Real estate investing is one of the most popular endeavors for do it yourself entrepreneurs in America. Because of the immense popularity on television shows, it would seem that flipping houses is a failsafe investment, and even those with no experience in the area would be successful. While many of these shows are built on ratings and not indicative of the true process, many people make a great living through flipping real estate. The benefits apply to both sides as homebuyers can purchase a move in ready home for which they may lack the skill to update themselves.
While the industry took a big hit after its role in the great recession, flippers are back in full force, and transaction are on the rise throughout the nation. In 2019, 246,000 homes were labelled as flip transactions, equating to 6% of all home transactions, and the highest rate since the recession! The premise is simple enough; buy a home below market rate and either hold until values rise or make improvements and sell for a profit. While the premise is simple enough, it is easier said than done, and the would be flipper should know that risk is inherent in any investment.
Risk aside, after the recession in 2008 for which real estate is generally accepted as a principal cause, there are legal watch out points that would be flippers need follow to ensure they are on the right side of the law. Many of these laws are to protect consumers from fraudulent schemes which artificially inflate the prices of real estate. The three most common regulations involve FHA re-selling restrictions, mortgage loan disclosures, and title requirements, all of which are explained in further detail below.
The largest regulation applying to flipped homes comes from the Federal Housing Administration. The FHA, which insures the vast majority of mortgages in the United States, imposes regulations on transactions that would be considered flips. The transaction requires FHA borrowers to wait a minimum of 90 days after purchase before selling a home. If the home is resold between 91 and 180 days from purchase, additional paperwork and approvals are required to ensure the transaction is legitimate. While this regulation applies only to buyers and sellers utilizing an FHA backed mortgage, again this is the majority of homes, and significantly reduces the potential pool of buyers in a would be flipped home. The principal reason for this is to avoid mortgage fraud, which is the secondary watch out point discussed below.
Mortgage Fraud can happen one of two ways, with the first scheme enacting fraud one the lender, and the second enacting fraud on the end consumer although both schemes are similar in nature. Typically, the purchaser will buy a distressed or dilapidated home with a little money down mortgage at a reduced rate. They will then collude with a second investor to purchase the home at a higher value, paying off the first loan, and increasing the home’s value. Then typically, a consumer purchases the home with a third mortgage after superficial improvements have been made.
This individual is left “holding the bag” for substandard renovations and highly inflated prices, while the colluding investors have made off with a profit for very little work. If the parties cannot find a buyer, they simply default on the mortgage and make off with the proceeds from the inflated second mortgage. While this example is blatant and represents the worst in mortgage fraud schemes, it is nonetheless a slippery slope, and even the best intentioned would be investors can find themselves on the wrong side of the law due to the complex nature of the transactions. For this reason, mortgaging requirements have become much more stringent on purchasers and short term owners.
The final legal pitfall for DIY flippers comes in the form of Titling requirements. Because home flippers are looking to buy under-valued real estate, they are typically on the hunt for distressed real estate, commonly bank foreclosures or estate held property. The problem with these forms of investments are that it can be difficult to discern true ownership. In foreclosures, the home may have been quit-claimed several times, or there may be several creditors claiming the home through various liens or bankruptcies. In estates, numerous family members may have a stake in the ownership of the home, and may not consent to the sale. Clearing title to homes can be a time consuming and costly endeavor, often times rendering a home flip un-profitable to the investor. For this reason, it is important with any investment purchase to carry title insurance for protection of your investment.
While television has widely popularized home flipping as a foolproof DIY investment, it should be noted that as with any investment, risk is involved. It is also equally important to ensure that you are following all of the laws in this highly regulated industry. Whether you are an experienced flipper or just starting out, if you need help navigating the legal requirements of real estate investing, consult the real estate attorneys at Thrift McLemore to discuss your needs! You can contact us by email at firstname.lastname@example.org or by phone at 678-784-4150 today!