Business, Legal & Accounting Glossary
Flipping is a term, used primarily in the United States, which refers to the practice of buying an asset and quickly reselling (“flipping”) it for profit. Though flipping can apply to any asset, the term is most often applied to real estate and initial public offerings.
Under the multiple investor flip, one investor purchases a property at below market value, sells it quickly to a second investor, who subsequently sells it to another party.
Profits from flipping real estate come from either buying low and selling high in a rapidly-rising market, or buying a house that needs repair and fixing it up.
Under the “fix and flip” scenario, an investor or flipper will purchase a house at a considerable discount from market value. The discount may be due to the house’s condition (i.e., major renovations and/or repairs needed) or due to the owner(s) needing to sell a house quickly (e.g., relocation, divorce, pending foreclosure).
The investor will then perform necessary renovations and repairs, and attempt to make a profit by selling the house quickly at a price nearer to full market value.
It is this type of scenario that is featured on the numerous reality shows which show amateur investors getting into this business.
Many experts blame the US real estate bubble in 2004 and 2005 on investor speculation and “irrational” flipping. Very low-interest rates were a root cause, but speculation and flipping compounded the bubble. Although the practice of flipping existed long before the real estate bubble, it became more rampant and widespread in those years. Flipping was so popular nationally that some DIY television programs detailed the process. Flipping trends have historically ended in disaster, such as during the Florida Real Estate Crash of the 1920s. In 2006 we see, reported by USNEWS on Wed June 14 2006, that the “Housing bubble correction could be severe.”
Flipping can play a role in the gentrification of older communities. As flipping occurs more and more in a community, the total cost of living there can rise substantially, essentially forcing the local people, specifically the younger generations, to relocate. During the real estate bubble, flipping and gentrification both have been linked to the mass migration of Californians to the (once much) less expensive areas of the surrounding states such as Arizona, Nevada, Texas, Oregon and Washington. This migration of Californians caused further gentrification in the areas that they had moved to en masse. Areas such as Phoenix, AZ and Las Vegas, NV which were once very inexpensive to live in prior to the real estate bubble are now quite expensive. The chain reaction continued (continues?), as the gentrified people of these cities had to find somewhere cheaper to live to maintain their standard of living, where they undoubtedly caused gentrification of their own.
The other significant adverse financial aspect of the mentality of “flipping” is when interest rates increase. The resulting lack of sales, and major price depreciations (often far below) their previous increases, results in a flood of properties on the market at one time, not selling due to lack of buyers, causing a meltdown of a local market and potentially the economy as a whole.
Although most arguments surrounding flipping tend to be negative, it is also possible to identify some benefits from the practice as well.
For example, “rational” flipping can encourage a rejuvenation and restoration of a previously decrepit neighbourhood. (Under the broken windows theory, an unkept house/area attracts a criminal element, which drives out those making a responsible living, which allows for more criminal element, and so on in a vicious downward cycle.) The restoration creates jobs, particularly in construction, for locals and generates more sales (and sales taxes) to local vendors (initially those involved in selling construction materials). The newly remodelled homes will then attract new populations and businesses to a region, encouraging more economic development, plus the remodelled homes’ higher assessed values brings more property tax revenues to local governments, allowing for more improvements to the area and driving out the criminal element.
Even on a single home basis, flipping can have positive impacts (the house itself will be in better condition and last longer, and can be sold at a higher price, thus increasing its property tax assessed value, plus increased sales for goods and services related to property improvement and the related increase in sales taxes).
As of July 7, 2006, the Department of Housing and Urban Development created regulations regarding predatory flipping within the Federal Housing Authority (FHA) single-family mortgage insurance. The time requirement for owning a property is greater than 90 days between purchase and sale dates to qualify for FHA-insured mortgage financing.
Flipping may also be a criminal scheme. Illegal property flipping is a fraud for profit scheme whereby recently acquired real property is resold for a considerable profit with an artificially inflated value. The real property is resold within a short time frame, often after making only cosmetic improvements to the real property. Illegal property flipping often involves collusion between a real estate appraiser, a mortgage originator and a closing agent. The cooperation of a real estate appraiser is necessary since a false and artificially inflated appraisal report is required. The buyer (ultimate borrower) may or may not be aware of the situation. This type of fraud is one of the most costly for lenders because the loss is always large.
The following is an example of an illegal property flip: A buyer contracts to purchase a property in his name for $30,000. Before closing the deal, he draws up a second contract to sell the property to a co-conspirator at $70,000 — a price substantially higher than market value. He seeks a loan for a second contract through a mortgage lender or a mortgage broker and submits an application. A real estate appraiser inflates the value of the property, enough to justify the loan, and is paid triple the usual fee. (although many times inexperienced or incompetent appraisers are unwittingly caught in the scheme through pressure and intimidation from the scammers) A mortgage lender approves the application and releases the $70,000. Next, the contracts for the property are closed either simultaneously or within a short time from each other. The originator of the scheme takes the $70,000, pays off the $30,000 and divides the remaining $40,000 between himself and any other plotters — usually the mortgage broker or loan officer and sometimes the second buyer. The lender ends up with a 100% or greater loan to value mortgage. That buyer makes a few payments on the property, then defaults and allows it to go into foreclosure. Finally, the lender learns that the property doesn’t even cover the loan value.
In the United States, the Uniform Standards of Professional Appraisal Practice (USPAP), which governs real estate appraisal, and Fannie Mae, which oversees the secondary residential mortgage market, have enacted practices to detect illegal flipping schemes.
In France, flipping is effectively illegal. Law requires that a person selling a property having owned it for under 5 years sell it only for the original purchase price.
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This glossary post was last updated: 23rd April, 2020 | 9 Views.