I knew a guy who was once given an expensive sports car. I was shocked when he told me someone came up to him and handed him keys to a Porsche. Nice stranger, right? A couple of news outlets even covered the story about this stranger’s generosity. Yet here’s the deal. The sports car owner was on the cusp of divorce and his soon-to-be ex would’ve potentially gotten the car anyway, so this was really more about dumping an asset instead of random kindness.
Now with that story fresh in mind, let’s consider the concept of an arm’s-length transaction. There wasn’t a buyer in this situation of course, but still there is something important here to note with the concept of “giving away” a property – or in other words selling at a price that really doesn’t reflect the market.
What is an “arm’s-length” sale? “It is a transaction in which the buyers and sellers of a product act independently and have no relationship to each other. The concept of an arm’s-length transaction is to ensure that both parties in the deal are acting in their own self-interest and are not subject to any pressure or duress from the other party” (Ivestopedia). The classic example of a non-arm’s-length transaction is a parent selling to a child. Instead of the seller acting in his best interest with the highest price, the parent offers the child a discount, which means it is a non-arm’s-length transaction.
Why does it matter whether it is an arm’s-length sale or not?
Chris Opfer of Mason-McDuffie Mortgage explains. Arm’s-length transactions are sometimes confusing to understand, and in many cases can cause big problems for loan officers. The whole idea is to make sure that none of the parties involved knew each other prior to the purchase contract being ratified. The thinking is that each party will fight for the best deal possible for themselves. If any of the parties did know each other, then that would be considered a non-arm’s length transaction and can cause issues when it comes to securing a loan. Loan fraud is always on the top of our minds, and it’s important to protect the buyer from being taken advantage of and to keep the property values consistent with the market and not too low or too high. This is exactly why we are never permitted to do a loan on a property for a short sale when a relative is buying from another relative. Non-Arms-Length deals are definitely possible though as I have done several recently. For example, a parent or child may have purchased a house for a family member who lost their home to foreclosure. Now that the family member can qualify for a loan again after three or four years, the displaced person can buy the house from the relative that bought it for them in the first place. Each transaction is different and should be looked at individually and given much thought before loan application is submitted.
Case-in-Point: FHA allows a family member to purchase another family member’s home as a principal residence if the property is the seller’s investment property. The max LTV is 85% unless the family member has been a tenant in the property for at least 6 months, and then it would be the normal 3.5%. Don’t forget that you have to prove that you were really paying the rent. This is just one example. There is not enough time to go through all of the possible scenarios.
One last “short” example: Lastly, we all know short sales tend to sell at a discount. However, there are some out there that are definitely not arm’s-length sales because they are seemingly being priced strategically low for the sake of a future flip. The game plan goes like this: Agent 1 “lists” the property at a ridiculously low price. The listing is likely only a technicality to show the bank the property was actually on MLS. Then Agent 2 shows up as the Buyer’s Agent on the deal. The property goes pending after zero days of market exposure on MLS. After escrow closes, the property is spruced up moderately, and either Agent 1 or Agent 2 lists the property again. Now I’m not saying this is fraud because it’s not my place to make that call. All I’m saying is this is not an arm’s-length transaction since the buyer and seller are not trying to get the best deal possible for their side, but are instead focused on the future flip transaction.
Question: Any thoughts, insight or stories to share? I’d love to hear your take.
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Hey Ryan:
At the intersection of Del Paso Boulevard and Arden in North Sacramento there is a 60 foot mural — yellow script with blue shading. It says: “In scarcity we bare the teeth.” If you stop to investigate, you will find a poem. Is it about human nature? Our current real estate market? What do you think?
Ricardo
Interesting. I’ll have to check that out Ricardo. What do you think the saying means?
It’s crazy how many parents are buying homes for their kids, either all cash or financed, and selling them back to them at one point or another.
I hear you on that, Brad. It’s definitely a nice set-up for the kids too (assuming parents sell at a discount). I appraised one recently that was purchased several years ago by the parents, and the kids had a good 10%+ equity in the house once they purchased it (FHA loan).
If parent sells at a discount, wouldn’t that in theory, have a similar impact to neighborhood values as a short sale?
Great question, Brad. One might think that would be the case, but I think of the following. First, the sale would probably be private, which means it is not on MLS. The sales on MLS are probably going to be what really sways the market the most. Appraisers don’t usually use private sales as comps unless they can be verified by a party to the transaction. Of course there would have to be a compelling reason to use private sales anyway if there are ample MLS sales to choose from. Secondly, one sale doesn’t make or break the market. Even if the sale was on MLS, it would be easy to give little weight to the sale if it sold at a discount. That is what I tend to do with short sales when they closed at insanely low levels (like the ones I mentioned at the end of this post).
So our appraiser used 2 examples of comparable homes that were actually bank owned but he said they were arms length. All examples were about 1 year old. He did not measure our property and was off by about 140 square feet. Spent less than 10 minutes at our house. This sounds very unethical to me. We plan to dispute the appraisal amount, but i was told it is up to him if he wants to change it. Do we have any recourse?
Thanks for checking in Katie. Bank-owned sales can be tricky from a price point because sometimes they really do sell at a distressed level, but other times not so much. Banks used to give these properties away during the foreclosure crisis, but now I see some banks actually overprice their properties (in Sacramento at least). I do share your concern about them being used – especially if there were other options. If there really weren’t other sales though, then to be fair I understand why the appraiser maybe used them. Setting that aside though, I would be most concerned if these properties sold below market rather than whether they sold as bank-owned homes.
Did the appraiser do an interior inspection? I’m not sure why the appraiser would not measure the house. Is there a sketch in the appraisal report? It is possible the appraiser appraised your house in the past maybe, so he already had a sketch, but otherwise if there was no measuring I certainly wonder how a sketch was produced. Ten minutes is really quick and not a good look. There is no amount of time an appraiser should spend at minimum, though I’d say 10 minutes is inadequate in my mind.
Recourse? You can ask the lender to have the appraiser take a look at the file again and reconsider some things. If for starters your house is 140 sq ft larger, that can make a difference in the value – especially if your house is smaller. I would definitely go through the reconsideration of value process. As a part of that the appraiser may be able to explain why bank-owned sales were used too. Your lender may have a form to use to dispute the value. If not, you can consider using the one at the following link or maybe drawing some ideas from the form I have on how to communicate well with appraisers in a process like that. https://sacramentoappraisalblog.com/2016/03/28/how-to-challenge-a-low-appraisal-and-tips-for-agents-and-appraisers/
So I’m attempting to purchase a home from my parent that I grew up in. It’s going through foreclosure due to a ballon payment issue. The home is valued at 1400000+ but selling
To me for 72000 because that’s what’s owed to bank. Now bank is saying maybe a conflict of interest because my parent is on one of my accounts and I’m on one of hers ( live out of state). Would be this consider a non-arms length sale or short sale? Is it possible if they will deny me the loan because of that?
Hi Cierra. Thanks for reaching out. This would definitely be considered a non-arms length transaction because these are your folks (and clearly they are selling for less than they would if they exposed the property to the open market). This would be considered a short sale if they are selling the property for less than the amount owed and the bank is taking a loss. It doesn’t sound like that is happening unless the bank has to eat real estate fees (and agent fees). I would think as long as you are paying all the real estate fees and the bank gets 100% of the money owed, then this would not be a short sale. As far as the loan going through or being denied I think a loan officer would have to pitch in there because that’s outside of my expertise as an appraiser. Clearly red flags are being raised right now though, so at the least there is concern there. If the loan is denied I might suggest reaching out to find a loan officer who is comfortable with your situation first or has specific advice on how to deal with your accounts. That way you can start the loan process again and hopefully find success. Or if the bank has issues only with the way your accounts are set up, I wonder if making a change in that regard would be the remedy.
You can also ask your local Title Company to pull a Property Profile for you. Ask that they include Comps and if they could adjust them to be specific to your home characteristics. This report from your local Title Company will show you the dates homes sold, how far away in proximity, sq. ft. beds, baths etc. With this you can then determine for yourself if the appraiser had other data in which he chose not to consider. Usually in California comps are considered for the last 3 months of sales to gather the information needed. If within the last 3 months you do not have like kind property selling it would be a reason to create a larger range of proximity for the search. Or if lack of sales for the inventory you may need to look at the last 6 months. For example when they appraised a ranch for me, they had to go 7 miles out to get comps as there were so few ranches remaining and nearby neighborhoods had no land and were brand new. New homes would not be a fair comp for the home built in 1972 and had 2 acres of land.
Hi Val. I appreciate your input. Thanks. I suspect a title rep would be able to easily pull all sales that are recent, though some of them might be private. If an appraiser is not able to verify the details of a sale, it would really be a blind “comp” to use. For instance, what if a title rep showed a sale at $525,000, but we didn’t really know the details of the transaction including condition, quality of construction, whether the seller gave personal property to the buyer and therefore padded the price, etc… So while I like the idea of a title search, these sales still have to be verified. Thanks again.
So I inspected a property last week, pre inspection it appeared to be significantly lower than market value. Phone calls revealed it’s a distressed sale, in pre foreclosure. Upon inspection I met sellers, both in mid 80’S, daughter, grand kids, stranger on sofa, someone living in shed in backyard. Buyer also showed up during inspection and informed seller needed repairs, and they should be completed ASAP before home goes into foreclosure. Not sure who buyer is, why would the seller not have listed and tried to sell this home. There are some subject to items, CO Monitors, smoke detectors, roof inspection, and removal of non op/unfilled fiberglass spa, partially in ground. Also a cost to cure of around 10k for flooring, interior doors, and bathroom repair. Transaction is over 150 K below mkt value, and exposure time is 1-3 months have concerns regarding this being an arms length transaction.
Hi Eric. Thanks for reaching out. Hmm, I wonder what is happening here. It could be a number of different issues. It could of course be a family member buying the property, but it also might be an investor who is simply scoring a good deal. There are lots of reasons why people don’t list on MLS. If this is a situation where a person needed a very quick sale, then the owner may have simply found someone to get it done right away, and any loss in money isn’t much of a factor. Of course the buyer could be taking advantage of the seller too. It’s hard to say. I think if this is for a loan, just be sure to look at the contract for the same last names and do your best to describe the sale. If you are concerned about the nature of the sale, maybe share your concern with the client. Ask the client if there is any reason they know of that would shed light on this being arms-length vs not. I don’t do much lender work these days, but I would certainly discuss in the final reconciliation that the property was not listed on the open market and that the contract price is simply low for whatever reason. One more thing though. I’d like to know how the buyer and seller met each other. How did they establish the price too? If there is an agent involved I would call the agent to find out. Then I would offer any relevant details in my report. Any thoughts?
Hey Ryan,
Listing agent responded:
1) They met by introduction from sellers daughter.
2) Sale price is based on what they owe
Any further thoughts?
Hi Eric. Good for you to reach out to the agent. This doesn’t sound like a situation where the seller is really acting in his/her own self-interest, though maybe the seller just doesn’t care though because they need to sell quickly. But it does make me wonder if there is something else going on (maybe the current owner would buy back eventually?). Technically if the seller and buyer didn’t know each other, it’s possible this is an arms-length despite the lower price, though it still makes me wonder since the introduction happened from a family member. That might suggest there is a relationship or ulterior motive there, which would clearly mean this was a non-arms length transaction. Ultimately if there is any other plan between the buyer and seller after escrow, that’s where I would say it is non-arms-length. I think the struggle here is selecting “non-arms-length” may involve an assumption if you don’t have all the details. Personally I would probably run it by my client first to say, “Hey, this smells like it might be a non-arms-length transaction. Any thoughts?” That way they can maybe talk it through and/or present any evidence either way. I think if you do select “arms-length” I would very much spell out in the report how the purchase price was established and why it is significantly lower than market value. I would do this in the contract section and the final reconciliation of value. Thus in two places you’ve covered your bases to tell the story of the property to the best of your knowledge. If you come across information where it seems the seller and buyer and plotting together somehow, then I would definitely select non-arms length. Ultimately I think you’re going to have to make a judgment call here. No matter what though, just explain why you did what you did.
I will say it’s a bit curious why the seller is going to go into foreclosure if they have equity in the property. Hmm…
One more thing. I might consider jumping on a forum of appraisers on Facebook to see what others might do. We can glean lots of wisdom at times from colleagues.
I have a situation of another sort. I own a condo. We have an association board member selling his unit to another board member for nearly 50% more than market value. Not sure what the angle is, but they’ve been reluctant to post the sale or sale price on our meeting minutes. And we were ambushed with the news at one of our executive meetings to vote on “first right of refusal”. Not sure if this should be pursued? Or, if we did, how would we investigate it?
Hi Wayne. Thanks for the comment. Hmm, it’s always a wonder why that would happen. If there is a loan involved, you’d think the lender’s appraisal would in no way appraise that high. But if this is a cash transaction, it’s a free country and one owner can sell way too high if he/she wishes. I would be surprised if your board can disallow a sale unless your board controls sales. I wonder what the reason is or what the end game is. It could be many different reasons and doesn’t necessarily mean there is something funny going on. Though once in a while I talk to people who are trying to manipulate the market and create outlier comps for future sales. That’s fraudulent of course. When I hear about a situation like this I would be more concerned if one or both individuals own other properties in the condo project and have plans to sell those at higher levels. That’s just where my mind goes though. I have no idea what is happening here.
Thanks for the info here. Your latest response contains the situation I was wondering about. We have an owner in our condo who owns a number of units and seems overly focused on selling them for more than they are worth. He sold one condo for about 100k above market value to an LLC that is controlled by a former employee of his. I believe he is somehow also holding the mortgage on this transaction and he’s doing the sales like this to create outlier comps for future sales of his other units. It seems to me it’s not an arms length sale and he is trying to manipulate the market. What kind of action do you think someone could take to stop him from manipulating prices?
Hi Anonymous. Yeah, these are definitely not arms-length sales. There is an agenda here and I hope nobody falls for the scheme. I don’t know that there is any action that can be taken to stop these sales if they are private sales (or even public sales). At some point if this individual is trying to deceive buyers though and pulls it off, it’s clearly fraud. In that case there may be some organizations interested in property crimes as such. I don’t know if the FBI would investigate something like this, but when people do stuff like this it doesn’t always end well. As an FYI, here’s a list of financial crimes published by the FBI. https://www.fbi.gov/investigate/white-collar-crime/mortgage-fraud/financial-institutionmortgage-fraud-news
Hi, I have just made an offer to buy a house that is considered a probate sale, even though it will not require court intervention. The sale history of the property seems odd. In 2006, it was sold as a Purchase/Resale Arm’s Length Residential Transaction and then in 2011,as an REO and Trustee Deed REO Repossession. Oddly, nine years later, it is now for sale for exactly $142k less than what they paid , which represents roughly 29% of the overall price paid in 2011. Am I missing something? is this too good to be true?
Sorry for the late reply here. I’ve had some health issues and I’ve been away from my desk. I’m just finally starting to get back (not even fully back yet). Honestly, it’s hard to give an answer here because I don’t know your market. I personally wouldn’t look to the past as a way to determine if you are getting a good deal today. Maybe you are. Maybe you aren’t. The key is whether the price at $142K less today is reasonable for the market. I’d look to similar homes to get a good picture as to what it is worth. My two cents.