Short sale fraud is costing lenders hundreds of millions of dollars as short sales increasingly take the place of foreclosures as a solution for distressed mortgages.
Among properties involved short sales, four percent are resold within the following 18 months, and 1.87 percent are part of an “egregious flip,” according to a short sale research study released Aug. 10 by CoreLogic (NYSE: CLGX).
The study assesses the risk for lenders of short sale fraud. CoreLogic defines such fraud as “a transaction where parties involved in the process manipulate the short sale transaction and/or subsequent transaction for profit.”
As a clear-cut example, imagine an agent hired on behalf of a lender to make a sale, where the lender is open to a short sale. After receiving an offer from a would-be buyer, the agent then contacts a third-party investor to make a lower offer than that of the would-be buyer. The agent then submits only the lower offer to the lender. After negotiating the short sale at the lower price, the agent then negotiates a subsequent sale at the higher price between the third-party investor and the initial potential buyer. The agent and the investor share the difference in the price.
“The fraud I guess is when there’s collusion when going into a short sale,” said Mark Riedy of The University of San Diego's Burnham-Moores Center for Real Estate.
Freddie Mac (NYSE: FRE) defines the practices as “any misrepresentation or deliberate omission of fact that would induce the lender, investor, or insurer to agree to the terms of a short payoff that it would not approve had all facts been known.”
Of all short sales nationwide, 55.8 percent took place in California, Arizona, Florida, and Texas. California alone accounts for 16.75 percent.
CoreLogic’s report defines a lender’s “unnecessary loss” on a short sale by the short-sale-to-resale percentage gain in price compared to the period between the two sales.
But Riedy says that’s too simplistic a qualification.
“If I go through short sale as an owner and told you what’s happening and this is the price, and you come in right behind it, it still might take six months to turn it because lenders take so long to agree to a short sale by going through committee,” he said.
Riedy also notes that a longer delay could work in the fraudulent party’s favor, as rising home prices might produce a stronger return six months from now.
CoreLogic determined that four percent of all properties subject to short sales were subsequently sold again within 18 months. Assessing the increase in price between those transactions as an unnecessary loss to the initial lender, the company found that 47 percent of those transactions, or 1.87 percent of all short sales, were potentially fraudulent.
Dawn Lewis, owner and agent at New Dawn Realty, questioned the company’s statistical definition of potential fraud, saying an accurate account would need to look at each transaction individually.
“There are some circumstances where a property is close to foreclosure, needs a lot of repairs, or for some reason is going to be very difficult to sell,” she said. “At that point you go after an investor anyway. Do I think there are agents that are low-balling and have investors in their pocket? Yeah, but it’s circumstantial.”
Riedy doesn’t believe short sale fraud is a problem in the market. Not having seen the CoreLogic report, he guessed that less than 1 percent of short sales were fraudulent.
Frank McKenna, vice president of fraud solutions at CoreLogic said his company also developed a more selective measure of potential short sale fraud, called “very suspicious short sales.” Roughly a third of the 1.87 percent of short sales flagged as potentially fraudulent qualified under this tighter measure, or one in every 200 short sales.
Despite the large volume of short sales in California, its rate of fraud is actually lower than the rest of the nation, at 0.81 percent. Those instances of potential fraud amounted to more than 12 percent of the nationwide total, a spokesperson for CoreLogic said.
San Diego County accounts for 11.1 percent of all suspicious short sales in California. Its rate of potential fraud is slightly higher than the rest of the state’s, at 0.85 percent.
Based on the company’s estimate that each instance of short sale fraud leads to an unnecessary loss of $41,500, short sale fraud amounts to $310 million in unnecessary losses for lenders annually.
Using that same estimation, short sale fraud in San Diego County has had a negative financial impact of $2,474,230 on lenders.
McKenna said rates of potential fraud are not increasing along with the increase in short sale activity.
“That’s surprising,” he said. “My gut tells me it is going to increase in time.”
“I don’t know that there’s proportionately more fraud [as total short sales increase],” but fraud picks up when there’s turmoil,” Riedy said. “In boom times there’s lots of fraud, and in times like this there’s a lot of fraud.”
He said that it would stand to reason that random individuals wouldn’t be responsible for the fraud that does exist.
“Frequently, wherever there is fraud it’s a concentrated source,” he said. “It’s either a company or a group that are allied in some fashion and work on it together.”
McKenna said the FBI investigates systemic patterns of short sale fraud.
“They’re very much looking into short sale fraud if it looks like an agent is getting involved,” he said. “It looks for agents that get into it over and over."
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