Uncle Sam wants you … to flip houses. That’s what the Federal Housing Administration told the country at the end of November.
On November 29, the FHA announced that it was extending the waiver of Regulation 24 CFR 203.37a(b)(2) for another two years. The waiver will allow the use of FHA mortgages to support the purchase of homes that are being resold within 90 days of acquisition. In other words, the waiver of the so-called “anti-flipping rule” is being extended through the end of 2014.
The Department of Housing and Urban Development’s purpose is to provide as much incentive as possible for flippers to pick up abandoned or foreclosed homes, renovate and improve them, and find buyers.
The anti-flipping rule was first imposed in 2003, because regulators were concerned that speculators were realizing “artificially high” profits on short-term sales after making only “cosmetic improvements, if any,” to houses. The FHA believed that the profits often came about as a result of “collusion” between a lender and an appraiser. Which is true – appraisal fraud was rampant during the run-up in housing prices.
The FHA broadened the restrictions in 2006 to take the edge off of a housing market overheating with speculators.
But as it turned out, the rule was dumber than a sack of hammers.
When the housing bubble popped in 2007-2008, thousands of investors with desperately needed capital for distressed sellers sat on the sidelines, because if they went all in into residential real estate, they couldn’t sell their properties to FHA borrowers. And since tighter credit markets meant that many buyers could not get cash or conventional financing, they represented a huge part of the overall housing market. Flippers – a valuable source of market liquidity and the traditional market-makers of the real-estate asset class – cooled off their activities just when they were needed most.
The rule also benefits FHA borrowers. Prior to the waiver, according to the Department of Housing and Urban Development, FHA borrowers were locked out of many affordable houses because they had to wait until the 90-day period was up before closing on the property. Sellers weren’t willing to wait that long since they incurred expenses of their own, taxes, and vandalism risk. Conventional mortgage and cash buyers were frequently able to swoop in and buy affordable properties out from under FHA borrowers. They had no artificial constraint that required them to wait weeks or months before they could get their deal closed and funded. Cash and conventional buyers could close right away, causing FHA buyers to get frozen out of some very affordable and livable homes – causing market distortion and frustration.
The FHA finally caught on and waived the rule in 2010 for two years. They extended the waiver for a year in January 2011, and again in December 2011, and are now are extending it through 2014 in an effort to lure as many investors as possible into the single-family home market.
The extension of the waiver is a welcome development. Indeed, the waiver itself freed up $11 billion in FHA-backed capital to help people buy residential real estate, including 23,000 homes in the last year alone. Too many residential neighborhoods are blighted with homes sitting vacant and neglected. These homes are bringing down property values throughout their neighborhoods, attracting vagrants and pests, and dragging down the value of surrounding homes.
In some particularly economically hard-hit areas such as Detroit, local officials have resorted to bulldozing entire neighborhoods in an effort to preserve the neighborhoods around them.
Had the rule been waived earlier, many of these houses could have been placed in short-sales with willing buyers who had the patience and capital to renovate them, rather than allowing them to sit fallow and act like a cancer in their neighborhoods. Unfortunately, the federal government went years before acting to free short-term investors to provide desperately-needed liquidity to the residential real estate market.
But with house prices still struggling, and hundreds of thousands of homeowners underwater, the FHA is looking to get vacant houses renovated and occupied again.
The waiver isn’t unlimited: The transaction must be an “arms-length” transaction. That means you can’t be taking advantage of a pre-existing relationship to get better terms on the deal. The FHA says there can be no “identity of interest” between the seller and the buyer. In plain English, that means you can’t buy a house from your dad and get your bother to fix it, and then turn around and sell it to an FHA buyer. FHA is still going to block that loan. Also, any transactions that result in a profit of 20 percent or more must also undergo scrutiny by an FHA-approved appraiser. And the waiver only applies to forward mortgages. Reverse mortgages (the FHA HECM loans) don’t qualify for the waiver.
The rule also puts restrictions on appraisers and inspectors: They cannot compensate anyone for the referral, nor can they receive any payment or other consideration for recommending or referring contractors for any renovations, improvements or repairs. They cannot themselves be involved in any way with repairs or renovations to the property.
Furthermore, the new FHA borrower buying the property from the flipper must demonstrate to the FHA that the flipper added sufficient value to the property through repairs and renovations to warrant a 20 percent profit within the 90 day period or less that the flipper owned the property. The borrower cannot use an appraisal done for a conventional mortgage for this purpose – even if the appraiser is FHA approved. The borrower must obtain a new appraisal.
The property, in addition, cannot have been flipped several times over the past year already. “Frequent-flipper” properties, in short, still cannot qualify for FHA financing.
The waiver of the rule is also contingent upon continued performance by FHA mortgage holders. If there is an increase in defaults in mortgages obtained under the waiver, the Department of Housing and Urban Development states that it will reinstitute the anti-flipping rule immediately.