HUD and FHA are finally beginning to demonstrate some rare common sense in realizing the value that real estate investors can bring to today’s housing market. The announcement by FHA that they will extend the waiver of “Anti-Flipping Regulations” through 2012 should be welcome news to the entire real estate industry, and the entry-level home buyers who will benefit from this waiver.
In May of 2003 FHA and HUD issued the original Anti-Flipping Regulations which basically said that any home that was owned for less than 90 days could not be purchased by a buyer using an FHA insured mortgage. As it happened, in May of 2003 myself and a business partner had just purchased a home built in 1949 that was in need of some major renovations. Our plan was to give it a thorough updating and resell it quickly to an owner-occupant buyer. Our planned turn around time was about 8 weeks from purchase to completion of the renovations. Bought in mid May of 2003, the plan was to have it back on the market, listed with an agent, by July, just in time for the peak selling season.
Just as we were completing a $20,000 renovation, which, among other things, included completely new kitchen, along with moving walls to combine the kitchen and dining area; a bathroom makeover, refinishing hardwood floors, some new plumbing, new paint inside and out, and landscaping, we were informed by our agent that HUD had just issued new rules for FHA mortgages, and that we had to “own” the home for 12 months before FHA would insure a mortgage for a new buyer.
After a rehab that was right on budget, and a schedule that was executed exactly as planned, we were confronted with the realization that we probably would not be able to get a qualified buyer in our planned time frame, because of this new anti-flipping rule.
We had lots of documentation showing that the improvement in the value of the home was legitimate. We shot extensive before and after photos of all the work that was done, and had all the receipts for the myriad of items we had purchased. There was plenty of information to substantiate that the renovations had drastically improved the value of the property, and that our planned asking price of $119,000 was totally in line with any appraisal by any legitimate appraiser. But it was a “no-go” with HUD, and we ended up having to rent the property, which resulted in a great hardship for my partner and I.
Fortunately, we were able to cash flow the property as a rental and it is still a rental to this day. But we had most of our cash tied up in the acquisition and renovation of the property. The anti-flipping rule essentially forced us into another business plan, and we elected not to pursue any further renovations at that point in time.
In 2010, in recognition of the housing crisis and given the large number of foreclosed homes sitting vacant, being stripped of their plumbing, appliances and copper wiring by thieves, HUD and FHA finally realized that perhaps allowing investors to buy these homes, fix them up and resell them quickly for a profit was not such a bad idea after all. The fact of the matter is that most home buyers do not have the skills or the desire to buy stripped out, run-down homes and fix them up. And as history has shown, this rule did NOTHING to control the fraud that it was intended to prevent when first implemented in 2003.
There is a great misunderstanding among the media HUD, FHA, and real estate industry participants about the word “flipping”. This word actually has more than one meaning, depending on your position within the real estate industry. Below is FHA’s definition of “flipping”, as taken from their own “Anti-Flipping Waiver” (see Supplementary Information Section)
“Property ‘‘flipping’’ refers to the practice whereby a property recently acquired is resold for a considerable profit with an artificially inflated value, often the result of a lender’s collusion with the appraiser. Most property flipping occurs within a matter of days after acquisition, and usually with only minor cosmetic improvements, if any. In an effort to preclude this predatory lending practice with respect to mortgages insured by FHA, HUD issued a final rule on May 1, 2003 (68 FR23370) that provides in 24 CFR 203.37a that FHA will not insure a mortgage if the contract of sale for the purchase of the property that is the subject of the mortgage is executed within 90 days of the prior acquisition by the seller and the seller does not come under any of the exemptions to this 90-day period that are specified in § 203.37a(c).”
For real estate investors, the term “flipping” simply means buying and selling quickly. There is no connotation of fraud just because a home is bought and sold in a short period of time. As with the deal I described above, in which my partner and I were left with over $90,000 of our own cash tied up in a property we could not sell, investors have to be able to buy and sell quickly because they can’t function if they cannot sell a renovated property quickly and pull their cash out.
It takes a lot of money, time and skill to buy, fix and resell even the least expensive of homes. With the median home price running around $170,000, most investors are working on homes that can be bought at a price well below this level, so they are catering primarily to the first-time-buyer market. And restoring the value of run down homes helps rid our cities of the foreclosure blight while improving overall property values.
Another problem for investors is the issue of “reselling the property for more than 20% of the acquisition cost“. Limiting investor profits on the resale of a home with documented, legitimate renovations shows a lack of understanding of the financial issues involved in buying and renovating houses. Again, in my own personal example, we spent $99,000 of our own money in hopes of netting a measly $20,000 gross profit BEFORE agent commissions and taxes. Our rehab budget alone added 20% to the acquisition cost! If we can’t sell for a profit that is above 20% of the acquisition cost, we can’t make a profit in many cases. And if investors can’t resell quickly, they can’t afford to stay in business. So while I strongly support efforts to reduce fraud, the anti-flipping rule actually hurts investors much more than it does lenders or appraisers.
I would advise FHA and HUD to seriously consider getting rid of the anti-flipping rule, in favor of specific documentation that FHA lenders should require from investors / sellers who are selling in 90 days or less. If you want to insure that an increase in property value is legitimate, have the investor / seller document the renovation from beginning to end with photographs before and after the work is done, provide receipts documenting actual costs of the work that was done, and finally, keep the inspection to verify work done and the back up appraisal requirement. But don’t stop investors from making a profit. That means more houses will sit vacant waiting to be stripped of what little value they have left. Homeowners next door will suffer a loss of property value, and first time buyers will have fewer affordable choices.
There’s nothing wrong with making a decent profit for a honest days work, and the risk that honest investors take when buying and renovating homes is well above average.