True story: On a chilly November evening in Burlington, Vermont in 1987, Stephen C. Brooks turned on the driveway heater in his home and then took off running some errands. For those of us who grew up in Hawaii, like me, a driveway heater is a gas system that heats water in pipes running under the driveway to melt snow and ice. While Stephen was out, his girlfriend Jill and her baby got severely ill. When Stephen came back home, Jill asked him to take her and her baby to the hospital. But the symptoms went away, and there was no diagnosis made. Concerned, Stephen called a heating and air repairman to inspect his heater.
The repairman identified a malfunctioning vent that was blocking the exhaust from reaching outside the house. The heater exhaust was instead being rerouted inside the house. He told Jill, “You’re lucky to be alive, because it’s carbon monoxide.” He made some repair recommendations, and the contractor told Stephen that the heater had been improperly installed. He also told him not to operate it until the system was repaired.
Instead, he prepared his home for sale, and instructed the agent showing his property to demonstrate the heater by switching it on and then immediately off. He did nothing to disclose the problem with the driveway heater, and did not mention the problems to the agent. In fact, Stephen actually demonstrated the system to buyers himself, without mentioning the problems.
The home was eventually purchased by John and Linda Ciferelli, and their 4-year-old child.
On December 9, 1988, the Ciferellis turned on the driveway heater, and went to bed. A house guest stayed up to watch TV and became violently ill. He opened a window and fell asleep on the couch. He woke up at noon, and became worried because the Ciferellis had not yet come out of their bedrooms. He went to the bedrooms and found Linda and her husband dead in their beds. The child was still breathing.
Stephen Brooks was convicted of involuntary manslaughter.
The Value of Transparency
For many years, the National Association of Realtors® opposed mandatory and systematic seller disclosure requirements, fearing that disclosure would dissuade buyers from making offers. But this case illustrates the importance of full disclosure.
As a property flipper, you have a lot riding on transparency in the system. If you flip a lot, you’re going to be on both sides of that transaction many times. It behooves everyone involved in the industry to maintain a robust ethic of disclosure.
Think of it this way: If you are looking at a house with defects, whether you discover them yourself or they are disclosed to you by the seller or seller’s agent, you can adjust your price to reflect the cost of repair or mitigation. But the Ciferellis could not adjust their offering price low enough to account for their deaths, and for their baby growing up an orphan.
Obviously, most real estate disclosure cases don’t involve death. But it’s still serious business. In a more recent case, a Massachusetts real estate agent was slapped with a lawsuit for failing to disclose to a buyer that a heavy smoker lived in the condo downstairs.
For real estate investment professionals (that’s you, flippers!), the best course of action is to be very open about disclosures. If there is any doubt about whether you should disclose, disclose. If you don’t want to disclose, that in itself is a reason to believe you should disclose. Why? Think about it.
As a flipper, you are routinely going to be buying from distressed homeowners and selling to retail buyers. Most of the time, these buyers will not be experienced, sophisticated, real estate professionals. You’re the “professional” in these transactions. That means that the courts and juries will tend to give your counterparties the benefit of any doubt. The innocent homeowners, not you, the professional, will be the sympathetic parties to any jury. If you’re ever in court, the plaintiff’s attorneys are going to milk that for all it’s worth. They will kick over every rock to make you look like a money-grubbing, lying, conniving real estate shark. But if you disclose everything in writing, before the lawsuit happens, you take the wind right out of their sails.
Know Your Jurisdiction
Disclosure laws vary by state of course. If you’re going to be a real estate flipper, be sure to speak with your attorney (you do have a real estate attorney in your court already, right?) about real estate disclosure laws, requirements and exceptions as they apply in your specific jurisdiction.
For example, many states only require you to disclose defects you actually have personal knowledge of. But some states, such as California, have a different standard: You must disclose defects which any reasonably perceptive owner would normally have knowledge of. This puts the onus on you to take steps to discover property defects.
California’s disclosure laws, while complicated, basically state that the seller has a duty to disclose to the buyer “facts which materially affect the value or desirability of the property.” California law also requires sellers to make additional disclosures of known natural hazards, such as proximity of earthquake fault lines, and any registered sex offenders living in the area. Not every state requires such disclosures.
However, there is at least one federal disclosure law that applies to all U.S. home sales: If the home was built prior to 1978, you must disclose all known lead paint and other lead hazards in the home, in accordance with the Residential Lead-Based Paint Hazard Reduction Act of 1992. You must also provide buyers with a copy of an Environmental Protection Agency brochure called Protect Your Family from Lead in Your Home.
In the long run, all parties benefit from full disclosure and transparency in the real estate world. Consider the U.S. stock market: Listing companies operate under strict SEC rules that require them to disclose all information that could materially affect the value of the stock in their annual reports and prospectuses. Failure to disclose could result in the CEO and CFO facing personal liability and even jail time, under Sarbanes Oxley. This isn’t always convenient for publicly traded companies. But in the aggregate, the U.S. has the most transparent capital system in the world, and buyers and sellers alike benefit from the increased efficiency.
Looked at another way, the potential price advantage of failing to disclose most flaws in a house is trivial compared with the costs of facing a court case for anything from failing to disclose to involuntary manslaughter.