Shadow Flipping - What The Heck Is It & What's Really Going On?
This practice is nothing new, and has been going on for decades, albeit historically more in the new "urban" condo market, which has long lead times that make it easy to assign the contract between purchase and completion.
For those of you who are new to the concept, here's how it works. A contract assignment occurs when a vendor sells their homes for, let’s say, $1 million to Buyer A, who decides not to go through with the purchase. Buyer A could be somebody who is unable to go through with it, because of sudden hardship or divorce, for example. But in this scenario, Buyer A is a real estate investor who is confident that they will never even have to occupy the home, but instead sells on the contract – assigns the contract – to the next buyer in line for, say, $1.2 million before the purchase closes. (It’s easy to find a Buyer B, who maybe just missed out in the bidding war and is now prepared to go higher.) Buyer A makes a tidy profit for no work, without even having to pay Property Transfer Tax, netting $200,000 minus the real estate agent’s fee. Buyer B gets the property for the higher price, and the purchase closes.
Sometimes, Buyer B is also a real estate investor, who having bought the assignment for $1.2 million, sells it on again to Buyer C for, say, $1.4 million. With a reasonably long purchase close, there’s plenty of time to do this kind of double-flip.
This is a perfectly legal practice. In fact, it was happening so much under the table in the last condo boom that it was made officially legal by the addition of an assignment clause in contracts. And there are many rules and regulations in place around contract assignments. The Real Estate Council of BC and the wider industry have spent many years honing these, to try to ensure the protection of the public, and penalties against agents who do not follow these rules are severe.
But here’s one concerning question. If our example property is worth $1.4 million on the market, why didn’t the original vendors get $1.4 million for it in the first place? Well, this could be one of three possible reasons:
House prices really are rising that quickly. But even in our current market, that is unlikely – 20 per cent a year, maybe, but not per month;
The original vendors wanted to sell the property quickly and priced it low for a fast sale – in which case, they risk the contract being sold on for a higher price; or
The original vendors were deliberately misled into believing that they could only get $1 million for that property, by an unscrupulous agent who has a vested interest in selling it at a lowball price in the first instance in order to flip it once or even twice.
It’s this last phenomenom – rare, we believe, but happening – that is the cause for concern here, and is the subject of the Globe & Mail investigation.
Such an agent could have two kinds of vested interest here:
Either they are doing it because they know they will get two or even three lots of commission for these multiple sales, and that is more valuable to them than getting a larger commission on a single, original sale;
Or, worse, that agent could actually be the second buyer, netting the entire flipping profit for themselves by selling it on to Buyer C. (An agent is legally obliged to disclose their purchase to the vendor if they are Buyer A, but not if they are Buyer B or C.)
And this is where the perfectly legal practice of contract assignment turns into something not legal. It is not legal is for any real estate agent to fail to act in the best interests of their client. The listing agent is duty-bound to achieve the best possible price for their vendors, so it is not legal for them to convince those original vendors to sell at a below-market price in order to facilitate a contract assignment.
Of course, the vast, vast majority of real estate agents are ethical, honest and law-abiding. Unfortunately, as in any profession, there are always a few bad seeds that threaten to damage the whole crop, which the local real estate boards and the Real Estate Council of BC are working hard to root out quickly. It’s that extremely small group of bad seeds that home owners must protect themselves against – and be protected against.
If the market continues to move really fast, and you can’t find an agent to work with who is prepared to put this clause in your contract, you need to be a little bit careful about who you work with (as you should do any time you are hiring someone for their professional services). Here are some guidelines:
Don’t just go with a random agent, or the first one you speak to, or one who knocks on your door, telling you they have a buyer for your home. Get recommendations for trustworthy agents, from other people whom you trust, and i nterview several agents, very carefully, before giving anyone the listing.
In the listing interviews, ask the agents what price they will list your home at, and make sure you've already done your research about what similar properties near yours have sold for recently. Is the agent telling you that you can’t get as much as your neighbour’s place? Is the agent offering you a discounted fee in exchange for selling at a lower price, or encouraging you to price low for a quick sale or to start a bidding war? These could be red flags.
Ask them what price they expect the property will be worth in a couple of months’ time, and whether there is a likelihood of a real estate investor wanting to flip it. If the answer is yes, tell them you want to list for that enhanced price. That extra money should go to you, not an investor.
Ask the agents to present their marketing plans designed to get you the best possible price for your home, including listing photographs, marketing materials and open house strategies.
After that, you’ve done all you can to hire an agent who has your best interests at heart. And when you do get an offer that you’re happy with and is worthy of your home, you need to accept it with an open mind, no matter what happens subsequently.
As for those bad seeds, there certainly needs to be stricter enforcement of regulations to ensure that agents can’t create an assignment scenario for their own benefit – and both the provincial government and the Real Estate Council of BC are on the case. Premier Christy Clark announced February 9 that if the industry does not put a stop to this kind of malpractice, Victoria will step in. Political pandering and more big government regulating is not the answer.
In response to the allegations, on February 9 the council appointed a new chair of its independent advisory committee, with the express goal of ensuring contract assignments are being carried out in accordance to best practices. The council also had this to say:
"Discussions have already begun between the Council and the Superintendent of Real Estate to identify possible measures that may strengthen the public protections available to real estate buyers and sellers. We look forward to continuing these discussions and to keeping members of the media and the public apprised of the results.
"The Council will be reminding all licensed real estate professionals, in the strongest possible terms, of their legislated duty to act in the best interests of their clients. Whenever we become aware of a licensee who fails in this duty, by putting their own financial gain ahead of their clients’ interests, that licensee can expect to have their actions investigated and may face disciplinary action from the Council. Brokerages have a responsibility to supervise and manage the activities of licensees engaged at the business, and brokerages who do not comply with these requirements can also expect to face discipline."
I would suggest any agent only being allowed to be involved in one transaction per property deal, and not being permitted to buy into any contract assignment where they have been the agent. And the implications for potential money laundering by real estate investors flipping these contracts also need to be dealt with, perhaps with the Real Estate Council of BC examining the provenance of any money being used in cases of contract assignment. The provincial government could also legislate for Property Transfer Tax to be paid on any contract assignments, rather than just on the final purchase, unless the assignment can be proven to be unavoidable, because of hardship or divorce, for example.
But contract assignments in themselves are, and should remain, perfectly legal. It's important that any buyer who finds themselves genuinely unable to fulfill a home purchase has a way of assigning their contract. And the practice is not driving up property prices in Vancouver – only the fact that we have buyers willing to pay that final price can do that.
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