The agency’s policy has encouraged investors to buy foreclosed and deteriorating houses from lenders, then repair them and resell within short periods of time.
The idea, according to acting FHA Commissioner Carol J. Galante, is to help “stabilize real estate prices as well as neighborhoods and communities where foreclosure activity has been high” by making it easier for investors to buy, fix up and sell run-down homes that add to urban blight and depress values.
The primary purchasers of the renovated properties are first-time, moderate-income families who might otherwise be frozen out of the market because they don’t have the down-payment cash required for a conventional loan. FHA down payments can be as low as 3.5%.
The Obama administration’s initiative in 2010 represented a reversal of earlier restrictions on flips first imposed in 2003. After scandals in Los Angeles, New York, Baltimore, Washington, D.C., and other large cities over widespread fraudulent flips — in which houses were sometimes resold for double their previous price within days or even hours — the FHA stopped insuring loans on houses whose sellers had owned them for less than 90 days.
Paul Wylie, a Los Angeles-area investor active in renovating distressed properties, welcomed the extension of the FHA policy because “it allows predominantly first-time buyers to compete with cash buyers, investors and others” for houses at affordable prices that have been professionally repaired. In some neighborhoods in and around Los Angeles, many homes that have been rehabilitated for resale within 90 days are what Wylie calls “foreclosure flips, short-sale flips or standard-sale flips.” The FHA is pretty much the only financing available for moderate-income, owner-occupant buyers of these renovated properties.
Bruce A. Calabrese, chief executive of Equitable Mortgage Corp. in Columbus, Ohio, says the essential ingredients in the FHA’s revised approach are its strict controls on appraisals, inspections and chain of title — all designed to ensure “that there is no funny business going on.”
The FHA’s policy requires property sellers to comply with a detailed list of standards. Among the most prominent:
• You can’t play games on ownership. All transactions must be arm’s length with “no identity of interest between the buyer and seller or other parties” involved in the sale. You can’t buy a house from your uncle at a bargain price, hire your brother to do a few quick repairs to it, then resell it for a huge profit to an unsophisticated buyer, supported by a hyped-up appraisal signed by a friend or partner.
• The seller of the rehabilitated house must have clear legal title to it. This may sound elementary, but some flippers during the late 1990s never bothered to acquire title and record it. They took over the property one day, slapped a little paint on the outside and sold it for cash the following day.
• If the selling price is 20% higher than what the house cost the seller, a second appraisal, conducted by a member of the FHA’s panel of approved appraisers, is mandatory to be certain that the improvements made to the property justify the increased price.
• An independent inspection report, conducted by a professional with no connection to other participants in the transaction, is also mandatory when the price jump is more than 20%. If there are repairs that are still needed that could affect the “health and safety” of the purchasers, they must be completed and a re-inspection conducted before the closing.
Bottom line: Flipping under the FHA’s rules should continue to be an important option for buyers of renovated, previously distressed houses and the investors who make it their business to find them and fix them up.