Flipping

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Flipping is a term used primarily in the United States to describe purchasing a revenue-generating asset and quickly reselling (or "flipping") it for profit. Though flipping can apply to any asset, the term is most often applied to real estate and initial public offerings.

The term "flipping" is used by real estate investors to describe "residential redevelopment". Redevelopment of distressed or abandoned properties or neighborhoods has sometimes been unfairly linked to malicious and unscrupulous acts in the post housing boom era by pessimistic or uninformed parties. The term "flipping" is frequently used both as a descriptive term for schemes involving market manipulation and other illegal conduct and as a derogatory term for legal real estate investing strategies that are perceived by some to be unethical or socially destructive. In the United Kingdom the term is used to describe a technique whereby Members of Parliament were found to be switching their second home between several houses, which had the effect of allowing them to maximize their taxpayer funded allowances.[1]

Types

Wholesaling and assigning a contract

Wholesalers make a profit by signing a contract to purchase a property from a seller and then entering into an agreement with a third party to resell the same property at a higher price for a profit. All rights to the original purchase contract are assigned to the new buyer and the new buyer pays an "assignment fee" to the wholesaler in order to gain all rights to purchase the property at the original purchase price. The original purchase contract usually has an "inspection period" which allows the original buyer to back out of the contract and not close on it if they do not find a buyer to assign their contract to. Many wholesalers have no intention of actually purchasing the property and simply use wholesaling as a tool to locate properties for other investors. Wholesalers that are able to identify good investment opportunities for other investors can make a good living by locating these properties and then assigning the rights to them to these buyers.

In many cases, if another buyer is not found prior to the end of the inspection period, the wholesaler cancels the original purchase contract relying on the cancellation for inspection clause in the original contract which allows the contract to be cancelled and their deposit to be returned to them. Wholesaling requires little or no money to be secured in escrow, and in most cases the wholesaler never intends to actually purchase the property. The practice of wholesaling is often advertised as "No Money Down and No Risk" by many real estate coaching companies and infomercials since the actual deposit can be as little as $10 and in effect even the deposit can be returned if the wholesaler cancels the contract prior to the end of the inspection period.

Some people are of the opinion that wholesaling is fraudulent misrepresentation since the wholesaler does not actually intend to close on the property themselves. However in the United States wholesaling is perfectly legal and every real estate contract allows the buyer an inspection period and any amount of deposit that buyer and seller agree to. The concept of wholesaling a property is no different than a wholesaler in any other industry that signs a contract to purchase goods with the hope of reselling those goods at a profit to a third party. In a successful transaction the seller is often unaware that original buyer is not purchasing the property. In some cases, wholesalers actually purchase the property for cash and then resell the property to their end buyer in a second closing. This practice is considered more costly since the buyer is paying closing costs to purchase the property and to resell the property. However many people consider double closing to be more ethical since the original seller sold the property to the buyer and then the buyer entered into a new transaction to resell the property to a new buyer. In cases where there are substantial profits from reselling it often makes sense for the wholesaler to pay for two closing costs (double closing) in order to not have to request a large assignment fee from their buyer.

Bank owned properties and short sales cannot be purchased using an assignment of contract so the double closing method must be utilized. In order for wholesalers to pay for the property before they can resell it they need to have access to cash or borrow "transactional funding" from a private lender so that they can pay for the property before they resell it.

Wholesaling a property multiple times

It is not uncommon for a property to be assigned multiple times and for a few wholesalers to make money in a transaction from the seller to the end buyer. The original wholesaler enters into a contract to purchase a property at below-market value, and then assigns or sells their rights to that contract to another investor. That investor then assigns their rights to said contract to a third investor and so forth. In many cases wholesalers work together ensuring that all parties get paid on a transaction. This practise is often frowned upon in the real estate community since it seems unethical or illegal. In practice there is nothing illegal about wholesaling or assigning rights to a purchase contract even if it is multiple times. It is important to understand that the reason there is an opportunity to wholesale is because the original seller is selling the property for substantially less than market value. This usually occurs when either the property or the seller is in distress. Examples of distress could be a property damaged by fire, flood, hurricane or a homeowner that is facing foreclosure and is about to lose their home and is selling it for substantially less than fair market value. The practice of buying real estate at substantially below market value is called Distressed Real Estate Investing or Wholesale Real Estate Investing hence the term "wholesaler".

Real estate flipping

Profits from flipping real estate come from either buying low and selling high (often in a rapidly-rising market), or buying a house that needs repair and fixing it up before reselling it for a profit ("fix and flip").

Under the "fix and flip" scenario, an investor or flipper will purchase a house at price often deeply discounted from the house's market value. The discount may be due to the house's condition (e.g., the house needs major renovations and/or repairs which the owner either does not want, or cannot afford, to do) or the owner(s) needing to sell a house quickly (e.g., relocation, divorce, pending foreclosure). The investor will then perform necessary renovations and repairs, and attempt to make a profit by selling the house quickly at a higher price (closer to or maybe a bit above market value). The "fix and flip" scenario is profitable to investors because the average home buyer lacks the time and funds to repair and update the house, so they seek out a move-in ready home instead, even if it is a little above market price.

Second home flipping

In the UK, Members of Parliament are given an allowance to maintain an extra home in London allowing them to live closer to the Houses of Parliament during the working week. Certain costs for this second home can be claimed and are thus partly funded by the taxpayer. Subsequently a MP can nominate any of their properties as the second home, called "flipping", and by nominating each as a second home can obtain further allowances. In some cases, MPs can simultaneously declare one home as their primary residence (for tax purposes) and as their second residence (for expense purposes). Following publication of the MPs expenses scandal on May 15, 2009 the practice ended.[2]

Effects

Bubbles

Flipping bubbles have historically ended in disaster, such as during the Florida land boom of the 1920s.[3]

In the 2000s (decade), relaxed federal borrowing standards (which included the abilities for a subprime borrower to receive a loan, and for a borrower to purchase a home with little or no money down) may have led directly to a boom in demand for houses, thereby affecting the supply. Since it was easier to borrow, many investors snapped up investment homes without having to put money down. Additionally, since so many investors were purchasing homes, this left even fewer homes available to be purchased by owner-occupants. Since the ones that were placed back on the market by flippers were priced higher than before the flip, buyers again had even less money to put down. This resulted in a continuing circle until finally the bubble burst in 2008 and borrowing standards began returning to normal, leaving the housing market to bottom out before it begins to steadily correct itself. Flipping was so popular in the United States that many DIY television programs like A&E's Flip This House detailed the process.

The other significant adverse financial aspect of the mentality of flipping is when interest rates increase. The resulting lack of sales, and major price depreciations (often far below) their previous increases, results in a flood of properties on the market at one time, not selling due to lack of buyers, causing a meltdown of a local market and potentially the economy as a whole.

Further information: United States housing bubble

Rejuvenation and gentrification

"Rational" flipping can encourage a rejuvenation and restoration of a previously decrepit neighborhood, but rising property values can also be seen in a negative light, termed gentrification.

Under the broken windows theory, an unkept house/area attracts a criminal element, which drives out those making a responsible living, which allows for more criminal element, and so on in a vicious downward cycle. The restoration creates jobs, particularly in construction, for locals and generates more sales (and sales taxes) to local vendors (initially those involved in selling construction materials). The newly remodelled homes will then attract new populations and businesses to a region, encouraging more economic development, plus the remodelled homes' higher assessed values brings more property tax revenues to local governments, allowing for more improvements to the area and driving out the criminal element.

As flipping occurs more frequently in a community, the total cost of living there can rise substantially, eventually forcing current residents to relocate, specifically less affluent younger and older people. On a small scale, flippers can cause distress and disturbance to their immediate neighbors by performing lengthy renovations. Flippers commonly have no interest in neighborhood integration,[citation needed] which may cause tensions with long-term residents. During the real estate bubble, flipping and gentrification both have been linked to the mass migration of people to California, where high real estate prices and ample jobs attracted wealth seekers.[citation needed] In response, many native Californians were forced to migrate to the less expensive areas of surrounding states such as Arizona, Nevada, Texas, Oregon and Washington.[citation needed] This migration of Californians caused further gentrification in the areas that they had moved to en masse. Areas such as Phoenix, Arizona and Las Vegas which were once very inexpensive to live in prior to the real estate bubble subsequently became quite expensive, although such prices have dropped significantly since 2006.

Property values

After a renovation, the house itself will be in better condition and last longer, and can be sold at a higher price, thus increasing its property tax assessed value, plus increased sales for goods and services related to property improvement and the related increase in sales taxes. Neighbors can also benefit by having more attractive homes in the neighborhood, thereby increasing the value of their own homes.

Regulations

In 2006, the Department of Housing and Urban Development created regulations regarding predatory flipping within Federal Housing Administration (FHA) single-family mortgage insurance. The time requirement for owning a property was greater than 90 days between purchase and sale dates to qualify for FHA-insured mortgage financing.[4] This requirement was greatly relaxed in January 2010, and the 90-day holding period was all but eliminated.[5]

Illegal activity

Flipping can sometimes also be a criminal scheme. Illegal property flipping is a fraud-for-profit scheme whereby recently acquired real property is resold for a considerable profit with an artificially inflated value. The real property is resold within a short time frame, often after making only cosmetic improvements to the real property. Illegal property flipping often involves collusion between a real estate appraiser, a mortgage originator and a closing agent. The cooperation of a real estate appraiser is necessary since a false and artificially inflated appraisal report is required. The buyer (ultimate borrower) may or may not be aware of the situation. This type of fraud is one of the most costly for lenders because the loss is always large.

The following is an example of an illegal property flip: A buyer contracts to purchase a property in his name for $30,000. Before closing the deal, he draws up a second contract to sell the property to a co-conspirator at $70,000 — a price substantially higher than market value. He seeks a loan for a second contract through a mortgage lender or a mortgage broker and submits an application. A real estate appraiser inflates the value of the property, enough to justify the loan, and is paid triple the usual fee (although many times inexperienced or incompetent appraisers are unwittingly caught in the scheme through pressure and intimidation from the scammers). A mortgage lender approves the application and releases the $70,000. Next, the contracts for the property are closed either simultaneously or within a short time from each other. The originator of the scheme takes the $70,000, pays off the $30,000 and divides the remaining $40,000 between himself and any other plotters — usually the mortgage broker or loan officer and sometimes the second buyer. The lender ends up with a 100% or greater loan to value mortgage. That buyer makes a few payments on the property, then defaults and allows it to go into foreclosure. Finally, the lender learns that the property doesn’t even cover the loan value.

In the United States, the Uniform Standards of Professional Appraisal Practice (USPAP), which governs real estate appraisal, and Fannie Mae, which oversees the secondary residential mortgage market, have enacted practices to detect illegal flipping schemes.

In television

In July 2012, business network CNBC green-lit several pilots for reality television series focusing on house flipping.[6]

The following is a list of several house flipping shows:

See also

Notes

References

  1. ↑ "Cabinet ministers have made tens of thousands 'flipping' their homes". London: Daily Mail. Retrieved 2009-05-08. 
  2. ↑ "How the Telegraph investigation exposed the MPs' expenses scandal day by day". London: Daily Telegraph. May 15, 2009. Retrieved 2010-05-07. 
  3. ↑ Crashes: The Florida Real Estate Craze
  4. ↑ Prohibition of Property Flipping in HUD's Single Family Mortgage Insurance Programs; Additional Exceptions to Time Restriction on Sales | Federal Register Environmental Documents | USEPA
  5. ↑ HUD Press Release, January 15 2010.
  6. ↑ "CNBC to Promote House Flipping". Helaine Olen. Forbes. July 25, 2012. Retrieved 12 February 2013. 

Published articles

Books

  • Bronchick, William; Dahlstrom, Robert. Flipping Properties: Generate Instant Cash Profits in Real Estate. 
  • Berges, Steve (2004). The Complete Guide to Flipping Properties. John Wiley & Sons. ISBN 978-0-471-46331-3. 
  • Levinrad, Lex (2012). Wholesaling Bank Owned Properties. Distressed Real Estate Institute. 
  • Weiss, Mark B. Real Estate Flipping: Grow Rich Buying and Selling Property. 
  • Hamilton, Gene; Hamilton, Katie. Fix It and Flip It: How to Make Money Rehabbing Real Estate for Profit. 
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