How FHA is killing recovery

FHA sucks.

FHATo be more specific, the FHA “second-appraisal-on-flips” requirement sucks.

For many borrowers, FHA is the only game in town.  Unless you have good credit and 10% down (or are looking to buy in a rural area), FHA is the only loan program willing to work with you.

So a foreclosure flipper is going to see a lot of FHA contracts.

The problem is that HUD/FHA still HATES flipping.  They used to have an out-right ban on investor flips within 90 days of acquisition, ostensibly to prevent fraud.  They changed that a few years ago with a waiver program.  Because preventing fraud ain’t that important after all…

But FHA is still a problem if your flip price is 20% or more above your acquisition cost– and you damn well better be flipping for more than 20% above your purchase price or you should hang it up as a real estate investor.

So how can your buyer get an FHA loan if you are flipping within 90 days, for more than 20%?  You either show the value of the work you did justifies the increase in price (which it won’t, since you actually need to make a profit), or you get a second appraisal that “provides appropriate explanation of the increase in property value”.

Well a second appraisal is cheap and easy, so that has to be the correct choice, right?

Wrong.  The second appraisal will kill your deal.  At least 80% of the time.

Over the past six months, we have suddenly started seeing second appraisals on FHA deals that aren’t fit to line a bird cage.

The first appraiser pulls comps within a few blocks, all the same size and age, all within the last few months…. and our contract price is perfect.  That’s exactly how it should be.

But mysteriously, the second appraiser is using properties miles away, selling six months ago, in completely different types of neighborhoods.  And even then, in those distant neighborhoods, they are only pulling the lowest sales and ignoring higher, more recent sales.  And the second appraiser just ignores all non-distressed sales.

Its almost as if… well, its as if HUD/FHA has specifically told the second appraiser that they better come in 10% below the first appraisal.  Like… EXACTLY 10% below the first appraisal.

So how does a market recover if a willing seller and willing buyer reach an arms-length  sales price, supported by an appraisal based on recent comps, but that deal mysteriously gets shit-canned by a secret requirement that forces the second appraiser to be overly-conservative?  That forces the second appraiser not to show the fair market value, but instead “explain the increase in property value”.

And how is it that this second appraisal requirement DOES NOT apply to bank-owned properties?  That’s right.  It doesn’t matter what the bank’s acquisition price was… there is no second appraisal requirement.  Because your Bailout money needs to be recovered before the real estate market is allowed to recover on its own.

What that means is that bank owned REO properties are setting the prices.  And flippers have to price their properties BELOW the REO price to get a successful FHA loan.  Or they have to wait 90 days.

So a flipper has a few crappy choices:

  • Wait 91 days to flip a house;
  • Take less than 20% for rehab costs and profit
  • Don’t accept FHA contracts

House Price teeter totterWe’ve decided not to accept FHA contracts for now.  They are just too much of a pain in the ass.  It means we won’t have as much competition for our homes (since the vast majority of borrowers are going FHA), and that probably means a haircut on our prices.  Which means we are helping to keep the real estate recovery at bay.

But at least we know that on the front end of the contract, instead of only discovering we are getting screwed when an appraiser decides it is better to have the pipeline of work from FHA than to uphold the standards and ethics of the industry.