is this strategy legal?

Question

a friend of mine was telling me about another friend's real estate "strategy".  sounds fishy to me, so i was hoping to get others' opinions.

basically, he says the guy does the following:

1) finds distressed property

2) obtains hard money loan to buy house (takes the loan out under a company he owns, let's call this company "A").  Say for instance $50,000.

3) rehabs house using outside contractors (tries to do so rather quickly).  Assume this costs $10,000.  (once again just using fake #s here)

4) sells house to company "B" which is a "real estate investment firm" (that he also owns).   Company "B" gets an appraisal for the rehabbed house (which has gone up in value).  Company "B" takes out a traditional loan for a much higher appraisal amount (say $150,000)

5) theoretically he now has a lump sum of $90,000 (150k - 50k - 10k) sitting in the bank (minus any taxes, sales fees, interest on hard loan, etc).  Let's call this $60k "cleared" after fees.

6) pay himself a personal salary of $50,000-60,000 (or some large amount that is a majority of that remaining lump sum).

7) rent the house out to try and pay down the $150,000 traditional mortgage.

He calls the $60,000 "profit".  I said it isn't profit until he sells the property to someone else or pays the mortgage down entirely.  I also think he is leveraged an insame amount (almost infinitesimally).  I asked what if for some reason he has to sell the house(s) (for instance if he can't get renters across all of his properties) which he would have to do at a loss causing a cascading storm of problems for him.  He said that since the guy took the money out of the investment firm, worst case they can foreclose on him and they can only seize the houses and not touch his personal bank accounts (thus it really is profit).

Sounds like a huge scam to me.  Sounds like it could be reasonable if he is able to make the renting work and actually pay down the traditional mortgage, but it doesn't sound like that is the guy's main goal (to be a landlord) from the way the conversation was worded.

Thoughts?  Is this guy a genius?  A quasi-criminal?  Or just someone taking huge calculated risks with little downside?

Thanks!

Bill Gulley · Answer

Transaction from A to B is not at arm's length, if he presents that to a lender as a purchase, it's mortgage fraud if he hides the fact he has interests on both sides. It's a refinance not a purchase. Bet he has tax problems too.

As mentioned, the numbers suggested aren't in reality.

He doesn't get the appraisal, the lender does, but he pays for it, no serious lender loans money on what some borrower obtains.

Yes, the can foreclose and then seek a deficiency judgment, being a commercial loan, then go after the LLC, then drill right through his under capitalized LLC and get to him personally.

No, he's no genius, more like an idiot.

Joe Villeneuve · Answer

Account Closed As far as only 10 mortgages is concerned, they could get 20 if each brother got 10 separately.

The loans may not be from a bank.

The description of "he gets am appraiser to give them a way over value..."  Not going to happen.  This whole thing blows up right there.  It's not so much the lender using the client's appraiser (although that is a shaky statement), it's more about the "way over value..." statement that tells me this is all full if s....  In this day and age, if an appraiser was caught doing that, he'd lose his license, and worse.

Joe Villeneuve · Answer

True about the mortgage not going to a company...it would still go to the individual, but the company can still hold title. I'm sure that is part of his plan.  He just didn't mention it.  Either way, he's overthinking it.

Account Closed · Answer

I don't think he is actually doing it.  There is no way a bank will use that guys appraiser and run with their numbers.  In this day and age, there is no way a bank is going to loan more than the property is worth either.

However, maybe he has a shady local bank he is working with.

Another thing to consider is how he is going to have large mortgage payments.

Another thing to consider is that most banks will not give out more than 4 loans so someone, some do 10.  So I doubt that he is able to get 20.

Account Closed · Answer

I doubt he is actually doing that because I don't know of any bank that will loan to a company with a mortgage.  They only loan to individuals, so his name would have to be on the loan.  Second, I don't know of any bank that will loan that much over what he paid and spent the first time.  Only spending $10k in rehab isn't going to justify the new value of $150k from the banks point of view.

Patrick Britton · Answer

Bill Gulley says it best...mortgage fraud.  lenders use their own appraisers who are on a rotation, a hidden rotation.  lenders cannot choose their appraisers anymore thanks to people like him cheating the system back in the 2000s

Scott Higs · Answer

big thanks to everyone for their feedback!  i'm going to learn a ton from this site.  I fear I might be missing or misrepresenting something, so i don't want to waste too much of your time.

Apparently the guy(s) (there are two actually, who are brothers) supposedly already own 20 or so properties, so they are making this work somehow (though i've only managed to find 3 online).  the numbers i was given were probably exaggerated a bit for illustration.

Not sure on the arm's length thing, they might be honestly disclosing their interests for all i know, but i wouldn't put it past them to try and hide things either.  The deficiency judgement thing seems to be a pretty big deal if anything ever turns bad.  I think they think they are protected because of the LLC.

I'm friends with the guy and like him, but i wouldn't trust him with my life.  The only thing that even sells me on it a bit is that 1) he never works even an hour a week and 2) he flies around the world constantly so it adds a bit of credibility to whatever he is doing.

ps - had to google ticket oak.  hilarious!!

Scott Higs · Answer

thanks for the thought.  makes sense.  now that you say that, it sounds like a very basic idea actually.  not sure why it surprised me so much.

i think what i'm struggling with is: why the second loan would come in at such a higher value?  for that to happen, 1 of the following must occur:

1) he finds an extrememly undervalued property initially (not sure that happens in this environment where it seems like there are tons of "investors" searching for properties and the city we live in seems to be in a "boom")

2) he gets the contractors to do work for below-market price.   ie: they charge him $10,000 for something that another contractor would charge $50,000 for.  (no clue why a contractor would ever undercharge for services, even if for a friend)

3) he gets an appraiser to give a way over-valued unrealistic estimate of the property after he rehabs it (never bought a house so no clue how this works.  are they gov. employees?  could he be paying off someone to do this?)

4) the bank that gives the second loan is very happy to give out loans over 100% LTV.  in other words, tehy know the property is only worth $60k (purchase price + rehab upgrades) but they'll give out a loan for more anyway.  (i can only image this being reasonable if they immediately turn around and sell the mortgage to someoene else.  Sounds a lot like 2006/2007 MBS illusions and garbage)

Does that sound accurate?  which is the most likely to occur?

thanks!

Joe Villeneuve · Answer

It doesn't matter.  He's over thinking it.  If the property was worth $150k to the second company, it was worth $150k to the first.  He could have just refinanced from the first company and done the same thing...without so many moving parts.

I think he may be a genius...with too much time on his hands.

is this strategy legal?

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