SHORT SALES ARE HAPPENING IN VEGAS THIS SUMMER
One in every 52 short sales in the first half of 2010 were “suspicious,” with the lender possibly falling victim to fraud, according to an analysis by CoreLogic..California led other states in these questionable transactions, with about a third of the suspicious short sales in the first part of last year, the analysis shows.
CoreLogic says that by the end of 2011, U.S. banks could face losses of $375 million because of short sale fraud. In the “suspicious” transactions, a short sale is quickly followed by a resale for a substantially higher price, sometimes on the same day. “This study reveals that short sales that show another sale transaction closing on the same day account for 16 percent of all suspicious short sales in the industry,” said Tim Grace, senior vice president of Product Management and Analytics at CoreLogic. “These same-day resales are on average $50,000 greater than the lender agreed upon short sale price.”
Investment companies are involved in a “largely disproportionate amount” of suspicious short sale transactions, the report states. Investors in limited liability companies are the buyers in 2% of all short sale transactions, but in 28% of the suspicious cases.
The estimated $375 million in losses for 2011 is up more than 20% from $310 million in estimated losses for 2010.
As part of the study, CoreLogic examined more than 450,000 single family residence short sales completed in the past three years.
One thought on “Short Sale Flopping Still Hapening”
Exposing Fallacies in the CoreLogic Suspicious Short Sale Report
Great Article By Ron Ballard Concerning Short Sales!
Could a highly publicized “study” warning of $375 million of “unnecessary” loan losses in “suspicious short sales” be manipulating figures just to sell more of its author’s services?
Prepare to read the following in depth analysis and I’m confident you’ll find that the answer is obvious.
Last week, articles began appearing in real estate oriented web sites and news services about CoreLogic’s “2011 Short Sale Research Study” and its alarming conclusion that lenders MAY incur up to $375 million in “unnecessary losses” due to “suspicious” short sales in 2011 alone.
It’s easy to parrot this fantastic conclusion. It’s another thing to analyze it. On Monday, June 6, I wrote my first article analyzing the study and found significant holes in it.
When looking deeper, one finds even more.
I understand that most journalists aren’t investigators and don’t have the time and resources to dig deeply into studies like this, particularly when the study’s title is so authoritative and the data looks so extensive.
Unfortunately, policy makers and regulators rely on information like this to make critical decisions.
What’s the result? Garbage in. Garbage out.
Give them faulty information and they will make ineffective decisions.
SUMMARIZING THE REPORT
It’s best if you read my June 6 article at http://bit.ly/illogic for background. I suggest the key premise of the study (besides that banks should buy CoreLogic’s over-hyped research services) is: If bank’s knew that a short sale property was going to be resold, then they could require the seller to breach the pre-existing contract with the current buyer and force the seller to enter into a contract with a subsequently found buyer who is ready to pay more now that the short sale has been approved.
Bear in mind that the study contains no discussion of consequences to the seller for breaching the contract with the buyer, nor to the banks for interfering with the contract of the buyer. As is the case in today’s political environment: it’s all about the banking corporations that are too big to fail and not about the individuals involved in the transactions.
The CoreLogic Study reportedly examines over 450,000 short sale transactions for single family residences (apparently excluding condos and coops, which in my clients’ experiences have a much lower level of resales and would skew the data downward) occurring over the last three years and categorizes them into “suspicious” and “not suspicious.” CoreLogic uses three parameters to categorize “suspicious” short sale resales:
1. Resales within 30 days with a 10% or higher resale value; or
2. Resales within 90 days with a 20% or higher resale value; or,
3. Resales within 6 months with a 40% or higher resale value.
Bear in mind that there is no legal basis for establishing these standards. No law sets forth an amount of “allowable profits” on real property resales. CoreLogic’s standards conceivably could be argued based on national averages, but real estate values are local. RealtyTrac is another large data provider. It’s study of pre-foreclosure discounts (short sales) for the first quarter of 2011 found a national average discount of 9.49 percent. (See http://bit.ly/q1RT2011 .) HOWEVER, the discounts for California and Arizona were 20.2% and 8.4%, respectively. Tennessee came in the highest at 34.9%. These numbers are affected by the overall decline in property values in a specific market. For example, if prices in Arizona have already dropped more than 50% from their peak, then the current discounts will be smaller because prices can’t go much lower.
Statisticians love math, so let’s crunch some numbers. Let’s assume a house with a current, non-distressed “fair market value” of $100,000. If the property is in Arizona, then the average discount last quarter would have been $8,400 for a short sale price of $91,600. If the property is in California, then the average discount would be $20,200, resulting in a short sale price of $79,800. Quite a difference.
Now let’s try to resell those homes for a “suspicious” 10% profit. The Arizona house would have to sell for $9,160 more than it’s $91,600 initial purchase price, resulting in resale price of $100,760. The California home would have to sell for $7,980 more resulting in a resale price of $87, 780.
Keep in mind that the assumed “fair market value” for each property is $100,000. Therefore, it unlikely that the Arizona house would have sold for more than $100,000; hence, investors likely would not even enter into the transaction because there is barely enough gross profit to cover closing costs when one considers acquisition costs of the initial purchase. The CoreLogic study implies that there should be a lot of “suspicious” short sales in Arizona due to the high volume of short sales generally, but the discount numbers indicate that “suspicious” short sales are unlikely in Arizona under market conditions of the first quarter of 2011.
It is unclear from the CoreLogic study (since the methodology is not clearly explained) if any “unnecessary losses” are speculated for Arizona. If so, the likelihood that they would actually be realized appears to be extremely unlikely in the lower mark-up ranges.
Now the “suspicious” California example sells for $87,780, which is more than 12% below the assumed “fair market value.” The end buyer is still buying at a discount from “market” and this hardly looks like a transaction in which anyone is being “gouged” at either end of the deals. The first buyer in this case could sell for a 20% profit and the difference merely represents the irrefutable market difference between selling the very same property as a short sale and not as a short sale – the 20.2 percent discount identified by RealtyTrac.
CORELOGIC’S MISLEADING EXAMPLES
Page 7 of the study shows two “real life examples of investor-involved, back-to-back short sale transactions. Profits to investors mean unnecessary losses for lending institutions” — according to CoreLogic.
The editorial bias demonizing investors is made without presenting necessary facts regarding the transactions. I sent out several emails asking for information on these transactions.
What I found out is astounding – but not for the reasons cited in the study or the articles about the study.
The Kings Beach Property: Kenneth Harney’s article characterizes the first example as follows: “A house in Kings Beach, Calif., was purchased near the height of the boom in 2005 for $530,000. On Oct. 28, 2009, it was sold to an investment group in a short sale . . . for $247,500. Later that day, the investors resold the house to a non-investor purchaser for $375,000. This produced a quick $127,500 profit — a 52 percent gain for the investment group in a matter of hours.”
Kings Beach is located on Lake Tahoe, right next to the border with Nevada. The buyer purchased the home as a demo-rebuild when the local market was still rising. At some stage in the construction there was a fire and the property was substantially damaged. Apparently the owner was under-insured or simply the victim of slow insurance claim reimbursement and was unable to complete the construction. Due to destruction of the roof, the property developed a mold problem. All the while, the local market was plummeting.
It’s hard to find a property with greater distress than this one – fire damage and mold in a declining market. Moreover, there were two judgments recorded, 4 mechanics liens, and past due income taxes to the Franchise Tax Board. It almost looks like CoreLogic intentionally picked the worst case example while withholding the relevant facts.
The property was listed in January 2009 and the foreclosure was commenced with a Notice of Default on March 25, 2009. (In California, the actual foreclosure auction can occur about six months after the NOD, which made the property at risk of loss by October.) The property went into contract for $375,000 but the buyer then backed out, presumably after conducting property investigations and finding how difficult it would be to clear the liens and complete the rebuild. The property went back on the market for $479,000.
Why $479,000 when the only contract was for $375,000? My guess is that the bank responded with a minimum price for short sale approval of $479,000. Unfortunately, there were no takes for $479,000, not even for $375,000. Understand that the cost to repair and complete the house exceeded $500,000. Who would want to touch that?
The property went into contract with the investor on June 21 and the short sale package was submitted to the bank on June 24. The investor made sure the homeowner signed an extensive affidavit showing understanding of the investor’s intentions with the property. Not only was notice of investor intent given in the short sale contract, the investor recorded a notice in July in the county records stating they were purchasing the property with investment or resale intent so no one would think they were hiding anything.
The investor got busy negotiating six liens and two judgments. All EIGHT lien-holders had to accept a discount, get paid in full, or get foreclosed out by the lender. Everyone involved in short sales knows it’s difficult to negotiate two and three lien cases. I have never heard of an eight lien case, much less an eight lien successful closing. That is an inordinate amount of work with a minimal likelihood of success. But this investor was bold enough to take a risk that no one else would take.
The original buyer who independently backed out of the first contract without collusion by anyone, subsequently told the investor they would still be interested in purchasing for $375,000 IF the property could be delivered clear of liens and ready-to-build. On August 31, 2009 the end buyer entered into a contract to purchase from the investor, subject to the contigency.
The investor completed numerous inspection reports, construction plans and building estimates based on the deteriorating condition of the property. They then obtained the building permits so the buyer would have a ready-to-build project.
The investor did not complete any physical improvements (although they likely carried the property preservation costs for four months). But the investor contributed substantial value by clearing eight liens and delivering a ready to build project with known construction costs, approved plans and active building permits. People involved in these kinds of projects would consider this accomplishment nothing short of a miracle. In no way was there any fraud or “suspicious” activity contributing to bank losses. There is absolutely no way that the bank could have obtained that price without doing all of the work the investor did. But banks don’t do that; investors do.
The bank likely netted far more from this sale than it would have by foreclosing on a mold ridden, fire damaged, deteriorating, partially constructed house. I know first hand. My son’s house suffered a serious fire less than six months after he moved in. Construction estimates kept rising while the insurance claim languished. Eventually, the costs to repair the 40+ year old house (which now had to meet current codes) rose to more than his original purchase price. If he had let the house go to foreclosure, it would have netted no more than land value LESS demolition cost, or less than $10,000 for a $107,000 house.
Moreover, CoreLogic misrepresents the numbers to exaggerate the “profit.” The study states that the investor made a 52% “profit”. (Harney uses a more vague term, “gain.”) That is entirely distorted. The property resold for a gross mark-up of 52%. “Mark-up” and “profit” are two entirely different accounting concepts.
“Mark-up” is based on the difference above purchase cost. “Profit” is based on the difference between sales price and costs. The true gross profit was only 34% ($127,500/$375,000), not 52%.
With real estate commissions of 6% plus typical closing costs of 2% ($30,000 total) and qualified inspections, biological hazard evaluations, structural engineering evaluation of fire damages, preservation costs, architectural/building plans, cost of closing funds, building permits, and the utility lien and mechanics liens that were held for the second closing, easily exceeding $25,000, the net profit was likely less than $72,500 or less than 19.4%.
This gain wasn’t made “in a matter of hours” as reported in the Washington Post, but earned over a period of four months of understandably hard work that likely consumed most of the investor’s time. All with the risk that the purchase might not close and that the property might not resell.
There is obviously nothing illegal, unethical, fraudulent or obscene about the Kings Beach transaction when one gathers the facts. What is obscene is the way CoreLogic and the press have mischaracterized it by omitting the critical back story.
The Gilbert, Arizona Property: Since my practice is in California, my sources of information for Arizona are more limited when reporting in a short time span like this, but this example is distorted as well. Harney reports, “A house in Gilbert, Ariz., sold for $400,000 in 2006. On March 2, 2010, it was bought in a short sale by investors for $220,000 and resold the same day for $267,500 — a 22 percent gain of $47,500.”
The real estate agents in Arizona that I contacted found one property meeting those parameters, so I’m pretty confident that they found it.
The original sale for $220,000 does not appear to have a listing on the MLS, so it likely was “for sale by owner” and I don’t know for how long. I also don’t yet know the foreclosure status. The MLS listing for the resale was entered for $275,000 on February 17, 2010 and indicates both that the property was vacant (because prospective buyers were required to turn on utilities for inspections) and that it was an investor resale that had not yet closed the first leg. Accordingly, prospective buyers knew what was involved. The property went into contract quickly on February 23 for $267,500. The $220,000 sale recorded (presumably closed) on March 11 (Deed Recording ID ending 5794, deed notarized March 3). The $267,500 sale recorded (presumably closed) on March 12 (Deed ID ending 9135, deed notarized March 6).
The deeds were pre-typed with a date of March 2, 2010, so that apparently is what CoreLogic used to report the “same day” sale, but that does not agree with the facts of actual recording dates. It appears that CoreLogic’s data services are not as accurate as they claim to be.
I don’t have the back story on the original seller, other than that the original mortgage on the $400,000 purchase was $320,000. This appears to be a conventional loan (20% down) and purchase in which the buyer was not engaging in aggressive financing. Since the house was vacant, some change in circumstances apparently occurred which caused the owners to move. Title was held as husband and wife.
CoreLogic again distorted the “profit” by using “mark-up” instead. The gross profit was only 17.76% ($47,500/$267,500), not 22%.
Assuming real estate commissions and closing costs of 8% ($21,400), the net profit was only $26,100 (or 9.75%). Incidentally, the investor’s purchase of $220,000 shows a mortgage of $227,172, which implies that its cost of funds was $7,172 and that it’s net-net profit was less than $18,928 (or 7%).
Without more information, this doesn’t look like the home run for the investor that CoreLogic implies. Since we don’t have any indication of collusion or wrongdoing, we don’t know if any of the “loss” is fraudulent. Moreover, the net spread potentially lost to the bank was only $26,100, which is $21,400 (45%) less than speculated by CoreLogic.
Hence, the $375 Million grossly exaggerated speculation of “unnecessary losses” is based upon:
CORELOGIC’S FUNDAMENTALLY FLAWED ASSUMPTIONS:
FIRST FLAW: CoreLogic’s first fundamentally flawed assumption is that the seller in distress could have received the same, subsequent, higher offer that the initial buyer (“investor”) received. As the RealtyTrac data shows, short sales sell at a discount below non-distress sale properties.
This presents a fact that is astounding to many uneducated observers: The very same house CAN have two different values on the same day. When the day begins, the house is a pre-foreclosure property with encumbrances in excess of value. In the morning, the initial buyer pays off the discounted lien for an amount to which THE BANK AGREED AFTER CONDUCTING ITS OWN INDEPENDENT PROPERTY VALUATION which considers the short sale stigma. Now the property is no longer a short sale or a distressed property. This eliminates the pre-foreclosure/short sale discount and the property returns to market value (in reality most short sales are in poorer condition than non-distress properties so the rebound probably isn’t to full fair market value). In the afternoon, the new end buyer is prepared to pay full value because they don’t have to deal with the delays, hassles, unpredictability and uncertainty of a short sale.
The investor buyer HAS added value to the property, even without hammering one nail or waiving one paint brush. How? The investor cleared title and eliminated the delays, hassles, unpredictability and uncertainty that exists for a short sale buyer. Therefore, the bank COULD NOT HAVE OBTAINED the second, higher price offer because it is based upon the prior, actual payoff of the liens and the bank does not payoff the liens for nothing.
If an accurate, unbiased study would be conducted analyzing the difference between the sale price of an “ordinary” short sale directly to an owner-occupant versus an investor based resale with clear title, my expectation is that the study would find: 1) that the price for the resale is higher than for the “ordinary” sale; and, 2) that the higher offer would not have been obtained but for the marketing done by or on behalf of the investor buyer (because it ordinarily occurs close to or shortly after the short sale approval when clearing title is essentially assured). Accordingly, most of the $375 million “unnecessary loss” estimate would disappear if the study would cure this one flaw alone.
SECOND FLAW: The “2011 Short Sale Study” states on page 4, “Not all transactions deemed suspicious using these criteria will result in a loss to the lender or mortgage note holder.” However, it does not state how, if at all, the study discounts the “unnecessary losses” for “suspicious transactions” which are not fraudulent – as only fraudulent transactions would be recoverable, not legitimate resales. If a high estimate of 20% of “suspicious” resale transactions are fraudulent in some respect, then that alone would lower the $375 million speculated losses to just $75 million.
THIRD FLAW: The CoreLogic study appears to assume that ALL of the gross profit on a resale constitutes “unnecessary loss” to the bank. This is never the case. As we saw in the Arizona example, closing costs and commissions likely consumed 45% of the $47,500 gross profit showing in the study. Alternately, if this sale had not been “for sale by owner,” it would have required a retail sales price of about $234,050 to net down to $220,000 after commissions on the first leg only. This would have greatly eaten into gross profits instead.
At a bare minimum, unavoidable closing costs and real estate commissions on the resale profit would reduce the marginal spread by 8%. This means the $375 million estimate is overstated by a minimum of $30 million and that no more than $345 million should be the starting point even if all transactions were somehow, remarkably fraudulent and recoverable.
Moreover, the study also assumes that none of the gross spread goes to pay liens outside of escrow. Few people like to admit it or talk about it, but one of real estate’s “dirty little secrets” is that junior lien holders often require payments outside of escrow greater than the amount approved by the primary lien holder. Hence, some of the gross profit which CoreLogic counts as “unnecessary loss” is actually repayment of junior lien holders to reduce their losses. Unfortunately, since these payments are “hush-hush” they are very difficult to quantify.
The $375 million speculative estimate is further falsely inflated by not allowing for property improvement costs. Resales with the longer holds of 30-90+ days likely involve more than cosmetic property improvements. These would often be more than 10% of the purchase price and reduce the “suspicious” 20% profit of “unnecessary losses” in half.
FOURTH FLAW: The potential losses are further overstated by not providing variations for local market conditions. As shown by the RealtyTrac data, the short sale discount in California was more than 20% last quarter. Therefore, any gross profit less than 20% should not be tagged as “suspicious” because it represents merely the difference between distress sale price and non-distress sale price. The reported discount last quarter for Florida was 14.85%, so the two States with the greatest number of short sales (and close to 40% of all short sales in the country per RealtyTrac) also have the highest overstatement of “suspicious” transactions, which easily could total 30%-40% of the $375 million – or more than a $100 million overstatement.
FIFTH FLAW: Finally, the study exaggerates losses by improperly alternating mathematical and accounting comparisons. For example, it tags a resale as “suspicious” when “the new sales price is at least 10% higher than the short sale price.” This means that a profit as low as 9% is tagged as “suspicious.” How is that? If the investor purchases the short sale for $100,000 and sells it for 10% higher, then the resale price is $110,000. When one calculates percentage profit ($10,000/$110,000), result is 9%.
IS THE RATE OF SUSPICIOUS TRANSACTIONS INCREASING OR DECREASING?
CoreLogic conveniently speculates the amount of “unnecessary losses” by creating an estimate of “suspicious transactions” for the first half of 2010 at $150 million, doubling it to annualize it, and then projecting a 25% increase for 2011.
Is this guess at a rate of increase reasonable under the current short sale environment in which banks have increased staffing and automation dramatically and added extensive independent valuation processes to determine acceptable short sales discounts? Not according to CoreLogic’s raw data. Figures 4 and 5 on page 4 show a decrease in the growth of suspicious transaction in second quarter 2010 compared to first quarter 2010. The spike in first quarter 2010 is understandable when one recalls the temporary spike in market prices resulting from the federal new home buyer tax credit. This brought a rush of buyers to the market who bid up prices. This also bid up resale prices for investor purchases that were already under contract and skewed the percentage mark-ups thereby resulting in more “suspicious transactions” merely to due market appreciation.
The suspicious transaction rates of the second quarter of 2010 returned to levels similar to the third quarter of 2009. Even though CoreLogic’s study was just published in May 2011, why was the data for the second half of 2010 omitted? CoreLogic conveniently states that it is still processing it. That makes sense for tagging “suspicious transactions” in the 90-180 day category after the third quarter. But why didn’t CoreLogic provide the comparative data for the less than 30 day and the 30-90 day categories, as well as complete third quarter data? Could it be that the rates of “suspicious transactions” are declining and that would be detrimental for CoreLogic to report?
WHAT IS A REALISTIC LOSS ESTIMATE?
The CoreLogic 2011 Short Sale Research Study obviously and grossly overstates the magnitude of “unnecessary losses.” Unfortunately, the vague, imprecise and summary nature of the “study” makes it impossible to state how badly the loss estimate is exaggerated.
By applying the high end of reductions estimated for the fatal flaws discussed above, the losses speculated about in the study would be entirely wiped out. However, this author has been involved in combating fraud in transactions in which my clients would have been a victim, so I don’t deny there are actual losses.
It’s hard to imagine that the methodology employed by CoreLogic can readily be corrected to result in a realistic number; however, the overstatement appears to be in a magnitude greater than 80%. That makes likely, actual losses far less than $75 million dollars, and probably closer to $40-50 million.
In this economy where Freddie Mac and Fannie Mae alone are receiving bail out support upwards of $140 BILLION, a $50 million potential loss could not even be seen on a budget chart showing the distribution of the bail out funds for these two institutions alone, much less spread among all short sales.
I’m certainly not saying that all short sale resale transactions are fraud-free. I’m sure that market manipulation occurs in a fraction of them. However, CoreLogic has overly exaggerated the magnitude of the problem.
The 2011 Short Sale Research Study does not provide a legitimate basis for banks to decide on purchasing CoreLogic’s dubious anti-fraud systems and it certainly is not a valid basis for policy makers and regulators to base any decisions.
Instead, it’s a perfect example of garbage in – garbage out. Banks and regulators would be well-served by treating it as outgoing garbage.