HUD PROPOSES NEW RULES ON FHA LOAN FOR “FLIPS”

As many of you may be aware, there has been a lot of negative press recently about “flips,” that is, buying and quickly reselling properties for profit. Despite all of the misinformation floating around, flipping properties is perfectly legal, ethical, moral, viable and profitable. The misinformed sources (realtors, bankers, title companies, etc) that tell you flipping is becoming illegal reminds me of that game we played as kids; one person whispers a secret into another’s ear, which is passed on and on until the message gets distorted beyond belief! A new proposed HUD rule just keeps feeding into the stupidity . . .
According to HUD, “property flipping” occurs when a property “recently acquired is resold for a considerable profit with an artificially inflated value, often abetted with a lender’s collusion with an appraiser.” First of all, the “often” part bothers me as a capitalist; if a recently acquired property is resold at a substantial profit, isn’t that called “capitalism?” Let’s face it folks, half of the properties that have sold in the last two years are “artificially inflated” based on low interest rates and the dot-com stock market hype. If flipping is legal and colluding with a lender is not, then HUD should just call “property flipping” what it really is: “LOAN FRAUD.” From this point on, you and I will call buying a property and selling for a profit “flipping,” ! and we’ll call the other thing “loan fraud.”
Enough of my personal tirade, let’s get back to the facts . . .
Since many of these “loan fraud” cases have involved low-income properties with FHA-insured loans, HUD has decided to get involved (this after a Senate hearing that blamed HUD for the problem!). Under proposed 24 USC Sec. 203.37a, any property that is being sold within six months of acquisition will not be eligible for FHA financing. This means if you buy a property, fix it up and sell it to a retail buyer, that buyer cannot get an FHA loan to buy your property.
Is this the end of the world? Of course not! There are dozens of other loan programs for low-income and first-time homebuyers that are not HUD-insured. You could also wait an extra month or so to sell the property (after all, it usually takes at least 2-3 months to acquire, fix-up and sell a rehab property). Thus, when you make an offer to purchase a property, you must figure on an extra two months of holding costs. For those of you who have been doing this business a while, you can remember when it used to take six months to buy, fix and sell a property. If you cannot afford to hold a property for an extra two months, then get a lease/option tenant to rent it for six months before buying. With a lease/option, it will take you longer to get your cash back, but it will usually mean a higher selling price and no realtor commissions!
If you read the new proposed regulations further, you will note that HUD has provided a loophole. On a case-by-case basis, HUD may grant an except to the 6 month rule if the buyer can show that the property is really worth what he is paying. The rules specify that the borrower can submit information such as a list of repairs, comparable sales and the fact that the investor bought the property cheaper in a distress sale. Of course, you, as the investor, should have this information ready to submit with the buyer’s loan application. Is this a pain in the neck? Of course it is, but you pay that price for dealing with Government-sponsored programs.
Another part of the proposed rule is that the purchase must be from the “owner of record.” Of course, this means you cannot assign a contract to a buyer who is getting an FHA-insured loan. To me, this is meaningless, since I only flip contracts to other investors. However, some people in sandwich lease-option deals have buyers that will apply for FHA loans. In this case, you may have to find another loan program or let the seller buy you out of the deal and close directly with the subtenant. Another way to handle this may be to convert your lease/option agreement with the seller into a land contract six months before the subtenant-buyer’s application for a loan. This is a gray area, since HUD has not defined what an “owner of record” is (in theory, a recorded land contract would show you, the investor, as the “equitable” owner of record). Also, you may be able to try the land trust trick as described! in my previous article (essentially buying the property in a trust name that relates to the seller’s last name, so the underwriter assumes your trust and the seller are on and the same!).
Finally, investors are panicking at the though that FNMA regulations may follow HUD’s lead and require the same six month moratorium. Personally, I doubt this will happen. HUD only got involved because most of the loan fraud cases involved FHA loans and the Senate blamed HUD. There are many stringent loan regulations over the years required for FHA loans that have not been adopted as FNMA standards.

Worst case scenario: what if ALL lenders require the new six-month rule? In that case, I will be looking for partners to get into the loan business. I will capitalize on this opportunity by creating a niche that nobody else is working. I am being facetious, of course, to make a point: some other lender will seize the opportunity and work with investors. As the stock market declines and interest rates are dropped by the Fed, the lenders’ competition for our business will only get stronger, leading to more and more creative loan programs.

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