Short sale flips (the process of shorting a property then reselling it for a cash profit in a simultaneous closing) have 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. So, what’s the real truth?

The basic process

The process of the short sale flip works as follows.

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

Step 2: The investor contacts seller’s lender to negotiate a short sale

Step 3: The investor gets the lender to approve the short sale

Step 4: The investor lines up back-end buyer

Step 5: The investor closes with seller, paying off lender, then resells to back-end buyer in simultaneous closing for a profit.

In essence, this is no different than a regular wholesale flip except, instead of paying off the seller’s lender in full, the 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 with the seller walking 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 make a profit. 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?

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 whose 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? Maybe. Maybe not.

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