“It’s very important to be aware of the implications of flipping new construction especially before [a property closes],” says John D. Pinson, CIPS, a broker with John D. Pinson Inc. in Palm Beach. “The reason? It can artificially inflate a market. What can happen is many people buying speculative could be caught when interest rates go up. They may be forced to perform [close on the property], and they can’t do so. That could cause the market to collapse. It happened two years ago in Sydney, Australia,” he says.

Attorney Doug Kaplan agrees that there are some risks. “In a condo situation, it takes a year or more before you have to close. That will give ample time in this madhouse market for the person who puts down a modest deposit to turn over that contract so that the buyer doesn’t have to close on the transaction [the assignee will close].” Kaplan, with Kaplan and Jaffe PA in Hollywood, the attorney for the South Broward Association of Realtors, warns of the problems. “From a mechanical point of view, the buyer of the contract may not close, which leaves you [the assigner of the contract] in a position to either close or lose your deposit. That’s risky,” he says.

Not only that but sometimes contracts flip several times before someone has to perform, according to Pinson. “Developers are making money along the way, but are the [rising] prices justified, or is it like a stock that’s been flipped but has no intrinsic value?” he asks. “When new production is increasing in value faster than existing product, when existing product is in a better location, then you have an issue.”

Flip Side

Not everyone agrees that flipping can cause a real estate market collapse.

Scrupulous investors can make good money through speculative buying without overinflating the market. And, with annual appreciation at 20 to 30 percent in some Florida markets, not everyone sees an end in the coming year.

“Every investment is spec if you get down to it,” says Dudley. “We don’t know what will happen tomorrow. I don’t think we’ll see any bubbles bursting in the next year or two in this marketplace, but you never know.”

Gilmore agrees. “I don’t buy into the argument that [flipping properties or contracts] inflates anything. Price goes up when demand is high. I don’t think it will have a negative effect. Builders and developers are getting a lot smarter, refusing to take the quick buck. Most investors are smart enough not to dump [everything at once] and deflate the market. You’re in to buy low and sell high.”

The fact remains that people willing to pay the price set the future for the market. “Pricing is determined by supply and demand,” says Dudley. “If there’s a demand for it, there’s nothing false about that person who wants [to pay a high price for] the house. Market value is what a buyer and seller agree a property should sell for.”

And most experts agree that real estate is a solid investment right now. “I make more money with my investments than at my sales manager job,” says Dudley. With a diversified portfolio, a property flip here and there can be a great way to bring in cash.

“I sold a house in Watercolor [a North Florida master-planned community] about two years ago,” says Harry Millsaps, a sales associate with Coastal Properties of Northwest Florida in Rosemary Beach. “Before the builder could complete the house, it [the contract] sold a few more times. I’ve got clients who are treating lots like [12-month CDs].”

An Industry Issue

Obviously, investing in real estate is a good thing and, in most cases, flipping contracts and properties can be a legitimate and ethical way to make money. From a legal point of view, says Kaplan, “the area in which a real estate professional can expose him- or herself is by making recommendations to prospective buyers to buy property currently under construction and representing to that buyer that a big profit can be had before he or she has to close. That kind of response may end up with the real estate professional finding himself or herself at the end of the lawsuit, no matter how well-intentioned the advice.”

Still, both the U.S. Department of Housing and Urban Development (HUD) and the National Association of Homebuilders (NAHB) have interests to protect from overly speculative buying.

HUD wants to manage its insurance risk exposure. In 2003, the department published a rule stating that if the resale date is 90 days or less after the seller’s acquisition date, the property is not eligible for FHA insurance. Further, if the resale date is between 91 and 180 days after the seller’s acquisition date, the property is generally eligible for FHA insurance, but HUD will require the mortgagee to obtain additional documentation if the resale price is 100 percent over the purchase price. The rule states, “Such documentation must include an appraisal from another appraiser.”

Speculative home buying concerns builders because a lot of this activity can generate substantial hidden inventory that could come back onto the market quickly if price appreciation should begin to falter, according to the NAHB. In that event, additional downward pressure would be put on market prices, and sales of new units coming onto the market would be severely disrupted. Indeed, speculators could not only unload units that they own but also fail to close on units they have contracted to buy — a key risk in the new-home market because of typically long lags between the signing of sales contracts and closings.

According to the NAHB, many builders also are concerned about investor-owned units standing empty in new communities. Large numbers of sold but vacant units can detract from the sense of community as well as the overall look and feel of an area under development.

“In a hot area where housing is booming, developers and builders are now putting a provision in the contract saying it’s nontransferable,” says Gilmore. “They’re also putting provisions in that say if you put money down on a contract, you must move in and live there for a year or else you pay the builder/developer any money you made off of it. That’s taken a great [many] investors out of that [single-family preconstruction] market.”

Dudley says, “A year ago, many developers and builders hadn’t caught on that investors were buying these things [preconstruction houses and condos] and flipping them or assigning the contracts. When they did wake up to it, they realized the amount of money they were losing, and now developers are switching tactics.

“Last year, people started making money [by flipping], and [now] everyone wants a part of it. The minute word leaks out about a new development, there are people [spending the night] in line outside the sales center.”

“Watch out for the bubble,” cautions Pinson. “It can come and bite you. Be sure you’re looking at the [local] market to see if it has too much product or is overvalued. The bubble may burst on the new product but not on the existing.”

But, says Dudley, “I’m comfortable with real estate because it’s an integral asset. There are 1,100 people a day who move into this state.”

6 Flip Tips

Whether you’re investing for yourself or working with an investor, you may find useful these tips from Stephen Simmons, an attorney with Murray, Simmons and Ziegler LLP in Fort Lauderdale, and Joe Boyd, managing partner with law firm Boyd, Lindsey & Sliger in Tallahassee.

1. Know the developer. “Has the developer had a successful project before? What is the completion date? Do your research,” says Simmons. “Make sure the investor has a very comprehensive idea of project completion. I see it more and more where people are holding out contracts and deposits, and the developer isn’t moving as quickly as [the investor had been] told. Carrying costs need to be analyzed [by investors to know the cost of delays].”

2. Be sure the contract is assignable. “I’m seeing lately that there are restrictions on assignments. Many times this information comes as a surprise to the investor,” says Simmons. He sees developers with regulations that say the buyer can’t assign [the contract] until he or she has lived there for one year or before a certain percentage of condo units are sold. “Also, the developer may hold the best units for the end, which makes assignment prior to that nearly impossible.”

3. Look for fees. Recently, developers have been charging assignment fees that may be five figures. “In order to assign the contract, the buyer has to pay a fee to the developer,” says Simmons. He also says that some developers are saying that resales must be done in-house. “The buyer has to use the developer’s real estate [associate]. For associates that’s fine, but for buyers or investors, it isn’t always a good thing.”

4. Know your boundaries as a broker. “If the broker is getting paid a commission for negotiating the assignment, [he or she] has to be careful that [he or she] isn’t involved in the sale of a secured investment,” says Boyd. “Make sure that you’re not selling financial contracts. Brokers who are negotiating contracts and making a commission on the markup, which is legal and ethical in the right circumstances, need to check with a securities attorney.”

Simmons agrees. “I could see a plaintiff lawyer suing a [real estate professional] and, in a deposition or trial, asking what type of specialized knowledge they [the professional] have about the properties. Someone who’s creative can come up with that cause of action,” he says.

5. Know the money. It’s important that you know that an investor should get professional help, such as from a certified public accountant (CPA), about ongoing tax liabilities. “So for investors, [real estate professionals] should advise them to get accounting advice, and that will help them determine whether to hold the contract or the unit [for a while] before they resell it,” says Simmons.

6. Know the local area. When it comes to a specific investment property, “[You] must be experienced in that area and in that neighborhood,” says Simmons. “If the market has reached top price, then investors need to be cautioned.”

Tracey C. Velt is an Orlando-based freelance writer and a contributing editor for Florida Realtor magazine.