Flippers beware of the FHA 20 % rule

January 29, 2010 by Mimi Miller.

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Investor Report: 20 Percent Limit
by Kenneth R. Harney

Foreclosure and REO investors have begun taking a closer look at the Obama administration’s recent loosening of rules on property “flips”… . And they’re seeing some potential complications.

The policy change allows investors to resell houses they’ve acquired and rehabbed in less than 90 days to buyers using low-downpayment FHA mortgage financing.

Most investors interviewed by Realty Times last week welcomed the loosening of the rules, but said there are snares for the unwary.

For example, the program sets a 20 percent cap on the difference between an investor’s acquisition cost of a foreclosure and the price paid by the new buyer.

Price gains in excess of 20 percent must be justified with extensive documentation of the improvements made and their impact on the property’s valuation.

Bobby Taylor, a broker with Coldwell Banker Mountain West Real Estate in Salem, Oregon, says the 20 percent standard limit is reasonable, but could prove troublesome for investors who overspend on fix ups or pay too much up front.

In the Salem market, according to Taylor, the average foreclosure sells for about $165,000, while the average non-distressed house sells for around $210,000. If an investor buys a foreclosure at $165,000 and does enough fix up to sell for $210,000 within 90 days, that increase would blow through FHA’s limit.

“Investors who can document how much legitimate value they added would still pass muster, but Taylor warns they’re likely to face tough scrutiny from lenders.

That’s because most FHA lenders today are extremely nervous about getting sideways with FHA - which lately has been sanctioning lenders for rule violations and kicking some of them out of its programs altogether.

Bruce May, who runs Genequity Investment Group in Vista, California, says the 20 percent limit could be a tight squeeze for investors who make significant improvements to properties.

“I think 25 to 30 percent would have been better,” he said, but 20 percent works on properties “where we know we can get in there, turn it around and get out” quickly at a moderate cost.

The challenge for investors focused on the returns on their investments, May said, will be controlling the sometimes high and unpredictable holding costs - which can range from “cash for keys” payments to tenants and former owners to ease them out of the properties, to insurance charges and even vandalism repairs.

On the whole, though, May says, the FHA policy change “is going to open up foreclosures to many more FHA buyers,” and should help put a lot of houses back into the marketplace faster than before.

Published: January 29, 2010

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