Investment Property Sales: Holding Beats Flipping

Speculators grab headlines, but long-term investors remain market drivers.

June 1, 2005

The home in the upscale Palm Desert, Calif., gated community has a lot to offer. It’s spacious, freshly painted and carpeted, and it has two newly tiled fireplaces. But is it worth the $965,000 it was listed for in April 2005? After all, the sellers had only purchased the house a month earlier for $825,000, and beyond making a few cosmetic changes, such as to the fireplace, had done little to justify the $140,000 increase.

Tales like this have been fueling accounts in the media that housing prices are being artificially inflated by speculators who, with little interest in the single-digit returns they can obtain in the stock and bond markets, have trained their sights on real estate.

Armed with cheap money from continuing low interest rates, they’re buying up homes in hot markets such as Palm Desert and Fort Lauderdale, Fla., with no intention of living in them or of even holding them for a day longer than it takes to sell them for a substantial profit.

“We’ve seen investors buy 10–15 units in a new-home tract” hoping to turn them over quickly, says Judy Zeigler, CRB, CRS®, a salesperson with Prudential California Realty in Palm Desert.

Still, the lion’s share of property buyers today picks and chooses properties carefully, holds on to them for the long term, and typically only sells them to help pay for retirement, say brokers and associates.

“Knowledgeable investors hold on to their properties for at least five or six years, and if they’re looking to their retirement, a lot longer than that,” says Timothy Kinzler, CIPS, CRS®, an associate with Coldwell Banker Real Estate in Delray Beach, Fla. “Strong appreciation is helping households—both investors and those looking for a primary home to occupy—shore up their financial position, which is what homeownership’s always been about.”

Investment, alive and well

It’s difficult to pinpoint the extent of aggressive, short-term investing in residential markets, but there’s no doubt investment of all kinds is growing and playing a role in continuing strong sales.

About one-quarter of the 8 million new and existing single-family homes, townhouses, and condos sold in 2004 were for investment, up more than 14 percent over 2003, NAR data show. “We’ve seen a shift over the last few years, with a growing number of second-home buyers purchasing primarily for investment,” says David Lereah, NAR chief economist.

The number of vacation-home buyers is growing, too. Nearly 20 percent more second-home units sold in 2004 than in 2003, up from 850,000 units to just over 1 million, according to NAR.

By far, though, the long-term buyer remains the most common investor, say practitioners.

In Minneapolis, if you take away short-term investors who are buying condominiums in bulk—thousands of units are under construction or recently completed in the downtown area and in some suburban markets—virtually all investors are in for the long term, says Fran Davis, a sales manager for Coldwell Banker Burnet in the city. Most investors fall into two camps, she says:

  1. Households buying second and third homes, often in resort areas, for vacation and semi-retirement
  2. Those buying homes, duplexes, and small apartments for rental income and sometimes for later sale to help finance retirement

Practitioners say they see little short-term investing among buyers of existing single-family homes, although when it does occur, it tends to be on the affordable side of the market. “Investors are always coming in and looking for homes they can fix up and sell quickly for a profit, and that can be a really good thing for the market,” says H. Dan Derbes, RAA, owner of H. Dan Derbes, REALTOR®, in Baton Rouge, La., and co-chair of NAR’s appraisal committee.

The key is how well they’re fixed up, and whether the amount of improvements justifies the price increase, says Derbes. A good renovation, no matter how quickly the property is sold after purchase, is good for the market; selling houses for a hefty profit after making only cosmetic changes isn’t—and it’s considered flipping, a predatory practice.

To help ensure properties are fixed up sufficiently to warrant a hike in sales price, the U.S. Department of Housing and Urban Development in 2003 issued final rules upping its appraisal requirements. The rules require two appraisals with detailed reports explaining any value hike 100 percent over the previous sales price before FHA will insure a mortgage for properties owned between 91 and 180 days. “FHA wants to know where the price increase is coming from,” says Derbes.

FHA won’t insure the mortgage at all, regardless of the size of the value hike, for properties owned 90 days or less.

Putting a stop to flipping is a goal NAR supports, although in comments made to HUD while it was writing the FHA rules, NAR cautioned against penalizing investors who, while selling quickly, nevertheless add value by fixing up property. “The end result [of such investment activity] is the availability of homeownership and a contribution to neighborhood revitalization,” NAR wrote.

HUD took NAR’s concerns into account. Originally, the agency sought to not insure any mortgages for properties held 180 days or less; it compromised with the 91- to 180-day rule.

The secondary mortgage market companies Fannie Mae and Freddie Mac have also stepped up efforts to make sure price increases are justified. Because of January 2004 revisions to the organizations’ joint standard appraisal form, lenders must provide a detailed analysis of a property’s sales history for the three years prior to the current transaction. The earlier version of the appraisal form required a sales history only for the previous 12 months. The latest version also requires appraisers to report sale prices of each comparable property within a year of the sale.

The three-year requirement tracks changes that the congressionally chartered Appraisal Foundation made in 2003 to its industry appraisal standards, called the Uniform Standards of Professional Appraisal Practice.

Demographics drive sales

Continuing strong demand for housing remains the main driver behind strong price appreciation despite the presence of speculators in some markets. That demand is fueled by growing household formation and immigration trends, so it’s not expected to dry up any time soon, say practitioners.

“In more than 20 years in real estate, I’ve never seen anything like the demand we’re seeing today,” says Arthur Pollio, an associate with Prudential Florida WCI Realty in Plantation, Fla., near Fort Lauderdale. “People are coming from everywhere, here and all over the world, buying up real estate. They’re buying to invest, yes, but they’re also buying to live in their purchases. This is capitalism at its finest.”

Quick selling means tax consequences

Owners who sell an investment property (one that’s not owner-occupied) before they’ve held it for one year are required to treat the sale as a short-term capital gain and pay tax at ordinary income tax rates. The rate can go as high as 35 percent depending on the person’s tax bracket. That means your clients could lose much of their gains. If they hold the property for a year or more before selling, sale proceeds are considered long-term capital gains and are taxed at a 15 percent rate.

One way your clients can defer any tax obligation on the sale of investment property that’s not owner-occupied is to plow their proceeds into property equivalent in value under Section 1031 of the Tax Code. Owners have up to 45 days to identify a comparable property and 180 days to conclude the transfer.

As a real estate professional, you can help your clients find the property and make the sale, but an exchange intermediary must handle the exchange end of the deal.

Asset help in bankruptcy law

Bankruptcy legislation President George W. Bush signed in April contains NAR-backed provisions that improve the position of landlords and owners’ real estate assets when tenants or owners file for bankruptcy. Among other things, the new lawCloses the loophole that allows residential tenants to avoid or delay eviction by declaring bankruptcy

  • Closes the loophole that allows residential tenants to avoid or delay eviction by declaring bankruptcy
  • Holds retail tenants facing bankruptcy to a firm deadline on whether to assume or reject a lease
Robert Freedman

Robert Freedman is the former director of multimedia communications at NAR.

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