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Flipping Real Estate

Flipping real estate can be profitable but you need to be aware of some recent issues. One common question I get are about how an investor can make money by buying undervalued real estate, doing some minor cosmetic repair and selling quickly or flipping for a handsome profit. This strategy is commonly referred to as "flipping real estate". Please email me with any specific flipping real estate questions

In years past, many real estate investors used this real estate flipping strategy successflly and today many book and course promoters still present the strategy as one of the best ways to make money in real estate. However, there are many issues involved that you need to be aware of before you invest your money.

In November of 2003 HUD issued a "Final Rule" stating that FHA would no longer insure real estate that had not been owned by the current owner for more than 6 months. Many conventional lenders have taken the position that 90 days is too short and now require that a property be owned for 1 full year before they will approve your buyer. Here is the problem. In years past, many individuals would buy distressed real estate with severe problems, frequently but certainly not exclusively in a center city, slap on some paint and resell or flip the real estate quickly. The unsuspecting, frequently undereducated, buyer moves in and at some point discovers the problems in the home. Often the individual is unable to make the repairs and then discovers that they are unable to sell either and defaults on the loan. Some industry watchers have estimated that nearly 1 in 3 defaults in recent years can be traced directly to this problem costing the industry and HUD billions of dollars. Invariably, in the serious cases, there was collusion between the investor, real estate agent and appraiser to ignore the problem areas and create an artificially high sales price. When this is found, it constitutes mortgage fraud and is being aggressively prosecuted by the FBI. I am aware of cases in MD, FL, and NC where people are going to jail for at least 10 years.

Here is the fallout from the unfortunate situation. If you or I, as ethical investors, buy at a good price, do some minor repairs, and attempt to sell a decent property at a decent price, the person we are trying to sell to may not be able to get a mortgage. True, we can always rent for a year and then sell but that was certainly not the original idea and you need to be aware. The other issue for your mortgage broker, and the reason I will decline to work on a loan if I suspect that the investor intends to flip the property, is that the lender will require any yield spread premium paid be returned immediately. Many lenders are creating "watch lists" of brokers who have participated in as few as two loans that are paid off early. In one recent conversation with the underwriting manager of a large national lender, I was told that her underwriters are being instructed to "find a reason" to decline a file if they see multiple mortgages paid off quickly on a credit report. This is considered evidence of flipping in the past and even if your intent is to hold this particular property this particular lender will decline you. A pretty serious consequence in my mind and a reason you may want to reconsider flipping real estate.

The following is an update from the FHA manual effective 1/24/05

Effective Date

Effective for loans closed on or after January 24, 2005

Property Flipping Guidelines

The FHA property flipping guidelines were enacted to curb fraudulent flipping by establishing time restriction eligibility requirements for properties to be purchased and financed through the FHA mortgage program. Property flipping occurs when a property is deliberately acquired through a sale for the purpose of a quick resale at an artificially inflated value. The FHA property flipping rules require a seller to hold title to a property for at least 90 days before it can be sold to a buyer seeking FHA-insured mortgage financing.

  • Any property being sold within 90 days of its acquisition by the seller is prohibited from being financed through the FHA mortgage program.
  • Properties that are being sold between 91 and 180 days following the acquisition by the current seller may only be purchased using FHA financing if all additional documentation requirements are met, including second appraisal requirements, to ensure that any increase in value has been supported.
    • Second Appraisals - FHA property flipping rules require a second appraisal to be obtained under certain circumstances. If a second appraisal is obtained, the repairs and valuation conditions from BOTH appraisals must be resolved, even if the conditions are different for each appraisal. When a second appraisal is required, the second appraisal must also be completed by an FHA Roster appraiser and must comply with all FHA requirements.
    • In situations where two appraisals are obtained, the required information for both appraisals must be entered into FHA Connection by the Loan Center personnel. FHA will identify the appraisals as “First Appraisal” and “Second Appraisal.”

For complete property flipping guidelines including the second appraisal requirements, refer to Mortgage Letter ML 2003-07 at the following link: Prohibition of Flipping Real Estate .

Revised Exceptions to the Time Restrictions

Exceptions to the time restrictions now include all of the following:

  • A builder selling a newly built home or building a home for a home buyer wishing to use FHA insured-financing.
  • The re-sale of properties acquired by an employer or relocation agency in connection with the relocation of an employee. A relocation agency DOES NOT include individual real estate agents that advertise themselves as relocation experts and who purchase properties from persons relocating to the area.
  • Properties acquired by inheritance:
    • A seller that inherited a property must be the owner of record but is not required to hold title to the subject property for 90 days before it can be sold with FHA insured financing. Further, since there was no previous sale of the property due to inheritance, there is no previous sales price that might trigger the second appraisal requirement set forth in the flipping rules. The loan file must be documented to evidence the inheritance.
  • Re-sales by HUD of its own REO (Real Estate Owned) properties:
    • All Federal agencies that acquire properties as a result of a function of their programs and quickly market and sell these acquired properties. This includes such agencies as the Department of Veterans Affairs, the Rural Housing Service of the Department of Agriculture and the Federal Deposit Insurance Corporation. It must be noted that this exception does not include sales of such properties by Fannie Mae or Freddie Mac or sales by private entities.

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