'Flip' Rules Are No Flop

Posted: Jan 13, 2011 8:01 PM
'Flip' Rules Are No Flop

WASHINGTON -- When you hear that the Obama administration plans to extend a policy that allows low-down-payment financings of "flipped" houses for 2011, your first reaction might be: No way. At this stage of the boom-to-bust-to-recovery cycle, is high-leverage house-flipping the type of activity the federal government should be encouraging?

Definitely not. A classic real-estate flip involves the quick resale of a house or condominium at a significantly higher price than the purchaser paid with only cosmetic improvements to the property, if any at all. Sometimes only the contract itself is being signed over to a new buyer at a higher price.

A transaction in Florida last year illustrates the concept: An investor bought 19 condo units in a financially distressed Miami development for $1.25 million. She closed on the deal and then resold the units barely 20 minutes later to another investor for $1.45 million -- a $200,000 instant profit. "That was a pretty impressive flip, even for this market," says Peter Zalewski, founder of Condo Vultures LLC, a firm that tracks condo activity in the Miami area and advises investors.

The Obama administration plan has no connection with deals like these, though the word "flipping" is in its title. A little history: For years, the federal government had prohibited the use of FHA mortgage financing by buyers purchasing homes from sellers who had owned the property for less than 90 days. The idea was to prevent speculators from defrauding the government through quick flips of houses -- usually involving straw buyers and corrupt appraisers -- at wildly inflated prices.

One side effect of that policy, however, had been to stifle purchase-and-renovate projects by legitimate, small-scale investors who buy houses after foreclosure or loan defaults and then resell them in substantially improved condition. In many parts of the country, first-time and moderate-income buyers often sought to buy these fixed-up houses using FHA-insured mortgages with 3.5 percent down payments, but were prevented from doing so by the long-standing "anti-flipping" rules.

This, in turn, left large numbers of foreclosed, vacant houses sitting unsold and deteriorating, with negative effects on the values of neighboring properties.

Last January, FHA Commissioner David H. Stevens announced a one-year suspension of that rule, permitting qualified buyers to obtain FHA mortgages on properties that were acquired by rehabbers less than 90 days before. The plan, set to expire at the end of this month, came with key safeguards for purchasers, including inspections and multiple appraisals in some cases to document the amounts spent by investors on the improvements.

Vicki Bott, deputy assistant secretary for single family housing at FHA, confirmed in an interview that the agency expects to continue the policy for another year, and hopes to make a formal announcement soon. Not only have first-time buyers responded overwhelmingly to the opportunity to buy "turn-key" renovated homes with low down payments, she said, but they have performed well on their mortgage obligations.

"Obviously we have concerns about flipping in general," Bott said, but FHA has seen none of the fraud problems, defaults and re-foreclosures that cost the agency millions in insurance payouts in earlier years. The challenge for first-time buyers, she added, "is that they often don't have the money to do repairs -- even replacing the carpet can be a hardship. So when you can bring in investors" who will do the renovations prior to resale, "it makes a huge difference."

What do investors themselves think about the relaxation of FHA's anti-flip rules? Not surprisingly, they tend to be enthusiastic. Paul Wylie, who with a group of partners and contractors specializes in acquiring, renovating and reselling foreclosed and distressed houses in the Los Angeles area, says the government's policy "has been a very positive approach" because "it recognizes the role that (private investors) can play in helping the housing market get back on its feet." In the L.A. market, according to Wylie, FHA financing now accounts for 40 percent of all home purchases and 60 percent of purchases in predominantly Latino and African-American communities.

Buying foreclosed houses "comes with a lot of risk factors," said Wylie. "There's no title insurance, we don't have a good idea of the extent of the defects" inside properties that have been sitting vacant or vandalized for months. Some houses come with delinquent property taxes to boot, which Wylie's group typically must pay.

This is not a game for the faint of heart.

Then again, the profit opportunities can be significant as well. Most of the Wylie group's houses sell for more than 20 percent higher prices than Wylie paid at acquisition -- a quick turnaround gain that potentially works for buyers, sellers, neighborhoods, and yes, FHA itself.