Disclosure on Short Sale Flips – New!

by Attorney William Bronchick

Short sale flips - the process of shorting a property then reselling it for a cash profit in a simultaneous closing - has been taking heat lately from title companies and real estate brokers. Realtor blogs are filled with drivel about how these transactions are illegal or unethical. What's the real truth?

The Basic Process

The process of the short sale flip works as follows.

Step 1: Investor signs a contract to buy a house from a seller who is behind in payments.

Step 2: Investor contacts seller's lender to negotiate short sale

Step 3: Investor gets lender to approve short sale

Step 4: Investor lines up backend buyer

Step 5: Investor closes with seller, paying off lender, then resells to backend buyer in simultaneous closing for a profit.

In essence, this is no different than a regular wholesale flip except instead of paying off seller's lender in full, investor pays off seller's lender at a discount.

The Hoopla

Some Realtors and title companies think there should be full disclosure to the lender and seller about the resale of the property, otherwise the bank and seller are being "defrauded". In order to be defrauded, someone must be owed a legal duty of disclosure. As far as disclosure to the seller, I see no issue because the seller is not getting any money out of the deal either way. His lender will not agree to a short sale while the seller walks away with money. So any profit made by the investor is fair game. As far as disclosing to the lender that you plan on reselling the property for a profit, of course you are going to do that. That's what investors do - they make a profit. If you planned on keeping the property as a killer rental instead of flipping it, there would be no issue. If you fixed the property up and sold it 3 months later, there would be no issue. For some reason everyone gets upset because you are flipping it an hour later for a profit. In order words, what exactly triggers a duty to disclose to the lender that you intend to make a profit? Well, in at least one state (Colorado), the law now requires you to disclose if the resale is intended within 14 days.  This requires an all-cash closing on the front end with no back-end contract signed until day 14, risking the loss of your back-end buyer.  Geniuses at the Colorado Legislature passed this law under "Consumer Protection".  Exactly which bank is the consumer??

Disclosure

Chances are this will end up in court someday and a jury will have to be convinced that failing to tell people you are reselling your property for a profit is somehow a fraud upon the lender or the seller. Nobody wants to be the test case, so I think that to be on the safe side, your contract with the seller should clearly disclose that you intend to resell the property for a profit. "Buyer may resell the property in a simultaneous closing for a higher price and make a profit." This covers the seller, but what about the lender? Well, the lender gets a copy of the contract in the short sale package the investor submits to the lender. This puts the bank on notice (We all know that the package is 100 pages long and the bank's loss mitigator is probably not going to read the contract in detail, but who's fault is that?). Should you further disclose in your cover letter to the lender that you have a buyer lined up to resell the property to at a higher price? Hmmm...