Real Estate Flipping: Is It Really So Terrible?

Contributors
Written by Peter G. Miller
on January 06, 2015 No Comments
Categories : Blog View

BLOG VIEW: When it comes to real estate flipping, there are usually two major views: Either real estate flipping is the scourge of the modern world or it's a socially useful business that often converts unwanted properties into valued additions to the housing stock.

This debate is not just an academic argument; it's a real-world discussion with billions of dollars on the table – and maybe some dollars for you.

Just Like Stock

Let's start with the idea of flipping. Imagine that Smith buys stock today and sells it tomorrow, making $100,000 in the process. There's no objection; indeed, Smith is likely seen as a financial hero, an economic mastermind feted by friends and envied by rivals.

Flip real estate and the social equation is different. Somehow, real estate flippers are too often degraded and devalued. The term "illegal flipping" is widely used, as if there were no other kind – or as if illegal stock fraud is unknown.

Generally, though, flippers come in the following three basic flavors:

Investors: They want to buy, hold and rent, but are open to a quick resale if the right offer comes along.

Arbitrageurs: Individuals who believe a property has been priced or marketed incorrectly. They want to buy and quickly resell, perhaps because of a change in zoning or the use of a different marketing strategy.

Rehabbers: Contractors who have the ability to quickly acquire and refurbish a home for a quick turnaround. Rehabbers sometimes have crews that specialize in repairs and upgrades going from project to project. They may concentrate in a given area where large stocks of candidate homes are available. For rehabbers, the big profits come from higher prices generated by the sale of homes in vastly better physical condition.

Financing

According to the National Association of Realtors, in November, foreclosures typically sold with an average discount of 17% while short sales were discounted 13%. Many of these properties are often good flipping candidates, depending on their price and condition as well as local market demand.

Many flippers buy property for cash. The cash required includes the money needed to acquire the property and also the cash necessary for repairs and vacancies. Properties are often acquired at auction with foreclosure sales and sometimes through short sales – deals where a home is sold at discount with permission of the lender.

Financing may be available but with different terms from the purchase of a prime residence. For instance, you may need 30% down plus money for fees and charges. If flipping is your goal, then look for loans that do not require a prepayment penalty. Also, flippers are likely ahead with higher rates and lower points because, by definition, they want short-term – very short-term – financing, loans that ideally might only last a few months. In all cases, run the numbers to see which options are best for you.

The HUD Rule

A big player in this debate is the U.S. Department of Housing and Urban Development (HUD) – and with good reason: When the buyer of a flipped home finances with a Federal Housing Administration (FHA) loan, it is the FHA – an insurance program – which takes the risk of loss if the home is foreclosed. When a home is illegally flipped and the loan is based on fraud, the odds of foreclosure go up, as do claims against the FHA.

To avoid excess losses, HUD adopted a rule in 2003 that the FHA would not insure loans if a home had been resold during the past 90 days. In time, the rule was loosened somewhat, with exceptions for such things as government sales, homes acquired by inheritance and properties in declared disaster areas.

It would seem that the HUD rule largely shut down the problem of illegal flipping, in part because the rule was widely adopted by private-sector lenders and investors.

Unfortunately, that's only part of the story.

The other part of the flipping story is the good part, the part about homes that are quickly refurbished and returned to the housing inventory as rentals or sales. As a society, we want that, because it rids neighborhoods of vacant and run-down housing. Unfortunately, by enacting its 90-day rule, HUD made it difficult for rehabbers to quickly come in, fix up a home and get out because buyers under the rule cannot get financing until at least three months have elapsed.

It was hard to realize the impact of the HUD rule until 2010. That year, in response to woeful market conditions and the need to spur sales, HUD suspended its 90-day standard, a suspension that continued until the end of 2014.

This suspension gives us a window into the world of flipping. Once the HUD rule was suspended, were there a lot of situations where homes financed with FHA loans were bought and resold in less than 90 days?

The answer, it turns out, is revealing. According to figures provided to Auction.com by HUD, between Feb. 1, 2010, and Aug. 31, 2014, the FHA endorsed 101,932 loans for properties that had been resold within 90 days of acquisition.

For 2015, HUD's 90-day rule has been re-instated, and that means we'll likely see less flipping. Now, instead, investors will be more likely to buy, hold and rent for at least a year – the time it takes to qualify for the long-term capital gains tax rate.

Peter G. Miller is a nationally syndicated real estate columnist. His books, published originally by Harper & Row, sold more than 300,000 copies. He blogs at OurBroker.com and contributes to such leading sites as RealtyTrac.com, the Huffington Post and Auction.com. Miller has also spoken before such groups as the National Association of Realtors and the Association of Real Estate License Law Officials.

(Do you have an opinion to share with MortgageOrb? Get in touch! Send an email to pbarnard@zackin.com.)

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