Chapters have been written about the warnings implied by the real estate “flip.” The flip is exactly what it sounds like. It is the sale of a contract to buy property before the contract closes, or resale of property immediately after closing. The flip is accomplished by assigning the contract between purchasers before closing, or by the purchaser actually taking title and then selling immediately. The flip creates ordinary income, not long term capital gains as are normally sought by real estate investors.
A real estate flip has a poor reputation. In a normal market, values are relatively stable and predictable. Historically, it was not expected that a purchaser could make drastic profits without even closing. When that happened, it signaled that something was unusual. Often, one of the parties did not understand the value of the property, or the price was being manipulated for reasons that could only be known by following the distribution of net proceeds after all transactions concluded. It is the latter of these, the possible misrepresentation of price, usually to the disadvantage of someone in the transaction, (often the lender) that caused commentators to advise closing agents to be wary of the flip transaction.
Today we have a new motive for the flip. Real estate values are so ambiguous and there is such upward pressure on price, that closing agents and lenders never know the real value of property. Today, the fact that a purchaser makes 25 or more percent on his “investment” before the contract is closed results from a perception of supply and demand, not generally a misrepresentation of price. Obviously, buyers, lenders, and the entire market must question the price reality on the high side of a flip transaction, but most of today’s flips are not an effort to hide facts, they are instead a reflection of the buyer’s perception of the market.
Realtors should nonetheless avoid preparing documents to assign contracts. The responsibilities of the parties in a contract between only two parties are complicated. When downstream third party rights are added to the mix, it is often impossible to predict all the consequences. For instance, if I assign a contract in which I am purchaser of a condominium unit to a buyer who pays me $50,000.00 for the assignment, what is his right against me if the seller refuses to close, or if the unit is not constructed as represented and the assignee refuses to close? Did purchaser simply make a dad deal, or is he entitled to return of $50,000.00 from me? From the Seller? Some of these transactions have been flipped several times. What is the right of the eventual assignee against each predecessor in the contract if the deal doesn’t close?
If the parties are out large sums of money because the documentation of these transactions is vague, they will likely look wherever they can for satisfaction. One who prepares a document that fails to consider these possibilities may well be caught in the search for satisfaction. An attorney is licensed to prepare those documents, and insured against the risk.
One thing is not new about today’s flip transaction. Quick profits still come with risks. To approach something so complicated as if it were simple merely increases the risk.
Learn to love your lawyer. It is sure to surprise him – or her.