Shorts Sales: How to Avoid Fraud in Back-to-Back Transactions

I don’t have to tell most of you that title companies are nervous about closing two transactions involving the same property on the same day. Real estate investors can have a real juggling act on their hands when they’re trying to quick-turn a short sale, except it’s the title company who has to keep all the balls from hitting the ground.

The truth is that investors can open themselves up for all kinds of trouble if they don’t know what they’re doing. Those closings may look like some huge shell game to people, especially those whose job it is to uncover fraud in the real estate business. Nobody wants to be accused of being a scam artist, much less suffer the legal consequences.

If you’re closing a quick-flip on a short sale, you can avoid even the appearance of fraud by carefully setting up each separate transaction with the title company ahead of time. The key is to be completely transparent. In each of the two transactions, everyone needs to know what everyone else is doing, and the title company just needs to follow certain protocols to keep everyone honest.

1. There must be zero or negative equity in the property. You’ll need evidence such as receipt of gross payoff letters (showing the actual total amount of indebtedness against the property, before discounting) as well as discounted (net) payoff letters. The final sales price minus the actual total amount of indebtedness must yield zero or negative equity.

2. There must be no cash given back to the property owner in the first sale, or the A to B transaction. The purchase price must be equal to the total of the amounts set forth in the discounted payoff letters, with a conveyance fee to be paid on this amount when the deed from the property owner to the investor/buyer is filed. The investor/buyer must bring his or her own good funds to close on the first sale, none of which go to the seller.

3. The second sale, or the B to C transaction, must be a completely separate transaction in that the C buyer must be an independent third party who is unrelated to the prior property owner.

4. The property owner, or the vested owner, must be present at the closing and sign a copy of that transaction’s HUD-1 stating that he or she has full knowledge of the sales price and the terms of the sale. The investor/buyer and the seller must agree to release the HUD-1 if the new purchaser’s lender requests written proof of the amount of the payoff of the underlying liens.

5. There must be written evidence that the investor/buyer’s funding lender on the purchase has full notice of the “double transfer” (property owner to investor, then investor to purchaser) involved in the overall sales transaction(s). This isn’t necessarily true of the foreclosing lender on the property. To the best of my knowledge, that lender has no right to obtain information on what happens to the property or the parties to the first transaction after the short sale of that property is closed.

If you have those five points covered, that juggling act can turn into a perfectly-timed relay race. This is one reason why I love being a real estate coach. I can talk about what I have learned over the years so you can know what you’re doing before you get into this stuff. If you’d like to lose the confusion in your investing career, sign up for a free membership in the coaching program. We’d love to hear from you!