ATTENTION:

THIS POST HAS 2010 UPDATES

SEE THE LATEST:

UPDATED FHA PROPERTY FLIPPING RULE WAIVER HERE

FHA has updated their flipping rule and their website (see bottom of this email for link and the exact and complete verbiage from the FHA website).

• The old flipping rule was that the property could not be flipped by a rehabber sooner than 90-days after the first purchase was recorded. (not the actual purchase date)
• The new rule now states that it is the acquisition date is the date of settlement (purchase date).

However, the old rule does still stand that the re-sale date is still the date of execution of the sales contract. So you can’t go under contract until the 91st date (don’t start counting until the day after the original date of purchase).

So here’s the problem.  If I buy a property and rehab it in 30 days and put it on the market – I have to wait 60 more days to sell to an FHA buyer – which happens to be the predominate buyer out there right now.

Here’s a possible solution that many investors have been using:

1.  Go under contract but in the additional provisions put in “This contract is to be replaced and superseded by a new contract dated ??/??/????” (at least 91 days after original purchase date).  This will ensure that the buyer and seller are both protected in the interim.

2.  I highly recommend that you have the inspection done immediately, so it isn’t off the market too long if an inspection resolution can’t be reached between the lender and buyer.  Once any inspection issues have been resolved, you can simply put “completed” for the inspection objection and resolution deadlines on the new contract.

3.  Find a lender and title company who is willing to do a lot of the preliminary time consuming processes prior to the 91st date.  NOTHING submitted to the lender should be dated prior to that 91st day – contract, earnest money, disclosures – NOTHING!

————————————————————————————–

Need Transactional Funding for Wholesale Flip Deals?

How to get Short Sale Funding for Double Close Transactions

How to Fund Wholesale Flip Deals with Transactional Funding

What is “Flash Cash” for Real estate Flips?

What is the Difference Between Simultaneous Closing and Back-to-Back Closing

This Post Sponsored by ShortFunding.com

————————————————————————————–

The link and exact verbiage from HUD/FHA handbook is provided below:

http://www.fhaoutreach.gov/FHAHandbook/prod/infomap.asp?address=4155-2.4.7.e

4.7.ee. Restriction on Re- Sales Occurring 90 Days or Less After Acquisition

If a property is re-sold 90 days or fewer following the date of acquisition by the seller, the property is not eligible for a mortgage insured by FHA.

FHA defines the

• seller’s date of acquisition as the date of settlement on the seller’s purchase of that property, and
• re-sale date as the date of execution of the sales contract by a buyer intending to finance the property with an FHA-insured loan.

Reference: For exceptions to this 90-day restriction, see HUD 4155.2 4.7.h

Other post that may interest you as a property flipper:

• Investment Property Purchase Formulas
• 10 Ways to Fund Real Estate Deals
• How to Fix and Flip a House

How to Get Fast Mortgage Approval and Best Rate

As the “apartment guy” in our real estate office,  I field a lot of questions about income properties from residential agents.  The most common question is “how do I value this building?”  The agents are all very accomplished at running values using comparable sales for single family houses, and even duplexes.  But when the valuation needs to be determined from income rather than sales comps, they ask for help and advice.   Obviously there are several objective and subjective factors that determine the value of income property – location, condition, stability, unit mix,  potential, etc.  But here’s the 2 minute “quick check method”  I teach them for running rough numbers to determine if a project is worth further research or investigation:

1. Multiply the number of units by the monthly rent (e.g. 4 units at $300/month each) = $1,200
2. Multiply by 12 to determine annual Gross Potential Income (total monthly rents x 12 months) = $14,400
3. Deduct from the GPI an estimated expense structure (I use 30% as an average, so $14,400 x .7) = $10,080 NOI
4. This number is the Net Operating Income (explanation below) Divide the NOI by the capitalization rate to get the building’s value (10,080/.08) = $126,000 is the value of the example building  “at a 8 Cap” rate.

Simple Cap Rate Calculation

That valuation should take you less than two minutes to calculate, but you should strive to learn and know the reasons behind the determination of certain inputs.  How and why I use 30% expense structure and 8 capitalization rate is subjective based on certain assumptions and factors about the building.  These numbers affect the value dramatically, so you must adjust them carefully and accordingly.  Here is further explanation of the concepts of NOI and capitalization rate.

The estimated expense structure of 30% in step 3 includes vacancy, taxes, insurance, management and repairs.  It does NOT include debt service for mortgage payments.   This is an average number, and is probably low for most buildings in any state of mismanagement.  Poorly run buildings with high vacancy rates, deferred maintenance, theft, vandalism, inefficient heating/cooling etc will have higher expense structures.  Conversely, a very well run and well kept building with utility bill backs and efficient management may run leaner than 30%.

The number determined by deducting expenses from gross income (in the example $10,080) is called the Net Operating Income, usually abbreviated as NOI.  Once you have the estimated NOI (or determined in fact with the buildings financial statements), you can determine the building’s value at different capitalization rates.  The concept of capitalization rate  based on NOI is usually the aspect of income valuation that residential agents struggle to understand.    Capitalization rate is a measure of the return of a building that does not factor in leverage (mortgage and debt service).  It would be the “return on investment” to an investor if the property was paid for in cash.  Since most investors use leverage, which affects the return tremendously, cap rate is a measurement by which to compare properties, but is rarely the actual “return on investment” to the client.

Cap rates that a building will trade for move up and down depending  on supply and demand, money markets, and other non-controllable factors.  But it is also subjective to buyer and seller in a transaction and the “quality of the investment” in the eyes of the buyer.  The higher the cap rate, the better the investment the property is for the buyer, but the lower the price is to the seller.  When talking cap rates, you must reverse your normal thinking.   Income investors want to BUY at high cap rates, but SELL at low cap rates (yes, buy high sell low!).  Cap rates on buildings can range from a low about 5 to a high of about 13 in “normal” market conditions, and as you will see the effect on the value or price is dramatic.  A well kept building with stable tenants and good management might sell at a “6 cap,”  and a run down building with dead beat tenants might sell at a 12 capitization rate.  Institutional buyers tend to purchase larger properties at lower cap rates, and independent buyers tend toward smaller properties and buy at higher capitalization rates.

Here is the reason the capitalization rate is so important to income investors.  Watch how much the value changes on our example property from a 6 cap value to a 10 cap valuation:

• $10,080/.06 =  $168,000  at 6 Cap
• $10,080/.07 =  $144,000  at 7 Cap
• $10,080/.08 =  $126,000  at 8 Cap
• $10,080/.09 =  $112,000  at 9 Cap
• $10,080/.10 =  $100,800  at 10 Cap

The opportunity you should be seeing here is twofold.  As an income property investor, if you were to find a seller willing to sell at a 10 cap on existing income and find a buyer willing to pay a 6 cap on existing income, you would have a price spread $67,200!   Now that is a flip, and you didn’t even do any remodeling!  The other method of increasing value of an income property is to improve the NOI.   Suppose you purchased the above building at a 7 cap rate for $144,000.  Over the course of a year, you were able to raise rents on the building by $100 per unit to $400 per month.  You were also able to implement a utility bill back system that lowered the utilities expenses to the owner by $300 per month.  The $100/mo income increase x 4 units is $400 per month, $4800 per year.  And the expense savings of $300 per month, $3600 per year savings translates to a total of $8,400 increase in the Net Operating Income.  If you apply the 7 cap rate to $8,400 per year ($8,400/.07) you have added $120,000 to the value of the building at the same cap rate.  Welcome to income property investing!

In the current financial environment, residential real estate investing continues to be a viable business, but the business has changed dramatically.  There are more challenges and deals require different credentials and strategies compared to recent years of loose lending standards and appreciating prices.  Private investment placement managers and established cash buyers are squeezing out the “mom and pop” investors because of lack of funding.  .

The housing market, driven by Wall Street speculation and mortgage backed securities, peaked in 2005, softened in 2006, crashed 2007-2008 and is now bottoming in 2009 in many markets.  Prices of houses and condos nationally have dropped significantly as has the number of homes being sold. The record number of foreclosures combined with a melt down in lending has created disastrous effects on the economy and changed the business models of most real estate professionals.

Like the businesses of real estate agency and mortgage brokerage, a cleansing of the real estate investment industry is occurring.  The Fix and Flippers of the boom years, mostly people who used 100 percent mortgages to buy appreciating houses for quick resale and profits have disappeared in most markets.  The real estate investors left over (the ones still in business) are well capitalized and using a buy and hold rental model.  Many are turning to private equity instead of banks and credit unions.

One major exit strategy for investment companies now is to sell the properties to passive investors who are getting into real estate as an adjunct to their regular jobs.  They are known in the business as “retail” investors.  These types of investors can still secure financing on investment property, and the companies servicing them successfully are providing the closest thing to triple-net (NNN) investment that the housing business has (NNN is a commercial real estate investment type where the owner is not responsible for any of the maintenance or expenses of the income property).  Pure passive investments in single-family were once difficult to find, but there are more service companies providing these opportunities than ever before.   There is also more demand from investors as money pulled from the market sits idle and falling to inflation in zero to low interest accounts.

In addition to the turn-key investment business model for retail investors, high-quality rehab and resale to first-time home buyers will work in some markets.  The first time home buyer market will be less affected because the buyers do not have any “baggage” – they don’t have to sell a property to upgrade.  Also, the loan programs for this type of borrower are healthier than normal conforming loans.

For most of my real estate investment career, finding the deal was the difficult part of the business.  Once you contracted a good deal, the capital was easy to find and it was relatively easy to sell.  That has all changed now.  There are properties at good values available everywhere from banks and motivated sellers, but the capital and sales are hard to come-by.  Once again, we real estate professionals and investors must reinvent ourselves to adapt.

I like the quote from Warren Buffet, “Be greedy when others are fearful and fearful when others are greedy.”  As difficult as it may be, I continue to recommend our clients invest in quality real estate now during the down cycle.  Please let me know I can be of assistance to you in any way.