When You Smell Something Odd

I received a call from a real estate owner whose property is listed for $ 1.1 million. She had just received a verbal offer for $1.5 million, but with the condition that she pay back to the Purchaser $350,000 cash “outside the closing”. If she agrees to pay back $350,000.00 to the Purchaser, the Purchaser’s agent will prepare the offer in writing. Quick math will show that the owner was to make an additional $50,000 for selling her property in that way.

What’s wrong with this deal?

The Seller will get her full asking price, plus Realtors fee, closing agents get paid, and the mortgage company will get a new transaction fee; at closing everybody gets exactly what they are in business to get. What could be wrong?

Nobody really knows without taking this deal apart, but our senses tell us there’s something wrong. Experience tells us even more. This offer just screams tax trouble, because the sale price is likely to be reported for the parties differently. However, this article ignores the probability of improper reporting for tax purposes.

First, the Buyer has a friendly appraiser, and probably one who can be counted on to deliver an appraisal equal to or greater than the contract sales price. A bank will be asked to make a first mortgage on this property for the appraisal amount. If the bank follows its guidelines and makes only an 80% loan, an equity lender will be asked to make a loan for the difference between the first mortgage and the appraisal. If an institutional lender declines to make the equity loan, the Seller will be approached at or immediately prior to closing to hold a second mortgage. The purchaser plans to walk from closing with $350,000 in cash.

So, again, if everyone is getting what they want, how can a responsible real estate advisor tell a client there may be something wrong with this?

The possibilities are endless. We know the property will be more than 100% financed, and that this loan will probably cause a loss to a bank. If a bank sustains a loss, someone in litigation will determine that cash was given at closing and which was not disclosed revealed in the closing statement. A closing agent may lose his license and probably be sued. An FBI agent may very well be called on to determine who created or caused bogus closing papers to be written, on which the bank will have relied, that caused the loss, which equals bank fraud.

Everyone associated with the deal will proclaim that “this was just another real estate deal”, and no one will admit knowledge of the slight of hand used at closing. But usually almost everyone in a transaction like this has relaxed his ordinary operating procedures. Sometimes only a little, but always some. The appraiser was either dishonest, or entirely too helpful in trying to make the deal happen. A closing agent ignored the rule that all the money is to be shown in the closing statement. Banks sometimes bend their own down-payment rules. In the end, everyone associated with the transaction will be tainted by a very high probability of civil litigation, exposure to criminal prosecution, and damage to reputation.

Really weird things happen in a really weird real estate market. Weirdness has been the order of things for the last two or three years because of a market on fire. Weirdness pervades now because the market has no fire at all. Specifically, “appraised value” of everything appears discretionary, even if the same property sold only last week.

While the market may be strange, our ethics and procedures should not be. The adage that, “if it looks too good to be true, it probably is”, is the very best real estate advice any of us can have. I don’t know how to tell anyone to smell out mortgage fraud, except to say that if it smells unusual, you must find out why.

The above example is only one variation on a very large theme. You show your love for the profession, each other, and yourself, if you blow the whistle on these deals before they happen.