“Every time I turn around I seem to read something in the newspaper or see something on the news about unscrupulous real estate “investors who are going to jail for illegal schemes involving flipping real estate. Is flipping real estate illegal?
Great, great question. And believe me, it's one I hear all the time. The concept of “Flipping Homes” is really one of symantics. “Flipping” is just another way of saying “buying, and then selling”. Let me be state very clearly that flipping real estate (also known as buying and selling a home) is not illegal in any way, shape or form. There is absolutely nothing wrong with buying a home cheap and then selling it for more then what you paid. Think about this: If I owned a car lot, I would be purchasing cars at one price (wholesale) and then reselling them at another price (retail) — and hopefully turning a nice profit, right? In essence, I would be “flipping” cars.
If I owned a Home Depot, I would be “flipping” everything from power drills to Christmas trees to my customers. What we're talking about here is capitalism – the free market exchange of goods and services for valuable consideration. Our economy depends on it and it's a normal way of life for all of us. Businesses “flip” goods and services to us that we, in turn, pay them for. The profit they receive is not unethical. So what about the “flipping” scandals we hear so much about in the media?
To put it simply, real estate flipping becomes illegal when loan fraud is involved. Typically this is because the resale relies on inflated appraisals, fake documents, sales to “straw” buyers who represent original sellers, or “phantom” second loans. There is absolutely nothing wrong with buying a home, investing in it (through repairs or just “riding” a good market's appreciation), and selling the same real estate for whatever larger value someone is willing to pay. If your buyer wants to pay you substantially more than market value, and they have the means to pay you, then it's their choice, plain and simple.
Let's look for a moment at the video gaming phenomenon. When the latest gaming system comes out, people will pay insane, crazy amounts of money just to get their hands on one the day it launches. When the Sony Playstation 3 was released in November 2006, the stores sold them for $600, give or take. That's the retail value. But as is typical for the high-end gaming systems these days, the initial supply for the PS3 was far outweighed by it's immediate demand, and only a handful of people actually got their hands on one the day it launched. Most people who were dying to get one were forced to wait until the next shipment.
However did you realize that a large number of those who were actually fortunate enough to get one weren't even interested in keeping it? Instead they went right to the online auction arena and let the market do it's thing. Did you hear about it? On launch day, when the stores sold the precious few game systems they had available for the “retail price” of $600, the buyers were simultaneously “flipping” thier systems on eBay and getting staggering return on their investment — anywhere from $3,000 to $10,000 from the hungry masses of gaming buyers.
Was this illegal? No. Immoral? Unethical? No. What were these systems really worth? Well the “appraisal” value (sticker price) was (and is) $600. But the market determined the value to be in the excessive four figures. Did the hungry eBay buyers know they were paying a price substantially higher than the sellers had just paid for the same system at thier local Wal Mart? Absolutely – and they didn't care. At that moment, the value of having a game system of their own on launch day was more important to them than the difference between the $600 sticker price and what they were willing to pay online.
How Is Value Determined?
In truth, value is not determined by how much something costs to make or purchase initially, but by what an eager buyer is willing to pay for it right now in an honest, open marketplace. Getting back to the point of this, as I said, what people typically refer to as “illegal flipping” of real estate is actually just mortgage fraud. But the media has for some reason, in it's glorious ignorance, latched onto the term “flipping” as the buzz word for describing these scams. This is a sad disservice to a world of honest, ethical real estate investors who “flip” for a living.
As a result the media has given real estate investors in general a bad name, because they aren't focusing on the real problem. The real problem with “illegal flipping” is when investors, mortgage brokers, loan officers, appraisers, etc. get together to create (i.e. fabricate) a better picture of a buyer's loan package to a lender than that which actually exists. They lie. They do things such as inflating appraisals, gifting down payment, drawing up false w-2's, manufacturing pay stubs, writing credit letters, etc.
The people who do this often do (and should) go to prison.
However real estate investors who are engaged in the legitimate business of flipping houses (whether as “wholesalers” or “fix-and-flip” rehab investors) are actually playing a key (and under-appreciated) role in stimulating our economy. They shouldn't unjustly be lumped into the category of “unethical” or “illegal” just because they invest in quick-turn real estate. The bottom line is, if you buy houses at a below-market value, sell them higher for a profit, and do so honestly, ethically and without committing loan fraud, then you are not doing anything illegal. You don't have anything to worry about.