Flipping Gains Respect – Flopping Generates Concern

Whether it’s reality real estate television or just a desire to see foreclosure inventories shrink in any way possible, flipping as a real estate strategy has gained followers, practitioners and respect in the last few years. There are profits to be made while still providing value to long term investors and end user consumer home buyers alike.

However, there’s a newer term in real estate, “flopping,” that carries a more negative interpretation, and it’s generating concern among banks and real estate analysts.

For a real estate purchase transaction to be considered “arms-length” there can be no collusion or personal/business relationship between the parties involved. With the high foreclosure inventories, and banks doing more short sales to avoid even more, flopping is becoming more prevalent. How does it work?

Let’s say that George buys a home at the peak of the market, around 2006 for $420,000. It is in an area where values have dropped by around 20%, making it worth more on the order of $336,000. George is under water, as his current mortgage balance is $362,000.

George hooks up with Gloria, a friend and business acquaintance. George convinces the bank that the home is really worth more like 30% less in the current market, but he’s been lucky enough to find a buyer (Gloria) willing to pay that 70% valuation, to buy the home for $294,000. Remember that the current value is really around $336,000 and the home is in good condition, not a trashed out foreclosure.

Gloria buys the home from the bank for $294,000 and is able to resell it for $336,000. Gloria and George split the approximate $40,000+ profit. The bank takes a loss of $68,000, the difference between what Gloria paid and the mortgage balance.

That’s flopping. In the days before the housing and mortgage crash, appraisers were the independent and unbiased third parties that would normally alert the bank to the true value of the property. However, reforms put into place are paying appraisers less, and not giving banks flexibility to work with the appraisers they want.

This creates more inefficiency in real estate markets, and that inefficiency creates opportunities for flopping.