REQUIRED READING: With any surge in volume – no matter what type of transaction – comes an increased risk of fraud. There will always be individuals who seek to profit from others' hardships, and the distressed-property market is no exception. The good news is that servicers can take proactive steps to avoid unnecessary losses when performing short sales and liquidating real estate owned (REO) properties from their portfolios.
According to CoreLogic's 2010 Short Sale Research Study, the number of short sales has more than tripled since 2008. This sudden onslaught undoubtedly increases the opportunity for fraudsters to manipulate the process and slip through the cracks. The CoreLogic study estimates that approximately 1.9% of short sales are considered risky and warrant further investigation – representing an estimated $310 million in collateral each year.
Recent efforts to expedite the short-sale process, including the government's Home Affordable Foreclosure Alternatives program, have also led to concerns that fraudsters might try to sneak their way into the process.
"I think the more you speed up the process, the more you're going to have fraud," says Frank McKenna, vice president of fraud strategy at CoreLogic. "It's just across the board – anytime you make the process faster, you tend to have fewer checks. It becomes more attractive. If you speed it up and make it a 10-day process, or a 20-day process, you're going to attract a lot more [fraud]."
When it comes to property disposition, fraud can occur with any party to the transaction, says Joe Filoseta, president and CEO of default solutions provider DepotPoint. That could mean the seller, broker, buyer or borrower – or a combination thereof. Collusion among parties and fraud by valuation companies and brokers are on the rise, he notes.
Whereas flipping properties by overvaluing them was a prevalent scheme of the last decade, one of the most common short sale fraud schemes today involves "flopping" by investors, McKenna explains. For instance, an investor approaches an underwater borrower and negotiates the sale on his or her behalf. The investor then solicits offers on the property, showing only the lowest offer to the lender, and later re-sells the property for the higher price to the undisclosed buyer who had submitted a higher bid. In this case, the fraudster takes advantage of all the parties involved: the lender, the borrower and the buyer.
In another popular scheme, brokers or investors fabricate Multiple Listing Service data or information related to the condition of the property or the borrower's situation, says Mark Chapin, chief valuation officer at Interthinx. "For instance, you might have an appraiser working on a completely marketable short [sale] or REO property and then report that property back to be – instead of "marketable' – "marginal,'" he explains. "So they're downgrading the appearance of the property so that then they can build a market approach that will allow them to come in with a lower value." Then, the property is flipped for a higher value within a short period of time.
But what, exactly, flags a resale as suspicious? "Typically, a 30 percent appreciation on the property within 30 days," McKenna says, noting that CoreLogic has seen resales with 100% appreciation the very same day. "But we do kind of draw the line, because it is very hazy what [is considered] a nice profit and what's a misrepresentation." McKenna adds that CoreLogic uses this appreciation indicator because the company does not necessarily have all of the paperwork from the investors and lenders to be able to see if the eventual buyer was disclosed. "You can't really fix up a property within 30 days if you're going to make a $20,000 to $30,000 profit on it," he points out.
The largest concentration of these flopping ploys is not occurring in places where the properties have suffered the highest losses in value (e.g., Detroit), Chapin says, but rather in areas where there is a heavy volume of distressed properties – higher-value areas in California and Greater Chicago, for example.
However, Chapin notes that short-sale fraud must be examined on a neighborhood-by-neighborhood basis. "You may have a cluster of neighborhoods in a five-mile radius, and you may find that Neighborhood A is experiencing a depreciation rate of three percent, while Neighborhood B has a different home type that may not have been as appealing as others, and is appreciating at 9.5%," he says. "So when you look at a statistic, you have to look at it neighborhood by neighborhood."
McKenna, on the other hand, says the incidence of short-sale fraud correlates with enclaves of shady investors working together. "We see hotbeds of this type of fraud in certain areas of the country," he says, listing Memphis, Tenn.; Atlanta; and St. Louis as prime examples. "When these investors tap into a strategy that works, they don't just do it once; they'll do it as many times as they can."
And while fraud committed by the borrower may appear less prevalent, it is another area that warrants servicers' attention. According to Jon Meade, vice president of loss mitigation at Fifth Third Bank, some borrowers are hiding their capacity to pay or falsifying a hardship in order to receive a short sale. "I think what we're seeing is the [borrowers] realize that they applied for a short sale and they have the capacity, so they'll be denied," he says. "So they try to give us the information that would show that they need a short sale and they're underwater."
Risk management
No matter what type of fraudulent resale servicers encounter, there are ways for them to mitigate that risk and minimize the losses on their books. "The No. 1 rule to prevent fraud, generally speaking, is know the parties that are involved in the transaction," Filoseta advises. Broker-driven transactions demand considerably more due diligence than servicer-driven ones, because there may be undisclosed parties involved in the transaction. In a servicer-driven short sale, however, the borrower is most likely emerging from some kind of loss mitigation alternative, such as a failed Home Affordable Modification Program modification, so the servicer is already familiar with the property and the borrower's situation.
For broker-driven short sales, Filoseta recommends that servicers verify all brokers' licenses and search their records, as well as investigate any third parties that are introduced into the equation. "The opportunity for a third party that's in some sort of collaborative, fraudulent arrangement could easily slip through the cracks," he warns.
Filoseta also suggests that servicers monitor transactions, even post-sale. It may not be the ideal technique for combating fraudulent disposition, he acknowledges, but it does allow fraudsters to be identified, making it more difficult for them to strike again. "The folks that are involved in fraud are not just doing this once – they're doing it as a business," he notes.
Fifth Third proactively combats short-sale fraud by keeping broker price opinions (BPOs) in-house, Meade explains. The company's Equity Decision unit is responsible for comprehensive property valuations, which include an appraisal, BPO and pull-down of title. Within a month or two after the short sale closes, Fifth Third also does a subsequent title search to see if the property has been flipped, which would necessitate further investigation.
Although Meade says he has not seen a lot of collusion taking place in Fifth Third's short sales, the company does require the buyer, seller and agent to sign an affidavit stating that they are participating in an arm's-length transaction. "If we find that they violate that affidavit, post-transaction, we'll go after them," he says.
As an additional quality-control measure, Fifth Third's Equity Decision unit continually monitors its vendors. "They'll look at the comps, they'll look at the quality, and if they feel that the vendor that's providing the service or product is not perfect or not up to the quality they expect, they remove them from the vendor list," Meade explains.
Despite Fifth Third's current due-diligence efforts, there was a point when Meade was worried that the quality of Fifth Third's short-sale transactions was suffering, because the servicer's loss mitigation staff was overwhelmed with loan mods. Now, Fifth Third's short-sale unit is centralized and focuses exclusively on short-sale transactions. This has allowed for a reduction in caseload per person and an increased focus on due diligence, Meade explains.
"They have the time to get forensic; they have the time to analyze every customer, every deal – so that reduces the likelihood of somebody trying to pull one over on us," he says.
With borrowers, verification and identification are essential. Borrowers must be examined pre- and post-transaction, Meade states. In addition to all the usual checks – income verification, credit checks, market-value research, title and asset search, etc. – servicers should investigate whether borrowers continue to experience hardship, even post-transaction, as well as follow up on deficiency notes, in order to prevent unnecessary losses.
Overall, industry experts agree that fraud – whether in short sales, REOs or any other type of transaction – is not going away anytime soon.
"We can expect to see different types of REOs and short sales – and just general valuation fraud schemes – prevalent in our marketplace until it starts to turn a little bit," Chapin predicts. "I think that you will see this activity going on into the foreseeable future. It's just the nature of the beast. Real estate is a barter commodity, and anytime you have a barter commodity, you have transactions that are unscrupulous."
