Real-Estate Sleight of Hand

Itzhak Ben-David is a Ph.D. candidate in finance at the University of Chicago’s Graduate School of Business. (Levitt is one of his dissertation advisors.) While pursuing his original research idea — the degree to which housing prices efficiently incorporate anticipated tax increases — Ben-David stumbled upon a slightly juicier topic: a real-estate sleight of hand known as the “cashback transaction,” in which the seller gives the buyer a clandestine rebate that the lending bank never finds out about.

Yes, it’s illegal.

Our current New York Times Magazine column is about Ben-David’s research. Here is his paper on the subject. Not only is the subject matter interesting, but the detective work he employed — a sort of mashup of the methodologies in the Levitt/Syverson real-estate paper and the Duggan/Levitt sumo paper — is really impressive.

As always with our N.Y. Times columns, we’ve posted some complementary research materials on the subject.

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COMMENTS: 32


  1. kkwan5 says:

    My initial reaction is that this is nothing new to familiar with real estate as an investor or agent. This has been happening in Denver which is considered a hot market. The ‘seller contribution’ is sort of a generally accepted practice because it greases the transaction and helps lower the cash down payment required. They the contributions are ostensibly to help defer closing costs and is a major bargaining point for many transaction.

    I can also see this with low income properties as well where low or no down payments are crucial to transactions. There programs that offer down payment assistance where a third party becomes involved as an escrow agent of sorts in order to legitimize the transactions.

    I’m not sure how clandestine this really is. It is another form of creative negotiating/financing vehicle. I’m not entirely convinced that this is victimless because it inflate appraisals and may come to bear in down markets but as a transaction between buyer and seller who is being cheated?

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  2. kkwan5 says:

    My initial reaction is that this is nothing new to familiar with real estate as an investor or agent. This has been happening in Denver which is considered a hot market. The ‘seller contribution’ is sort of a generally accepted practice because it greases the transaction and helps lower the cash down payment required. They the contributions are ostensibly to help defer closing costs and is a major bargaining point for many transaction.

    I can also see this with low income properties as well where low or no down payments are crucial to transactions. There programs that offer down payment assistance where a third party becomes involved as an escrow agent of sorts in order to legitimize the transactions.

    I’m not sure how clandestine this really is. It is another form of creative negotiating/financing vehicle. I’m not entirely convinced that this is victimless because it inflate appraisals and may come to bear in down markets but as a transaction between buyer and seller who is being cheated?

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  3. kkwan5 says:

    I dug into the details of this more and this is truly a cashback that is greater than any closing costs incurred by the buyer or repair allowances and the like. Given that I recind any defense for the cashback type of program since it has more far reaching and clearly illegal.

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  4. kkwan5 says:

    I dug into the details of this more and this is truly a cashback that is greater than any closing costs incurred by the buyer or repair allowances and the like. Given that I recind any defense for the cashback type of program since it has more far reaching and clearly illegal.

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  5. fheinsen says:

    Nothing new — this kind of fraud has become more and more common since the residential real estate market started cooling off. Here’s an earlier article on the same subject:

    http://www.washingtonpost.com/wp-dyn/content/article/2007/04/20/AR2007042000887.html

    “The basic scenario, Crabtree said, involves real estate agents who have listed houses that aren’t selling. To move the properties, they entice buyers or friends to ‘submit an offer [for the home] that is $30,000 to $100,000 above the current list price’ with the promise that they will get substantial cash at closing.”

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  6. fheinsen says:

    Nothing new — this kind of fraud has become more and more common since the residential real estate market started cooling off. Here’s an earlier article on the same subject:

    http://www.washingtonpost.com/wp-dyn/content/article/2007/04/20/AR2007042000887.html

    “The basic scenario, Crabtree said, involves real estate agents who have listed houses that aren’t selling. To move the properties, they entice buyers or friends to ‘submit an offer [for the home] that is $30,000 to $100,000 above the current list price’ with the promise that they will get substantial cash at closing.”

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  7. Li says:

    Are you sure this is illegal everywhere? A friend was recently shopping for condos in Washington, and at least one property’s listing price was “X, with $5,000 cash back.” The condo was structurally sound but needed work, and the 5k was supposed to go towards renovations. The same friend put an offer on another condo which included a cash back clause in the contract.

    But to be fair, neither condo went to a stage where the bank was involved, and I don’t know how they would have reacted.

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  8. Li says:

    Are you sure this is illegal everywhere? A friend was recently shopping for condos in Washington, and at least one property’s listing price was “X, with $5,000 cash back.” The condo was structurally sound but needed work, and the 5k was supposed to go towards renovations. The same friend put an offer on another condo which included a cash back clause in the contract.

    But to be fair, neither condo went to a stage where the bank was involved, and I don’t know how they would have reacted.

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  9. Mack says:

    @4 -

    I’m sure it’s possible to legally structure almost any kind of loan, especially one where part of the proceeds goes toward the purchase of property and part goes to improvements. That’s quite common.

    It doesn’t matter whether you advertise it as ‘cash back’ or not — what matters is that the lender and the borrower agree on the terms and that everything is done in the open.

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  10. Mack says:

    @4 -

    I’m sure it’s possible to legally structure almost any kind of loan, especially one where part of the proceeds goes toward the purchase of property and part goes to improvements. That’s quite common.

    It doesn’t matter whether you advertise it as ‘cash back’ or not — what matters is that the lender and the borrower agree on the terms and that everything is done in the open.

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  11. fredjones says:

    There are other reasons for a cash back transaction. Years ago, when purchasing a condo in San Diego from a developer in an all cash deal, the developer said he would only accept our offer if we paid a 25% higher price to be refunded to us at escrow. The reason was so that there would be a public record of the higher transaction so they could convince future buyers to part with more money. Worked out well for us … the property appreciated quite well from our perspective.

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  12. fredjones says:

    There are other reasons for a cash back transaction. Years ago, when purchasing a condo in San Diego from a developer in an all cash deal, the developer said he would only accept our offer if we paid a 25% higher price to be refunded to us at escrow. The reason was so that there would be a public record of the higher transaction so they could convince future buyers to part with more money. Worked out well for us … the property appreciated quite well from our perspective.

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  13. procrastinating_econ says:

    I will humbly deviate from the post and bring bloggers attention to some Gatonomics from Bill Gates for Harvard Students during their commencements:

    http://www.news.harvard.edu/gazette/2007/06.14/99-gates.html

    My favorite part, “We can make market forces work better for the poor if we can develop a more creative capitalism – if we can stretch the reach of market forces so that more people can make a profit, or at least make a living, serving people who are suffering from the worst inequities.”

    It sounds so cool, only if it was true! I think the probability of the world being destroyed is much higher than poverty being eradicated, simply because poverty is a relative concept. Once you reduce hunger-related poverty, you’ll have other good reasons to feel miserable if you are at the bottom half of the economic pie.

    Unfortunately, even evolution teaches us that all lives are not created equal.

    Here is Bill Clinton’s address also for Harvard students:
    http://www.news.harvard.edu/gazette/2007/06.07/99-clinton.html

    Clinton talks about how we are 99.9 same i.e. all of us are %#$#$* in the same way.

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  14. procrastinating_econ says:

    I will humbly deviate from the post and bring bloggers attention to some Gatonomics from Bill Gates for Harvard Students during their commencements:

    http://www.news.harvard.edu/gazette/2007/06.14/99-gates.html

    My favorite part, “We can make market forces work better for the poor if we can develop a more creative capitalism – if we can stretch the reach of market forces so that more people can make a profit, or at least make a living, serving people who are suffering from the worst inequities.”

    It sounds so cool, only if it was true! I think the probability of the world being destroyed is much higher than poverty being eradicated, simply because poverty is a relative concept. Once you reduce hunger-related poverty, you’ll have other good reasons to feel miserable if you are at the bottom half of the economic pie.

    Unfortunately, even evolution teaches us that all lives are not created equal.

    Here is Bill Clinton’s address also for Harvard students:
    http://www.news.harvard.edu/gazette/2007/06.07/99-clinton.html

    Clinton talks about how we are 99.9 same i.e. all of us are %#$#$* in the same way.

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  15. osamaomar says:

    We have these real estate fraud people operating in our area but they are very slick. The money back to the buyer is usually based on a overly generous appraisal that can only come from someone who is colluding with the scamsters. Several of these houses are in my neighborhood, one across the street for me.

    The straw buyer is used to create an additional layer of distance between the masterminds and the fraud itself.

    Read a little about it here:

    http://www.mortgagefraudblog.com/images/uploads/2005-07-05_-_Inman_Article_-_Ebay_Straw_Buyer_Ad_-_7-12-05.pdf

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  16. osamaomar says:

    We have these real estate fraud people operating in our area but they are very slick. The money back to the buyer is usually based on a overly generous appraisal that can only come from someone who is colluding with the scamsters. Several of these houses are in my neighborhood, one across the street for me.

    The straw buyer is used to create an additional layer of distance between the masterminds and the fraud itself.

    Read a little about it here:

    http://www.mortgagefraudblog.com/images/uploads/2005-07-05_-_Inman_Article_-_Ebay_Straw_Buyer_Ad_-_7-12-05.pdf

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  17. mpearl says:

    As implied by others, the payment itself is not per se illegal. The illegal part is submitting a signed mortgage application in which you attest that no such payment was made.

    Similar things have been done very above board for years. CitiBank used to have a program, they called it key-loans, which was called tiered-payment mortgages in the secondary market. A seller would deposit some money with the lender. That money would be used to subsidize the borrower’s monthly payments for the first 24 or 36 months of the mortgage. The mortgage payment sfor the borrower would be one amount for the first 24 or 36 months (and that amount would be used to determine the borrower’s ability to pay) and a different, higher amount (equal to the normal amount for a level pay mortgage) for the remaining 324 or 336 months. One would expect a relatively high degree of prepayments, and delinquencies right around the time the payment changes.

    There are other similar programs going on. Look for “buydown mortgages” in your favorite search engine.

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  18. mpearl says:

    As implied by others, the payment itself is not per se illegal. The illegal part is submitting a signed mortgage application in which you attest that no such payment was made.

    Similar things have been done very above board for years. CitiBank used to have a program, they called it key-loans, which was called tiered-payment mortgages in the secondary market. A seller would deposit some money with the lender. That money would be used to subsidize the borrower’s monthly payments for the first 24 or 36 months of the mortgage. The mortgage payment sfor the borrower would be one amount for the first 24 or 36 months (and that amount would be used to determine the borrower’s ability to pay) and a different, higher amount (equal to the normal amount for a level pay mortgage) for the remaining 324 or 336 months. One would expect a relatively high degree of prepayments, and delinquencies right around the time the payment changes.

    There are other similar programs going on. Look for “buydown mortgages” in your favorite search engine.

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  19. dwolf says:

    I suspect that there is little incentive to legislate any change- as increases in property sales prices leads to increases in property taxes- The victims may be both the buyer and the neighbor whose comparable value just went up and so did both of their taxes.

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  20. dwolf says:

    I suspect that there is little incentive to legislate any change- as increases in property sales prices leads to increases in property taxes- The victims may be both the buyer and the neighbor whose comparable value just went up and so did both of their taxes.

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  21. spicey says:

    In the UK you sometimes see cash back in new build developments, particularly those aimed at first time buyers, to help with moving in expenses.

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  22. spicey says:

    In the UK you sometimes see cash back in new build developments, particularly those aimed at first time buyers, to help with moving in expenses.

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  23. Bruce Hayden says:

    Let me note that with good credit, you can, or at least could, essentially get a zero down loan legitimately. I did so in AZ about 6 years ago. The down payment was a 2nd, through the same (initial) lender.

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  24. Bruce Hayden says:

    Let me note that with good credit, you can, or at least could, essentially get a zero down loan legitimately. I did so in AZ about 6 years ago. The down payment was a 2nd, through the same (initial) lender.

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  25. Bruce Hayden says:

    I was impressed with the methodology. Very ingenious.

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  26. Bruce Hayden says:

    I was impressed with the methodology. Very ingenious.

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  27. sygyzy says:

    @#7 – Spam much?

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  28. sygyzy says:

    @#7 – Spam much?

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  29. cab says:

    Since the original research idea had to do with taxes, I am curious to know to what extent the buyers and sellers involved in these transactions consider the tax implications. By engaging in a cashback transaction, the buyer would have a higher basis for property taxes and a larger mortgage balance for interest and closing costs. The seller would also have a larger investment gain on which taxes would be owed (though, a 1031-exchange could at least defer the seller’s additional liability).

    If all these factors are considered, this means that a seller shouldn’t be willing to give the entire overage back to the buyer, in order to reserve for her additional tax liabilities (e.g. at 15% LT cap gains, she should require 17.65% more than the cashback amount to the buyer). In addition, the buyer is not getting the full benefit of the cash she received, since she must pay taxes, interest and loan closing costs on this additional “purchase price”.

    If the buyer and seller both properly consider these factors, I am curious how often the reduced interest rate the buyer gets on the mortgage for putting 10% down outweighs the larger mortgage balance, increased closing costs and property taxes for the transaction to make economic sense.

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  30. cab says:

    Since the original research idea had to do with taxes, I am curious to know to what extent the buyers and sellers involved in these transactions consider the tax implications. By engaging in a cashback transaction, the buyer would have a higher basis for property taxes and a larger mortgage balance for interest and closing costs. The seller would also have a larger investment gain on which taxes would be owed (though, a 1031-exchange could at least defer the seller’s additional liability).

    If all these factors are considered, this means that a seller shouldn’t be willing to give the entire overage back to the buyer, in order to reserve for her additional tax liabilities (e.g. at 15% LT cap gains, she should require 17.65% more than the cashback amount to the buyer). In addition, the buyer is not getting the full benefit of the cash she received, since she must pay taxes, interest and loan closing costs on this additional “purchase price”.

    If the buyer and seller both properly consider these factors, I am curious how often the reduced interest rate the buyer gets on the mortgage for putting 10% down outweighs the larger mortgage balance, increased closing costs and property taxes for the transaction to make economic sense.

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  31. If the lender knows about it (i.e. its on the HUD1) AND 6% or less, it is legal. Most lenders won’t agree to more than 3%, which is typical closing costs (so buyer does not get cash back, but gets their closing costs paid), and the home has to appraise for the higher value. When the market was appreciating these deals (legal and illegal) were common, now that home prices are depreciating lenders and forcing appraisers to be much more conservative and this practice will go away, at least until the pendulum swings back

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  32. If the lender knows about it (i.e. its on the HUD1) AND 6% or less, it is legal. Most lenders won’t agree to more than 3%, which is typical closing costs (so buyer does not get cash back, but gets their closing costs paid), and the home has to appraise for the higher value. When the market was appreciating these deals (legal and illegal) were common, now that home prices are depreciating lenders and forcing appraisers to be much more conservative and this practice will go away, at least until the pendulum swings back

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