Vincent Quayle and the folks at the St. Ambrose Housing Aid Center in Baltimore began to sense something was wrong about 1997, when people began coming to them for foreclosure counseling who weren’t victims of recent unemployment, illness, or divorce, but people who had never really been able to afford the house they owned at all. And their numbers – and the number of foreclosures – were increasing exponentially.
Andre Weitzman, a Baltimore attorney, got curious when in the process of representing Yvonne Peaks, a woman whose newly-purchased house had collapsed when the City demolished the one next door, he discovered that Robert Beeman, the man she’d bought the house from for $83,000 had bought it himself a month earlier for $15,000. From the property records, Weitzman found more than a hundred other people who bought from Beeman at substantial markups on quick resales and sued Beeman and G. Samson Ugorji, the appraiser, on their behalf in Spring 1998.
John O’Donnell, a Baltimore Sun reporter, had been working on a story about the high cost of renovating Baltimore townhouses when he happened on Weitzman’s suit. He started nosing around, eventually compiling his own database of 400 rapid resales, and then hit the streets interviewing and filed a major story on land flips in Baltimore on August 1, 1999.
In O’Donnell’s first story, Baltimore’s then-Mayor Kurt L. Schmoke said he didn’t know anything about flipping in the city and that if it were a crisis, “It’s been a quiet crisis.” Schmoke’s City Housing Commissioner Daniel P. Henson III said he had heard about flipping but doubted there was anything illegal about it. Homebuyers, he thought, should be warned to be more careful not to overpay.
There is a temptation to see guys like Beeman as private sector counterparts of non-profit housing developers – providing affordable housing to first-time homebuyers and keeping up values in the neighborhood. Or at least to say they are doing the capitalistic thing – buying low, sometimes fixing up properties a little, and selling high – and we should be proud of their entrepreneurial spirit.
But the truth is that behind the paperwork of property flips are a lot of lies orchestrated to create an illusion that the properties are worth more than they are, or the buyers are financially stronger than they are, or both. When markets cannot differentiate between illusions of value and the real thing, everyone gets hurt – not just the buyer, but the whole neighborhood.
A Widespread Problem
Land or property flipping (as distinct from loan flipping which is repeated refinancing by predatory lenders) happens when property is purchased and quickly resold for a large profit, after little or no meaningful rehabilitation. There is growing evidence that property flipping has become epidemic in low-income urban housing markets.
In Baltimore, 2000 properties were resold within 120 days in the past four years for at least twice, and sometimes up to ten times, what the seller paid. According to the Cleveland Plain-Dealer, 1000 flips, worth more than $31 million, have occurred there since 1997, about 80 percent in the lowest income East Side neighborhoods. Boston researcher John Anderson has been documenting the growth in land flips in the low-income, predominantly minority neighborhoods there since the early 90s. “So much fraud, so little time,” he quips. HUD recently launched investigations of property flipping in Atlanta, Los Angeles, Chicago, and New York.
Flipping isn’t new. In Brian Boyer’s 1973 book on FHA-financed land flipping and block-busting schemes, Cities Destroyed for Cash, he describes walking around a boarded up HUD-owned house in Detroit and hearing a child playing in the yard commenting to a friend: “That man…[is] a speculator, gonna buy up this house and trick some poor mother again.”
Price Versus Value
Flipping is a cyclical problem embedded in the dysfunctional housing and mortgage markets in low-income neighborhoods. Property flippers usually justify their profits in one of three ways. First, they allege they got lucky and heard about a “bargain” they were in a position to “snap up” at a below-market price. Second, they assert they are smarter than other buyers in the market and saw unrecognized value in the property that they were able to market to bring a higher sale price. Finally, and perhaps most common, sellers say they put value back into the property by rehabbing it before reselling it.
Flippers often call themselves “developers.” The more authentic among them buy houses in poor neighborhoods, dirt cheap, replace the windows and put on vinyl siding, then quickly sell them to unsuspecting first-time homebuyers at huge mark-ups. The less authentic among them simply buy and hold the property for a few months, weeks, days, or even hours, before reselling them at double or even triple what they paid. The most criminal among them sell and resell the property to each other several times before selling it to a buyer who never takes possession of it before defaulting on the mortgage, in order to engineer a completely phony high-price sale.
The flipper never does the substantive rehabilitation – electrical, plumbing, heating, roof replacement, insulation, porch replacement, de-leading, using licensed contractors who take out building permits and whose work is inspected by city inspectors – that would justify significantly higher resale prices.
Yet the flippers claim if someone is willing to pay this much that is how much it must be worth.
Anyone who has worked with low-income people facing overpriced financial services, or even retail services, know that that claim is bogus. Sales price and market value are not the same. Fair market value is what well-informed buyers acting in their own best interests will pay for a property offered on the open market using typical financing. In property flips, these conditions are not met.
Take, for example, the case of a buyer with absolutely no savings. Two identical houses are for sale on the same street. One is selling for $50,000 and the other is selling for $100,000, but the first would require a $5,000 downpayment. The seller of the second house is willing to take back a second mortgage for all the buyer’s cash expenses. The buyer has no choice. They must buy the more expensive house or not buy at all.
That does not prove the house is worth $100,000. The financing was not typical. The buyer was not in a position to negotiate anything; the seller, in fact, was able to set the price. And arguably, the buyer was not particularly well-informed or acting in her or his own best interest in taking on a mortgage in excess of the property’s true, $50,000 value.
At other times, sales price exceeds value because the buyers are working in concert with the sellers and are not even attempting to negotiate the best price. Baltimore Sun reporter John O’Donnell wrote on June 19 about Mary Anne Shirvani Kintop, a Pennsylvania woman, who took out twelve mortgages for over $1 million in eight different names, including those of her two young daughters. Her 7-year old took out three. A real estate broker, William Otto Schmidbauer, was the seller in all the cases. When O’Donnell found Kintop, she was living in poverty, recovering from a stroke and a long-time drug habit. Her former husband remembered Schmidbauer had paid her $800 to $1000 for the use of her name for each mortgage. So if Mary Anne Shirvani Kintop paid $100,000 for a house, we shouldn’t infer too much about its value from that.
Flips Harm Whole Neighborhoods
Protesting that some home prices in low-income areas are too high can appear, superficially, to be playing right into the hands of the appraisers who refuse to value houses in lower-income neighborhoods above some invisible ceiling no matter how wonderful they are. (See Shelterforce, May/June 1997).
The problem here, however, is not a high price; it’s a high price relative to a property’s underlying value. In a rational market, a well-maintained house with a new roof and updated systems would get a better price than a fully disinvested house with a leaky roof and antiquated systems.
But markets heavily impacted by land flipping are not rational markets. Each flipped sale is an incorrect price “signal.” Other sellers and buyers in the same housing markets make inferences about what other houses are worth based on flips, without realizing they are not market sales. Like viruses in a hard drive, these sales corrupt the entire market.
Whatever price a heavily disinvested house that has been flipped can garner becomes a new “bottom” for all properties in that market. Buyers, not realizing the flipped prices resulted from non-market sales, will mistakenly decide that prices for more invested properties should be higher. Over time, prices in the entire market move upward. Temporarily.
When the flipped properties go to foreclosure, as they almost inevitably do, often all at once, prices plummet below actual market values until the excess supply is absorbed. If another owner has to sell at that time, they risk getting less than they owe on their mortgage.
Land flipping accelerates disinvestment. Flippers pull value out of properties, not put investment dollars in. The instability caused by high foreclosures fractures the social fabric and ultimately lowers the actual values, not just the prices, for all properties in the immediate neighborhood. The risk for other owners of getting no return for improvements is often high enough to discourage other owners from significantly rehabbing their own houses.
All You Need Is Fraud
Healthy neighborhoods require rational housing markets where more valuable houses get higher prices than less valuable ones. In upper-income neighborhoods, real estate brokers and mortgage lenders insist everyone play by the rules so this happens. In lower-income neighborhoods, many of them break the rules themselves.
Property flips almost invariably involve mortgage fraud. The proof of the fraud is in the loan files, which lie about what a property is worth, and lie about the buyer’s ability to repay the mortgage.
An appraisal to determine the market value of a flipped property can lie by either misrepresenting the condition of the property, or by comparing it to sales that are not really comparable – that are in other, more highly-valued neighborhoods, or that have also been flipped recently.
The illusion a buyer can afford the mortgage is sometimes supported with falsified, or even completely fabricated, documents. Forged paycheck stubs, Federal tax returns, and credit reports can now be created by a computer and a laser printer.
Historically, fraud prosecutions have done little to hinder land flippers. In the wake of the FHA scandals in the early 70s, when block-busting and land-flipping using FHA mortgages left tens of thousands of homes in America’s inner-cities vacant and boarded, a small percentage of the property flippers, real estate brokers, and appraisers involved were indicted, tried and convicted of fraud. It made no long-term difference.
Some of today’s flippers and their accomplices will be tried and convicted, too. But the rewards of flipping can be so great, and the risk of prosecution so small, that prosecution can be expected to have little deterrent effect.
After the Baltimore Sun’s stories began last year, alerted community leaders decided to go beyond the prosecutions law enforcement is vigorously seeking. In January, they met with Senator Barbara Mikulski, a savvy and powerful native of these neighborhoods. Quayle gives her all the credit for making Secretary Cuomo and HUD care about the problem.
A hearing Sen. Mikulski held in March led to the creation of a joint task force with HUD, a 90-day FHA foreclosure moratorium, and a three-month intensive research effort in Baltimore. In June, the Task Force announced a Fraud Prevention Plan that may, for the first time, actually prevent future property flipping using FHA financing.
Rather than place the onus on the buyer not to overpay, this approach places the responsibility on FHA to make certain properties are not overfinanced.
New systems will be designed and implemented to identify flipped properties before they are insured and to monitor the track records of appraisers and mortgage brokers, modeled on the recently implemented Credit Watch program for Lenders.
Lenders, appraisers, and brokers whose loans default at above-average rates will be suspended from FHA participation. Furthermore, FHA will institute early warning indicators to identify high-foreclosure zones that may have been subject to property flipping and mortgage fraud leading to the higher default rate and target those areas for intensive investigation as they have done in Baltimore.
More to Be Done
Numerous problems remain. HUD Inspector General Susan Gaffney is concerned about exactly how all this will be implemented, who will do it, and who will pay for it. Probably the larger concern is that in most markets, including Baltimore, the vast majority of property flips are not financed by FHA but in the private mortgage market. This portion of the market does not have a Fraud Prevention Program. It may be that local governments will have to institute ones that cover all lenders.
In the meantime, community advocates and activists should learn to recognize and monitor property flipping in their own neighborhoods. Investigate the circumstances of each sale, publicize those findings as widely as possible, and protest lenders whose loans make these manipulated sales possible.
“Sunlight is the best disinfectant,” wrote Louis Brandeis, in his 1913 book Other People’s Money. At a minimum, it is a good place to start.