Flipping is a term used primarily in the United States to describe practice of buying an asset and quickly reselling (or "flipping") it for profit. Though flipping can apply to any asset, the term is most often applied to real estate and initial public offerings. The term is used in the United Kingdom to describe a technique whereby a Member of Parliament switches his second home between several houses, which has the effect of allowing him to maximize his taxpayer funded allowances.
Types of flipping
Multiple investor flipping
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.
Real estate flipping
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.
Fix and flip
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.
Second home flipping
Members of Parliament in the United Kingdom are given an allowance to maintain an extra home in London to be able to work in London. Costs for this second home can be claimed and thus funded by the tax payer. The MP can nominate anyone of his homes as his "second home" afterwards. By nominating another home as his second home, called "flipping", a new set of allowances can be obtained. In some cases, MPs can simultaneously declare one home as their primary residence (for tax purposes) and as their second residence (for expense purposes). As of May 15, 2009 and following the British MPs expenses scandal, this practice was banned by the leader of the Conservative Party for Conservative MPs.
Effects
Bubbles
Flipping bubbles have historically ended in disaster, such as during the Florida land boom of the 1920s.
In the 2000s, relaxed federal borrowing standards (which included the abilities for a subprime borrower to receive a loan, and for a borrower to purchase a home with little or no money down) may have led directly to a boom in "demand" for houses, thereby affecting the "supply". Since it was easier to borrow, many investors snapped up investment homes without having to put money down. Additionally, since so many investors were purchasing homes, this left even fewer homes available to be purchased by owner-occupants. Since the ones that were placed back on the market by flippers were priced higher than before the flip, buyers again had even less money to put down. This resulted in a continuing circle until finally the bubble burst in 2008 and borrowing standards began returning to normal, leaving the housing market to bottom out before it begins to steadily correct itself.
Flipping was so popular in the United States that some DIY television programs like A&E's Flip This House detailed the process.
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.
Further information: United States housing bubbleRejuvenation and gentrification
"Rational" flipping can encourage a rejuvenation and restoration of a previously decrepit neighborhood, but rising property values can also be seen in a negative light, termed gentrification.
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.
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 and older generations, to relocate. On a small scale, flippers can cause distress and disturbance to their immediate neighbors by performing lengthy renovations. Flippers commonly have no interest in neighborhood integration, which may cause tensions with long-time residents. During the real estate bubble, flipping and gentrification both have been linked to the mass migration of people to California, where high real estate prices and ample jobs attracted wealth seekers. In response, native Californians were forced to migrate 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.
Property values
After a renovation, 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. Neighbors can also benefit by having nicer homes in the neighborhood, thereby increasing their own home values.
Regulations
As of July 7 , 2006 , the Department of Housing and Urban Development created regulations regarding predatory flipping within Federal Housing Administration (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.
Illegal activity
Flipping can sometimes 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.
See also
- Housing bubble
- United States housing bubble
- IPO pricing
- Phillip E. Hill, Sr.
Notes
References
- ^ "Cabinet ministers have made tens of thousands 'flipping' their homes". Daily Mail . http://www.dailymail.co.uk/news/article-1179291/MPs-expenses-How-Cabinet-ministers-tens-thousands-flipping-homes.html . Retrieved 2009-05-08 . ...
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