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Over the last three and a half years our firm has represented over 350 investors from 40 states victimized in Florida flipping deals gone bad and in the process worked out more than 200 toxic mortgages for these individual investors. What happened?


What the Southwest Coast of Florida had aplenty in 2003 were platted lots. The four major areas with platted lots were Cape Coral and Lehigh Acres in Lee County, Rotunda in Charlotte County and North Port in Sarasota County. Another area with platted lots aplenty was Sebring, in the center of Florida about 100 miles east of Sarasota. These lots were selling in the $2,000 to $5,000 range in 2003.

What the Orlando market, Miami and the Florida Panhandle had aplenty were inventories of new condos and townhouses, condo conversions (apts converted to condos) and completed subdivision homes. There were also partially-completed developments in the Panhandle where both completed townhouses and homes were being sold along lots with homes to be built.


Wall Street was packaging end loans, meaning loans on completed homes and condos. At the same time, Fannie Mae and Freddie Mac were heavily funding end loans. The mortgage and banking industries sought to fill this demand, but Florida did not have enough completed product to fill it. One way the gap was closed was through the conversion of apartment buildings to condos. To meet the rest of the gap, new homes needed to be built. The well-capitalized national and regional subdivision builders stepped up to fill part of the demand.

The issue was how the rest of the demand for new product would be filled. The answer was small developers and home builders. However, banks had been burned lending money to small developers and builders building spec homes. What the banks were comfortable with was lending money to individual investors with good credit scores at high interest rates who would close on a lot owned by the these small developers and builders and be bound under a construction loan for the completion of a home on the lot. In theory, once the home was completed, the lot purchase and construction loan would be converted to an end loan saleable to Wall Street or Fannie and Freddie.


Appraisers distinguish houses from dwellings. A house is the physical construction. A dwelling is a house that someone actually lives in. Florida historically attracted retirees and other transplants who would move to Florida and buy a residence or second home. However, fueled by speculation and the concurrent demand for mortgage product, the market in Florida beginning in 2004 acted as if everyone who would be coming to Florida in the next ten years to retire or relocate was coming at once. Consequently, a lot more houses and condos were built than there were people intending to purchase and live in them. Who bought the excess product? - investors.


The Flip

Perhaps fueled by the Enron mess and general dissatisfaction with the stock market, in the first half of the last decade individual investors left the stock market and began to look at real estate investing as the new panacea. Real estate investment clubs formed throughout the country. The real estate investment seminar business took off. Financial advisors around the country started selling real estate flip investments to their clients. Certainly, infomercials and the internet fueled interest in these deals. The promise was "the flip." Buy a house or condo with little or no money down, flip it and make $30,000 or $40,000 in a short period. Sometimes the prospect was hold and rent with a positive margin, but the prospect of 'the flip" was the dominant theme.

The problem was that sometime in 2005 the market turned and there were no longer investors waiting in line to purchase the houses and condos at the ever-increasing prices. At the same time, building departments were six months behind in issuing permits for new houses and the hurricanes of 2005 caused supply problems in the building industry and a consequent run up of construction costs. Yet, the flip deals kept being heavily sold throughout the country well into 2007.

Selling Below Appraisal

Investors were told in many cases that they were buying a lot/home package or a condo at 10% below appraisal. Besides baiting the investors, this allowed the deals to be sold with little or no money down because all the regulators and Fannie and Freddie wanted to know was that no more than 90% of appraised value was being financed. What in actuality occurred is that the homes and condos were priced by the builder/developers and the appraisers knowing in advance the contract price produced appraisals which placed the contract price exactly 10% less than the appraisal. The appraisers used faulty comparables and misrepresented features in the comparables in order to justify their numbers. In many cases, rather than these deals being sold at 10% below appraisal, they were worth considerably less than the purchase price.

Cash Back

In some deals, investors were promised an immediate "return of equity" after closing of up to $50,000. Seminar participants from the last seminar would be brought on stage to tell new participants that they indeed received a check for $50,000 after closing. For a seminar that the participant may have paid $9,000 to attend, getting $50,000 back after closing seemed like a good deal. How was this accomplished? Say a developer by example wanted to net $600,000 from the sale of a townhouse. The developer would get together with the seminar company and offer the following arrangement: The developer would secure a false appraisal on the townhouse for $800,000. The developer would contract to sell the townhouse to the seminar participant for $700,000 and the seminar participant would secure a mortgage from a mortgage broker in attendance at the seminar for $700,000 based upon the mortgage coming in at more than 10% below appraisal. The developer would then after closing rebate $100,000 to the seminar operator who would in turn split that money with the seminar participant. The problem is that now the seminar participant, although having cash in their pocket. owed $800,000 on a property likely not worth $500,000. This is a mortgage that of course would be securitized and end up in one of the portfolios that Wall Street was selling.

Credit Partners

Seminar participants with bad credit were sometimes linked with seminar participants with good credit in order to get the "bad credit" participants into deals. The "good credit" participants would secure the mortgage and take title to the property with the guarantee that within a year of closing the seminar company would either flip the property with the upside going to the seminar participant with bad credit or the mortgage would be refinanced by the seminar company. The typical fee for agreeing to leverage your credit in this manner: $15,000. The problem was that many of the seminar companies went out of business and left the participant who allowed their credit to be leveraged holding the bag.

Mortgage Payment and Rental Proceed Guarantees

Some promoters guaranteed that upon the purchase of a condo, the promoter would pay the mortgage payment and condo assessments for a stated period of time and/or guarantee that the rental income for a stated period of time. This might occur for the first two or three months but soon the promoters were claiming a lack of capital due to market conditions and thereafter failed to honor the guarantees. The same happened with lot/home packages in Southwest Florida.

Closing Cost and Construction Interest Guarantees

On the deals where investors closed on a lot with the prospect of a home being built on it, the builders promised to pay closing costs and construction interest. Instead, the closing costs and construction interest were paid out of the borrowers' loans. When the builders defaulted in mass, the borrowers were left with a large mortgage balance which included the closing costs and construction interest with little or nothing to show for it.


There were two main criteria for approval of the mortgages on the "flip deals": a good credit score for the borrower and an appraisal to support value. Minimum monthly income to support mortgage payments was supposed to be a third criteria but since these were "stated income" loans, the mortgage brokers involved time-after-time either had applicants sign applications in blank and they filled in fictitious income numbers afterwards or the mortgage brokers induced the applicants to inflate their income numbers themselves. Because the appraisals were often "cooked", the bottom line was that based merely upon a good credit score, mortgages were regularly granted well in excess of the real value of the property to individuals who couldn't afford to make the first month's mortgage payment.

To make matters worse, seminar participants and others being pitched these deals were urged to not stop with one deal, but to buy two or three or more. When they asked if on the application for each loan they had to disclose that they were entering into other deals at the same time, the mortgage brokers invariably told them no. This is how people with yearly incomes of less than $100,000 entered into loans totaling two million dollars or more.


False Appraisals

The use and perpetuation of false appraisals drove the market. Wall Street, Fannie and Freddie bought mortgages on the pretext of their being no more than 90% of appraised value when in fact the loan to value was often in the negative. The mortgages were thus both under-secured and at an increased risk of default. The investor borrowers at the same time were being induced to buying property they believed had a 10% equity cushion which in fact was worth less than the mortgage balance.

Mortgage Applications

Unqualified investors were induced to apply for mortgages which they couldn't afford on the basis that they would never actually have to pay the mortgage payment because someone was going to guarantee the mortgage payment until the property was flipped. The mortgage brokers and banks facilitated false information being placed on applications, especially as it related to income and other debt, because they knew there was a market to resell these mortgages.

False Promises

At some point in 2005, it was obvious that the market was overheated and homes promised to be built were not going to be built yet these flip deals continued to be marketed aggressively all over the county.
Downside risks were never discussed with investors. The prospect that the investor with little or no money down would never be responsible for actually making a mortgage payment or paying taxes lured many people into these deals. Of course, these representations were made to get investors to closing at which point shortly thereafter the guarantees were determined to be illusory.

Cash Back and Credit Partnering

Under normal market conditions, a bank would never loan money on a deal if the seller after closing was rebating a portion of the purchase price to a seminar leader the borrower. This is a clear indication that the price of the property had been inflated. The same is true for credit partnering. The lender wants to know that the party obliged under the mortgage is actually the party who will be paying the mortgage obligation.

Excessive Fees

A hidden cost of high mortgages based upon inflated appraisals is that it also translated into excessive fees being charged at closing. Key closing costs are tied to a percentage of the purchase price and mortgage (loan origination fee, loan points, title insurance premium, real estate commissions, etc.). Since many of these deals involved little or no money down by the purchaser, these fees were invariably charged to the mortgages which were then packaged by Wall Street or bought by Fannie or Freddie.

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