Tuesday, October 16, 2007

The effects of Fraud on Prices

If you have not been reading much real estate news you may be unaware of just how much fraud there has been in real estate over the last few years. There have been several major fraud rings operating in places like the Inland Empire, Bakersfield, Atlanta, New York and nearly every other hot market. Some of these rings are now under investigation and there have actually been a few arrests. Many more are sure to follow as the FBI starts to investigate these rings.

This fraud took many forms and there were several different scams. The most popular was to find an “investor” or using identity theft use some poor guys name and credit to purchase a home from an honest seller. They would often offer the seller far more than they were asking but then ask for the excess to be refunded to them after closing. So a seller asks $500k, these clowns show up and say, “I’ll give you $600k but you give me $100k back at closing. Most sellers were happy to do it, as they got their house sold. In this scam they would have an appraiser and often a mortgage broker working with them in order to secure financing. Once the property was purchased the buyer would often take his cut and vanish without making any payments on the loan. They would often times purchase multiple properties at the same time in order to increase the money they stole.

A second version of this scam is where they buy the house at asking price then refi immediately and pull money out based on a phony appraisal. Once they get the money they stop paying the loan just like in the first scam.

The results of these scams is to artificially inflate the value of homes in the area. As you can see from this example pulled from a realtors blog, it only takes ONE of these scams in an area to screw up the whole neighborhood.

Real Estate Fraud

I was startled in early 2006 when I interviewed to list a small house near the train tracks in Mag Center in Riverside, and the sellers told me that other agents had told them the tiny 2/1 bungalow was worth over 400k. I told them this was impossible. If their house had been one of the cute historic Tudor-style cottages from the 1920's, it may have been possible, provided that it was in excellent condition. But their house was from 1959 and, though nicely updated inside, the exterior was chocolate chip mint green. I gradually talked them down, and for the next 6 months, I struggled to get their price down to reality.
There was, however, a house across the street that was from the same year and had similar square footage though with a 3rd bedroom and another bathroom. This house had sold late in 2005 for 480k, which seemed bizarre. It couldn't have been worth more than 380k during the slow fall period, and even that would have been pushing it. This house would come back to haunt everyone.
A neighbor called me off my sign for a CMA. When I met with her and told her what her house could go for at that time, she informed me that they owed more than that. They had just refi'ed a few months before, and an appraiser had said their house was worth much more. That's when I realized that the mystery house was getting people into trouble.
I poked around some more and discovered that the house had been sold in 0 days on market, with the agent representing both sides. According to public title records, the buyer had gotten 100% financing. Yet the house had been listing just a year before and had failed to sell at 359k, even though it was described at that time as a 4-bedroom.
Well, this past spring, that house went on the market as a pre-foreclosure house. They were asking 305, dropping to 299k without any bites. Now it's bank-owned with a dead lawn and a couple of broken windows. They're currently asking 295k.
Just where did that extra $100,000+ go? Apparently, according to mortgage fraud investigations into companies such as Stonewood Consulting in Murrieta, the money would appear to go to the buyer at close of escrow. The buyer would then give the money to his mortgage broker who would then promise to help pay the mortgage while investing the money in other properties for the buyer. The realtor got an extra 3k in commission (it was 3% to the buyer's side, but there was apparently a dual rate commission, so we don't know how much total he got.) He didn't do the loan, as far as I can tell, but he's likely related in some way to the lender. In the end, the buyer was stuck with an unpayable mortgage and couldn't possibly sell the house for close to what he owed. The bank is stuck with a house that wasn't worth nearly as much as had been invested. And who knows how many home owners in the neighborhood have been affected by that scam.

You have to wonder just how much of the run-up in prices was caused by this fraud. There already have been several LARGE examples of this scam found in the IE. The Stonewood scam (you should read this article) from the South IE (Temecula/Murrietta/Corona) is a perfect example. How many more groups were operating out here that we don’t know about?

Here's another very good article about real estate fraud


Aaron said...

Great stuff as always. We see a lot of examples of this fraud at the end of the housing bubble, but how much of this changed the comps during the run-up in prices. I'm betting a lot. I hope a lot of people go down for this, but aside from a few show trials I bet most are going to get away this.

PS -- your links in this story are broken

golfer_X said...

thanks, links fixed