This article addresses the conflict of interest that occurs when a listing broker or his agent receives undisclosed benefits for acting as or representing a speculator intent on flipping a property the broker or agent has been employed to sell.
Agency duties come first
Flippers, ever alert to upward momentum in real estate prices, continue to have a steady presence in California’s real estate market. They are presently scooping up properties at what they optimistically believe are cheap prices, then temporarily sitting on them in hopes of making tidy profits when prices rise (as speculators always expect they will), a process known as flipping. [For more information on speculator activity in California’s real estate market, see the April 2010 first tuesday article, Market trends in February sales data for California and Southern California.]
Among these speculators are Department of Real Estate (DRE)-licensed brokers and sales agents. When acting solely on their own behalf in a flip, they blend into the masses of speculators as principals who lie in wait of profits. Thus, they owe no agency duties and are not required to voluntarily inform any party they hold a DRE license. [For more information on the flipping process, see the April 2010 first tuesday article, Flipping: contracting to assign or double escrow the resale transaction.]
However, a significant conflict of interest exists when a seller’s broker (or agent) also:
- represents a flipper as the buyer in the transaction; or
- purchases the property with the intent to flip it himself.
A broker and his agents who engage in this type of risky behavior need to keep their fiduciary duties to their seller at the fore, and disclose facts which might influence the seller’s decisions about the sales price or the timing of the sale. If not, the broker will face dire consequences for his (or his agents’) less-than-aboveboard dealings.
A licensee acquiring and flipping a property he or his broker has listed violates agency duties owed to the seller when he fails to disclose the compensation or benefits he receives on a flip of the property:
- by withholding material facts, called misrepresentation; or
- through blatant deception.
The listing agent who withholds facts about a flip
Consider a broker who enters into a listing agreement with a seller to locate a buyer for the seller’s property. While employed as the listing agent for the seller, the broker becomes acquainted with a real estate speculator who inquires into the broker’s single family residential (SFR) listings, including the seller’s property. The broker enters into an oral, written or implicit agreement to represent the speculator as a buyer.
The broker promptly discloses his dual agency to the seller when information about the seller’s property is provided to the speculator, the moment negotiations first commence. However, at no time does the broker indicate to the seller that the prospective buyer is a speculator intent on flipping the property at a profit. [See first tuesday Form 527]
The speculator makes an offer on the property at a price below the seller’s listing price. When the seller, aware of the dual agency, discusses his desire to counter at a higher price, the broker dissuades him from doing so, advising that the prospective buyer may walk away from the deal if asked to pay a higher price. The seller accepts the speculator’s offer.
Before escrow closes on the sale, the broker enters into a listing agreement with the speculator to resell the property for a price above the price the speculator is paying the seller.
Escrow closes as agreed. Immediately, the broker markets the property for the speculator. A homebuyer is located who acquires the property at the newly listed price – a profit for the speculator.
The seller learns of this broker-assisted resale by the speculator, and makes a demand on the broker for a return of the broker fee he paid and payment of the difference in the price spread between his sales price and the speculator’s resale price.
The seller claims the broker violated his fiduciary duty owed to the seller since the broker failed to disclose the buyer was a speculator, a material fact in the seller’s determination of the sales price he would have accepted for his property.
The broker claims he owes no money to the seller for this omission about the nature of the buyer as a speculator since the broker had no duty to disclose the buyer was a speculator intent on flipping the property at a higher price.
Does the broker’s failure to disclose the speculator status of the buyer make him liable to the seller for the seller’s lost price?
Yes! The broker owed the seller with whom he had a listing agreement (and thus an agency relationship)a fiduciary duty to disclose all material facts which might affect the seller’s setting of the sales price.
Here, the broker knew the buyer was a speculator who was going to “flip” the property at a greater price when the seller accepted his offer. Further, the broker knew the speculator would re-list the property with him and he would receive a second fee for being the speculator’s agent on a flip. The broker failed to relay any of this information to the seller prior to advising him to accept the speculator’s offer, the final moment at which the seller could have considered the price and the timing of the sale differently had he known the buyer was a speculator intent on flipping at a higher price, not a homebuyer intending to occupy and use the property as had the seller. [Jorgensen v. Beach ‘N’ Bay Realty, Inc. (1981) 125 CA3d 155; see first tuesday Form 119]
The effect of flippers, exacerbated in recent years by volatile pricing of real estate, is exactly parallel to the previous example. This case study is illustrative of the height of the prior great flipping (equity purchase) binge in the late ‘70s: wealth being sucked out of the hands of owner-occupant homeowners and diverted into the hands of speculators who add no value to the property and deceptive listing agents who receive two fees.