While the adage “What you don’t know can’t hurt you,” is typically more of a hope than a fact, it can be particularly wrong for home buyers and investors.
In recent years as the real estate market has gone up and down, there has been a cottage industry of investors purchasing residential property with the intent to rehab or upgrade it and sell it at a profit. This concept became known as “flipping” and while it has received some negative connotations over the years, it is not necessarily a bad thing. In fact, many popular TV shows are based on the very same concept such as “Flip or Flop” and “First Time Flippers”.
Many times, those involved in such transactions are sophisticated real estate investors or home improvement contractors. On occasion, someone may try to tackle a project like this hoping to make a quick buck. Those parties may see the potential in a property to be profitable if they can purchase it at a lower price, hire out work or provide “sweat equity” to update it, and ultimately sell at a higher price with the hope that the proceeds resulting from the increased sale price outpace the costs of the labor and materials put into the property.
However, there are a number of issues that those involved in that particular process should be aware of as it can affect their rights, obligations, and liabilities related to the property that is being flipped and to future owners of such property. In this scenario, there are a number of areas that both real estate investors, contractors, and home buyers should be aware of:
1. Contractor Licensing Issues. Depending on who owns the property that is being flipped, there may be a different individual entity that undertakes the updating work in a particular property. To the extent the work is done by a state-licensed residential contractor, there is less concern with how the work is being completed, whether it is being properly permitted, and inspected, and who is responsible for the warranty obligations for that license required work if there is a problem in the future. However, if the property is being flipped by a real estate investor or other individual, and the work is completed by that individual instead of a licensed contractor, there can be issues about who is liable for any problems resulting from that work. A “weekend warrior” or DIY type person working on a home does not have the same potential protections as a licensed contractor is something goes wrong (insurance, licensing, etc). That could limit a future buyer’s recourse for subsequent issues with the home.
2. Disclosure Requirements. As many real estate agents know, but possibly not many contractors, Minnesota law has certain requirements for disclosures that a seller must make when a residential property is being sold. Minn. Stat. §513.52, et. seq. has disclosure obligations whereby a seller of a property must disclose all “material facts” of which he or she is aware that could affect the buyer’s use and enjoyment of the subject property. In this context, there is also a related requirement in Chapter 82 that requires the same disclosure obligations for a licensed real estate agent. A real estate agent acting as a flipper potentially has two potential areas of liability for failing to disclose material facts about the home.
In the context of a property flip, the issue becomes the knowledge that the seller/flipper of the property has and to what extent that is disclosed to a prospective buyer. Most of the time, in a flipped property situation, the owner attempting to flip the property has only owned the home for relatively short amount of time. Therefore, any previous issues or concerns that existed in the home may not be known by that current property owner. Therefore, it is important that the fact of the limited amount of ownership time be disclosed to prospective buyers as well as, arguably, the fact that work has been done on the property to upgrade it to be sold, along with any other facts that the flipping party becomes aware of.
In addition, depending on who has completed the work on the property, there may be some additional disclosure requirements – or at least a strong suggestion – as to the nature of the work completed. In particular, if a flipped property has been worked on by an unlicensed contractor, homeowner, (or other party not licensed for construction work), it may be advisable for the seller to disclose that fact to any prospective buyer. Certainly, if the individual owner does some of the work on the property him or herself, a prospective buyer is likely to want to know that fact to make sure they take extra caution in inspecting or otherwise evaluating their purchase of the property.
3. Responsibility for Statutory Warranty Obligations. Related to the preceeding information, a “home improvement project” of any significant nature may be required to comply with and provide for the warranties set forth in Minn. Stat. Chap. 327A. That warranty scheme provides a one, two, and ten year warranty “program” for any significant home improvement work project. The home improvement covered by that law is defined as “repairing, remodeling, altering, converting or modernizing of, or adding to a residential building”. The exact nature of what type of work is covered by the statutory warranty is somewhat open to interpretation. Therefore, any owner attempting to flip a property needs to be aware of the potential responsibility under the statutory warranty and the obligations that entails.
If the property owner is a licensed contractor doing the work under their license, taking out the permits, and otherwise acting as a contractor in completing the work on the property prior to sale, if the work meets the definition of home improvement project under the statute, that contractor is likely required to provide the warranties set forth in Chapter 327A, as to the extent they apply.
Alternatively, if the property owner is not a licensed contractor and the work has been done by that owner, a question may exist as to whom, if anyone may be responsible for any statutory warranty that might cover that work.
Recently, a Bill was introduced into the Minnesota Legislature that would theoretically hold an owner responsible for the warranty obligations if they complete the work themselves in this context (S.F. No. 3443). That proposed legislative amendment appears to be directly aimed at the flip situation involving real estate investors, or parties attempting to flip a property who are not licensed contractors. In the past, there has been a hole as to who may be responsible for any issues with the work that exists in that context, where the work is done by a “homeowner” rather than a licensed contractor. While that bill may not become law, it highlights an unresolved issue on the coverage of the Minnesota statutory home warranties in the context of a flip.
4. Loan Requirements. Depending on the nature of the rehab/flip project and the individual owner/company who is attempting to receive financing for such a project, there may be additional requirements set forth by a lender, which must be complied with in order to obtain financing including a requirement that any work on the project be done only by a properly licensed contractor. When seeking financing from a lender for a flip of this nature, the property owner should be aware of the requirements of that lender and any funding that is received. If such restrictions in the loan documents are required, then the funding is likely to require some more creative financing or an influx of cash to complete the initial purchase of the property subsequent to it being rehabbed and flipped.
Recently, there was introduced into the Minnesota Legislature a legislative amendment intended to require that all loans being used to fund the construction of a new home or home improvement project require verification that the work is being completed by a licensed contractor (S.F. No. 3444). Not only might this codify existing requirements of some lenders, it will essentially require that all lenders loaning money for a flip-type project require that work be completed by a licensed contractor thereby eliminating that source of funding for any owner who may seek to do the work themselves.
While this brief article only touches the tip of the iceberg in regards to the issues of flipping property, it does provide some points for anybody involved in these types of projects to be aware of.