financing.

I encountered this company in a purchase loan application with a contract price which was twice market value.

Another type of "transaction facilitation" is those services which "rent" cash down payment money overnight to buyers while the purchase price is inflated to cover the amount of the phony down payment.  Law enforcement has been shutting down such operations in the United States. Read my post: https://www.internationalappraiser.com/search?q=down+payment+fraud

5. The missing addendum

Sometimes the purchase contract has a dangling reference to an addendum that suspiciously gets separated from the contract. I am looking right now at a purchase contract with an asterisk by the stated sales price. Below the asterisk is the explanation: “*Sales Price is subject to adjustment based on Special Provision Addendum”. When I requested the missing Special Provision Addendum, it stated that the purchase price could be adjusted to 50% of my appraised value. Knowing that a property will be sold at half my appraised value – now that is a sobering thought.

6. The straw buyer

I recently appraised a parcel of raw land for a purchase money loan to a prospective developer of a hyperscale supercomputing facility along the NLR (National LambdaRail).  The purchase application indicated that the buyer, who supposedly owned a hyperscale computing company, was putting no cash into the transaction; seller financing would fill the funding gap.  At the same time, there was no discernible relationship with the sellers.  The appraisal failed to hit the purchase price, but rather than trying to negotiate the purchase price down, the buyer spent two months arguing that the property should be appraised higher.  Finally, a background check indicated that this man was no computer expert but had a history of legal judgments, bankruptcies, aliases, criminal convictions -- and a degree in political science.  It appeared that he may have been hired to be a fake buyer to bail the sellers out. These types of arrangements are sometimes found offered on LinkedIn.

Straw buyers are more common than you would think.  As I drive around L.A., for instance, I see simple signs stapled to telephone poles advertising "Real Estate Investment Partners Wanted".  What happens when one calls the number is that a fee will be offered to someone with good credit to sign a mortgage loan for someone with impaired credit.  The fee might be $5000 or $10,000 for a residential mortgage, but I've seen a fee of $50,000 offered to sign a commercial mortgage.  In each instance, the real estate partner will be guaranteed to have his name released from the mortgage lien after funding of the loan, but it often does not work out this way, as what starts as mortgage fraud (use of a straw buyer with a high credit score) often continues as a mortgage fraud; the real estate "partner" is not released from the mortgage lien and ends up being pursued by a lender for the full amount of a delinquent mortgage loan. The organizer of the scam has already left town with the funds. Moreover, the "real estate partner" with the high credit score cannot report this fraud to law enforcement because he has already become an accomplice to mortgage fraud.

Other purchase contract deceptions

It is risky, any way, for an appraiser to automatically assume that a contract purchase price is identical to market value.  I have seen fake purchase contracts and purchase contracts which disguise the fact that the buyer and seller are one and the same. I have seen purchase prices inflated by real estate syndicators who are compensated as a percentage of the transaction price.

Many appraisers are so convinced that the purchase price is real that they make the mistake of making unconventional adjustments to sales data to support the stated purchase price. They may choose much newer properties or much smaller properties as comparable sales and fail to make adjustments for age or size.

Questions to ask

The first thing I do in analyzing the purchase transaction is to peruse the Internet to try to find the property listed for sale. LoopNet and realtor.com are good sources, but sometimes if you just google the address of the property, you can find a more obscure listing. When I find the property listed at a price below the contract purchase price, and the property has already spent a substantial time on the market, that is cause for suspicion.

The next question I ask the buyer and the seller, separately if possible, is "who were the listing broker and the buyer's broker on this transaction?" The reason why I ask is that I see so many purchase loan applications which are not represented by a broker, begging the question of how the buyer and seller found each other in a market with so many properties listed for sale. 

If there was no broker, there was most likely no listing or advertising, meaning the buyer already knew the seller, increasing the odds that the purchase transaction is not arm's length or could even be a "pocket-to-pocket" transaction with the owner buying the property from himself with my client's financing. Past experience has shown me that this is a way to make the lender the unintentional buyer of a hard-to-sell property.

One tell-tale sign of a fraudulent purchase is when the buyer complains that the value is too low. In legitimate purchases, the buyer often uses a low appraisal to negotiate a better price, and they sometimes even thank me for saving them money, but when a buyer starts making phony excuses as to why the appraised value should be higher, it is a signal to me that the buyer is either already affiliated with the seller, a straw buyer, or else the buyer and seller have negotiated a separate purchase agreement and the contract I was given was phony.

Recent adverse publicity for the appraisal profession

The National Association of Realtors (U.S.) has recently unleashed their well-funded publicity machine to criticize appraisers for failing to "hit" purchase prices. They publicize sob stories of realtors whose purchase deals fell apart.  "I had a bona fide purchase contract and the incompetent appraiser appraised it too low!" Such things could be said about me, too, but nothing is being said about the epidemic of deceptive purchase contracts nowadays.

To appraisers who think they must "hit" the purchase price:

If it was really true that the market value of a property is always the same as the purchase price, there would be no need for appraisals, would there be? 

It doesn't help, though, that some lenders have policies of sanctioning appraisers who don't "hit the purchase price".

Next stop: Puerto Rico

Related articles

• Appraisal in the former Netherlands Antilles
• 'Flippers' get a break from the FHA

Down Payment Fraud – in the Perpetrator’s Own Words

 

I received a lot of feedback on my recent post on Purchase Contract Scams, and I was asked if I could provide an example, so I present one here in the fraudster's own words.

 

The above video was made in 2007 and is an illustration of a phony down payment scheme which can lead to mortgage loan losses.  Observe that he never states that his scheme is illegal. The red flag in his presentation is the discrepancy between the purchase price of $250,000 and the appraised value of $300,000.   

What immediately charmed me about the video presentation was the speaker himself in his sunglasses. Is he blind?  Is he Kanye West? No, he was the founder of a service known as Payout One, and he evidently thought his future to be so bright that he had to wear shades indoors. Payout One has ceased operations since then.

 

PayoutOne was one of many "private contribution" services at that time which deceived lenders into thinking buyers were making down payments and paying higher prices than actual. Some of these services, such as the Nehemiah Program, even had religious affiliations, with the attitude that this was the morally right thing to do in order to let low income people own homes. The "private contribution" would be added to the real purchase price to create a new "contract purchase price" that would mislead lenders and appraisers.



I first became aware of Payout One on a hot August day in 2006 on the south side of Kansas City, in a neighborhood (near the intersection of Broadway and Armour) that often leads the nation in multifamily foreclosure rates.

 

I was there to inspect an apartment building, and the purchase price didn’t make sense to me.  The price was not supported by comparable sales in the neighborhood.

 

It also made me suspicious when several people showed up for my visit, because additional people are often sent to persuade me about something that I might not believe if told by just one person.  

 

If I feel that I am being misinformed, I search for the “weakest link” in the group and try to isolate that person for further questioning.  On that day, I judged that person to be a young man who showed up in suit and tie (unnecessary and uncomfortable on the south side of Kansas City in August), carrying a very thick file.  He introduced himself as the mortgage broker’s assistant.

 

When I got him alone I asked if I could see the file. He said “Sure.  You can even have it!”  I struck pay dirt when I found the escrow instructions from Payout One, as illustrated here.

 

In short, the purchase price had been inflated by $742,500 with this phony down payment.

 

Final thought

 

Readers, please use this information for good and not for evil.

Commercial mortgage “straw buyer” scams

Future Bible theme park or flooded sand quarry?

“Straw buyer” mortgage scams are often associated with handwritten “real estate investors wanted” signs stapled to telephone poles. Call the number on the sign and someone might just offer you $5000 to buy an overpriced house for them, using your good credit and good name. After closing, just transfer the deed to them and they will take over the payments. Then they disappear before you can transfer the deed and you are stuck with a house you overpaid for and are legally obligated to make mortgage payments for. You can’t report them to law enforcement, as you have just become a part of the mortgage fraud. The FBI has already labeled the practice of using straw buyers to mislead a lender as illegal "nominee fraud".

Straw buyers are sometimes employed in commercial mortgage scams, too, but are likely to be knowing participants in the fraud. They may be recruited in a LinkedIn group by someone offering $50,000 to someone to help buy a commercial property that cannot sell. For a clever person down on his luck, this can seem like good money.

The straw buyer has to come up with a believable enterprise that would make a compelling story that would justify an unwarrantedly high offer.

In one such case, a hyperscale computing startup company sought a location at the edge of a southwestern city and chose a 70-acre parcel to build a 100,000 square foot headquarters building. Their CEO presented me with an unsigned purchase contract for $8.5 million, of which $4.5 million would be provided by my client as a first mortgage loan and the remaining $4 million would be seller financing. I am always on the guard against “soft second” financing, which is tacitly a forgivable loan, so I checked the preliminary title report and the listing history of the property for some answers.

Red flag no. 1: The preliminary title report ordered for the buyer requested only $4.5 million of title insurance coverage, not $8.5 million.

Red flag no. 2: The property had been listed for sale on LoopNet for 28 months and the sellers renewed their listing 8 days previously at a price of $6.9 million.

Red flag no. 3: The sellers, who were local, never tried to contact me or meet me at their site, a situation I find common in straw buyer scams. They count on their straw man or men, hired for their marketing skills, to do their selling. Most ordinary sellers want to be there when I visit and can be pushy as hell, but in straw buyer scams they never want to meet me or talk to me.

Red flag no. 4: The borrower’s company had no history. A check of LinkedIn indicated several employees scattered around the country, but way too few employees to justify a 100,000 square foot headquarters building. The company web site was supposedly under construction and had the cryptic statement, “We are in stealth mode”. This statement is now 6 years old.

When the appraised value ended up being too low, the CEO insisted on having the appraised value increased, even flying across the country to bother the lender. I told the lender to ask him why he does not make the same effort to have the purchase price reduced; after all, this shopworn property was already listed for sale at $1.6 million below the contract purchase price. The borrower responded that he didn’t want to bother the sellers. He instead ordered an MAI appraisal which claimed that the property was worth $10 million.

Then I ordered a background check on the CEO and everything became clearer. While I expected someone with perhaps a PhD from Cal Tech or Stanford, instead I found someone with a bachelor’s degree in political science who kept on moving around from apartment to apartment in various states, had a bankruptcy on his record, as well as a criminal conviction for check fraud – perhaps the type of guy who would respond to a “real estate investors wanted” ad.

In a more colorful straw buyer scam, I was sent to Texas to visit the site of a proposed Biblical theme park, seen in the above photo. The developer had a purchase contract for $3 million but stated that the property was really worth $12 million. Although this developer claimed to have an office near the airport, he insisted that I meet him at a Denny’s restaurant near the site. (I prefer to meet real estate developers at their offices just to prove to me that they are real developers.)

I had already tried to run a background check on this man, but his name was so common, I could not distinguish him from many other people. I found his LinkedIn profile, but he had no history that extended back farther than 5 months. He claimed to have an MBA from Harvard. I e-mailed the HBS registrar and they replied that there was no record of him as an MBA student.

After a one hour presentation at Denny’s of marked up surveys and a singularly unusual illustration,

he drove me to the site in a rented subcompact car. The site was an abandoned, flooded sand quarry. I commented that a lot of the land was under water, and he responded that much of Disney World was built on Florida swampland and that the water would suit his “Jesus walking on water” and “Moses parting the Red Sea” exhibits. But quarry water can be deep, and the only uses I have seen quarries repurposed for are agricultural or fishing uses. Perhaps he could have built a "Voyage to the Bottom of the Sea" exhibit?

(The above illustration, titled "Babylon", was located by Google search as created by Austrian artist P. Pirker in 2007 and is available for free download at fantasyartdesign.com . It has been downloaded 17,302 times since 2007.)

The developer's survey indicated that the parking lot would extend into the adjacent nature preserve, and he said that the local town had approved this intrusion, although the nature preserve was state-regulated. When I walked on to the nature preserve I found four of these signs:

Imagine children and alligators in the same parking lot.  What could go wrong?

Researching comparable sales I found the perfect one just across the street, an abandoned sand quarry which sold for $225,000 to an organic farmer, which begged the question, how can one abandoned quarry be worth $3 million and the other just $225,000?

There was no development plan, not even a written plan that could be shown to me. There was no sewer leading out to this site and the road leading to its southern boundary was only two lanes, but then he told me that he had searched the world for the right location for a Bible theme park, and that this was it.

I had no credulity left, but since I now knew what he looked like I did a Google image search and found him as an alumnus of Tel Aviv University (an Israeli university). But when I re-ran the background search I found no history of the man after year 1987. No addresses, phone numbers, relatives, co-workers, places of employment, property ownership, etc. It was as if he had not been in the United States for more than a quarter of a century. Israel, perhaps?

His project did not get funded, but I learned some other amazing things. The man had two legitimate social security numbers. How can this happen? The Social Security Agency explains that it assigns sequential social security numbers to an immigrating family, but a minor is permitted to request his own unique SSN, which he did at age 17 while also having his name legally changed. A background search on the other SSN showed the use of both the old name and the new name and at least one alias name.

Here is the pattern of a commercial straw buyer scam:

1. The buyer, not the seller, shows the property.
2. The seller does not contact me, and if I contact them they tell me "talk to the buyer."
3. The buyer inundates me with irrelevant and misleading data designed to inflate my estimate of value.
4. When the appraised value is too low, they try to either beg or bully me to increase the appraised value. 
5. Most buyers thank me when I tell them they are overpaying for a property and subsequently reduce the price (Yay!) or else terminate the deal. Then I suggest that the buyer gets the seller to reduce the price and they tell me that they can't do that, yet there are no other bidders on these undesirable properties. And there's no sale.

In some cases, the straw buyers have already acquired the property, such as acquiring the seller's LLC (not recorded as a real estate transaction) or establishing a private joint venture with the seller. If the appraised value comes in too low, straw buyers do not try to negotiate a lower selling price, but instead waste their efforts on discrediting me or begging me to increase the appraised value.

Here are some parting thoughts. Appraisers are trained to analyze the property only; whoever owns it is immaterial because the standard definition of market value asks us to estimate what the next owner would pay for the property. In real life, though, an appraiser can be misled by false representations. Doing a background check on a commercial mortgage applicant can often clarify the loan applicant’s real agenda and alert the appraiser to perform a higher level of verification of the facts presented.

Related posts:

 http://www.internationalappraiser.com/2013/11/critical-thinking-skills-needed-for.html

http://www.internationalappraiser.com/search?q=purchase+scam

http://www.internationalappraiser.com/2013/05/down-payment-fraud-in-perpetrators-own.html