Wholesale vs. Illegal Flip

by Vena Jones-Cox

Question:

Now that wholesaling is illegal, what do we do for quick cash? C.B, Cincinnati

Answer:

I’ve gotten this question a lot lately, thanks to the passage of the new HUD “flipping” rule and the subsequent attention the media has been paying to “illegal flipping.” Let me make the immediate statement that

WHOLESALING IS NOT ILLEGAL.

RETAILING IS NOT ILLEGAL.

The “illegal flipping” to which you’ve seen reference is a completely different animal than wholesaling or retailing. Illegal flipping involves deception, false appraisals, and, usually, bank fraud.

Although it wears many faces, an “illegal flipping” transaction typically has several of the following characteristics:

  • It is done with the intent to defraud the buyer
  • The buyer is an unsophisticated, low-income homeowner
  • The property is purchased at a very low price and sold at a retail or higher-than-retail price
  • The seller does minimal repairs to the property, usually covering up any major defects without fixing them
  • The seller colludes with a particular appraiser to get a higher-than-market appraisal
  • The seller colludes with a mortgage broker to falsify information on the buyers application, making them seem more qualified then they are

Wholesaling, on the other hand, is an open profit-making transaction between two relatively sophisticated businesspeople.

A (legitimate) wholesale transaction looks like this:

  • Both the buyer and the wholesaler/seller openly enter the transaction with the intention of making a profit.
  • The buyer is a relatively sophisticated, experienced renovator or landlord.
  • The property is purchased at a very low price and sold at a significantly below-retail price.
  • The seller does no repairs to the property at all. The buyer determines from his/her experience what needs to be done and estimates the cost.
  • The buyer completes his own appraisal based on his experience.
  • There is no lender, and thus no bank fraud.

A true retailing transaction looks like this:

  • It is done with the intent of providing a qualified buyer with a top-quality home
  • The buyer is typically middle-income, as the properties chosen by real retailers are not in low income areas
  • The property is purchased at a very low price and sold at a retail or higher-than-retail price
  • The seller does all the renovations necessary to bring the house into prime condition for the area
  • The seller prices the house correctly in order to attract a qualified buyer. Therefore, no appraiser collusion is necessary
  • The seller pre-qualifies all potential buyers to assure that they will be able to purchase the property quickly and with no hitches, thus assuring the seller a quick return of his investment

HUD’s new “illegal flipping rule”, however poorly conceived, is intended to stop the losses FHA has incurred by insuring loans on properties that have been “illegally flipped”.

Since these properties usually turn out to be full of problems that the homeowner can’t afford to fix, and since the homeowner generally can’t afford the payments in the first place, FHA has become the proud owner of thousands of these properties in recent years.

The unfortunate side effect of this rule, though, will be that tens of thousands of low and moderate income homeowners will be denied affordable loans on the best properties in their chosen areas, simply because the retailer hasn’t owned the property long enough.

The other sad consequence is that millions of Americans, yourself included, are getting the impression that buying and selling real estate for a profit is somehow unethical in and of itself.

Reprinted from the Real Deal, a monthly newsletter for Real Life Real Estate Investors with permission of Vena Jones-Cox. Get a free 3-month trial subscription by clicking here. One per household, please.