ASHI Responds to HUD’s Request for Comments

Pence hand-delivered the following to the General Counsel’s office on ASHI’s behalf in response to the agency of Housing and Urban Development’s (HUD) September 5, 2001 request for comments on its proposal to reduce property flipping.

On behalf of The American Society of Home Inspectors, Inc.®

Regarding [Doc. No. FR-4615-P-01] RIN 2502-AH57 Prohibition of Property Flipping in HUD’s Single Family Mortgage Insurance Programs

November 5, 2001

Summary:  the American Society of Home Inspectors, Inc. recommends that the proposed regulation be modified in two ways.  First, as the Department conducts case-by-case reviews to determine exceptions to the six-month-between-sales eligibility limitation for FHA financing, actions and documentation offered by mortgagors (in addition to mortgagees) should be considered by the Department.  Second, voluntary action by home buyer mortgagors to obtain independent professional home inspections, with the subsequent repair or elimination of any defects affecting the value of the property detected by such inspection, should be expressly noted as a favorable factor for the Department’s consideration in the case-by-case reviews.  Such a provision is consistent with existing HUD recommendations that home buyers take an active role in protecting their interests by voluntarily obtaining home inspections.

Introduction
I appreciate this opportunity to present the views of my client, The American Society of Home Inspectors, Inc. (ASHI), headquartered in Des Plaines, Illinois, regarding the U.S. Department of Housing and Urban Development’s proposed rule to reduce the incidence of property flipping in FHA-financed home sales.

The American Society of Home Inspectors, Inc., (ASHI)
ASHI is a national membership organization comprised of 5,700 home inspection professionals throughout the country. ASHI is the oldest and leading non-profit professional association for independent home inspectors. The organization cooperates with its 80 Chapters in furthering the home inspection profession. Since its formation, ASHI’s Standards of Practice have served as the home inspector’s performance guideline, and are widely recognized and accepted by professional and government authorities.

The ASHI membership subscribes to a professional Code of Ethics that prohibits them from engaging in activities that might create a conflict of interest and thereby compromise their objectivity. Under the Code of Ethics, home inspectors have no personal financial interest in the outcome of their inspections.

ASHI full Member home inspectors must conform to a rigorous, highly–specialized set of performance criteria unparalleled by other parties in real estate transfer. All ASHI Members must have demon-strated their proficiency by performing at least 250 fee-paid inspections in accordance with the ASHI Standards of Practice. They must pass the National Home Inspector Examination, administered by the Examination Board of Professional Home Inspectors, which tests their knowledge of residential construction, inspection techniques, and report writing. They must also pass the ASHI Standards and Ethics Examination, demonstrating their knowledge and understanding of the Standards of Practice and the Code of Ethics.

In keeping with its charge to provide ongoing professional education and development, ASHI and its chapters sponsor periodic technical seminars and workshops for members. ASHI also serves the public interest by providing accurate and helpful consumer information to homebuyers on select home purchasing issues and home maintenance, and by offering comment on public policy affecting home transfers and consumer interests.

Background
ASHI agrees with the assessment by HUD and Committees in the House and Senate that cases of predatory lending and property flipping do indeed occur at unacceptable rates, and regulatory action must be taken to address these issues.

In its proposed rule, HUD describes property flipping as a subset of the larger problem of predatory lending:

A major example of predatory lending is property “flipping”,
the practice whereby a recently acquired property is resold for a considerable profit with an artificially inflated value, often abetted by a lender’s collusion with the appraiser. Most property flipping occurs within a matter of days after acquisition, and usually with only minor cosmetic improvements, if any.
HUD proposes to amend HUD’s FHA single family mortgage insurance regulations at 24 CFR part 203 by offering three new provisions set forth in a new § 203.37a. This section would prescribe certain new requirements regarding the eligibility of properties for FHA mortgage insurance.  

Analysis
ASHI is commenting on the Provisions #1 and #3, both of which are predicated on a proposed six-month prohibition of eligibility for FHA financing following a previous sale.

1. Six-month restriction on sales. Proposed § 203.37a would provide that any property being sold within six months after acquisition by the seller is not eligible for FHA financing… As noted, property flipping involves the rapid resale, often within days, of a recently acquired property… HUD believes that the proposed six-month restriction on resales is of sufficient duration to preclude such short-term property flipping…

3. Exceptions to property flipping restrictions. While HUD wishes to assist FHA borrowers in avoiding predatory sales practices, HUD is also aware that justifiable circumstances may sometimes exist for the quick and profitable resale of a recently acquired property.

HUD does not wish to prevent the ability to use FHA-insured mortgage financing for the purchase of properties acquired through such legitimate transactions. Accordingly, new §203.37a would authorize HUD to grant exceptions, on a case-by-case basis, to the proposed property flipping restrictions where the mortgagee demonstrates that the sales price of the property corresponds to its market value. Such documentation may include, but is not limited to, evidence that the sale price reflects a rapidly appreciating real estate market, that the seller has made improvements that result in a corresponding increase to the value of the property, or that the property is being sold at below market value due to a distress sale or at a tax sale.  

The remedy recommended in Provision #1 is based solely on the time interval between the current sale and the previous sale.  While a rapid resale – in this case, defined as one occurring less than six months after the previous sale – may provide a good indication that something may be wrong with the new transaction, the time element itself is only a symptom, not a cause, of a property flipping problem that may or may not exist. In other words, the proposed rule may help identify situations at high risk for property flipping, but it does not provide or encourage actions to protect prospective homebuyers or the Insurance Fund – other than to require the passage of time.

Further, the time element, by itself, is a non-specific symptom of possible property flipping. Certainly it is feasible that competent developers might make legitimate valuable and substantive improvements in less than six months that would justify a substantial increase in the value of homes. Such situations should not be barred from eligibility for FHA financing, and Provision #3 allows mortgagees to apply for exceptions based on certain demonstrations that rapid increases in value are justified. Of course, property flipping sales involving homes held six months and one day could go forward with the full involvement of FHA.   

Unfortunately, the proposed rule does not allow exceptions to the rule based upon legitimate, strong “due diligence” actions by mortgagors during the six-month period to protect themselves and the Insurance Fund. The Provision #3 exceptions should not be limited solely to actions or documentation generated by mortgagees.  Mortgagors are in a position to voluntarily take steps to detect elements of property flipping and should be encouraged to do so in all HUD action to thwart property flipping. Similarly, actions and documents generated by mortgagors to protect their interests and greatly lower the risks of property flipping should be considered by HUD as well in the case-by-case reviews.

One such action that can be taken by the voluntary action of mortgagors – obtaining home inspections – is addressed below. In cases where exceptions are warranted because of extensive repairs or other legitimate factors justifying a rapid rise in value, home inspection documents might provide the Department some of the best proofs supporting such claims. The vast majority of such documents would be generated by the actions of mortgagors to protect their own interests; conversely, cases in which home inspections are commissioned by mortgagees are rare, possibly non-existent. The regulation should be modified to allow the Department to take into account anti-property flipping acts by mortgagors, such as voluntarily obtaining home inspections.  

While rapid turnover is an indication of possible property flipping, the real cause is the intentional attempt of sellers to artificially inflate the value of properties, by active fraud or deceit, to the detriment of homebuyers. A corollary to property flipping is that homebuyers are often susceptible to the fraud or deceit because they lack sufficient knowledge and expertise to look beyond cosmetic changes to determine the true condition of a home.

A homebuyer fully informed about the true condition of a property is a useful and reliable preventative to property flipping. Very few homebuyers have the capability to personally assess key home systems in a comprehensive way. The imbalance of power between buyers and sellers is even greater in the environment in which most predatory lending cases arise. However, homebuyers can readily level the playing field quickly and economically by engaging independent professional home inspectors to perform this function for them.  

The role of home inspectors can be crucial in defeating many in-stances of property flipping.  Home inspectors that meet the rigorous ASHI criteria have two characteristics that are important in any discussion of solutions to predatory lending or property flipping.  

First, home inspectors are uniquely experienced professionals fully trained to examine the major technical components and overall structure of a home. For example, the ASHI inspection protocol provides the homebuyer with the most focused evaluation of a home’s major systems and components, including the heating system, central air conditioning, interior plumbing, walls, ceilings, floors, windows and doors, the foundation, basement and visible structure. Home inspectors can provide the required expertise to pierce mere cosmetic changes and uncover serious flaws that might be indicative of property flipping.  No other party in a usual home sale has the technical depth of knowledge and expertise possessed by professional home inspectors.   

Second, home inspectors are the only professionals in typical home sales transactions working exclusively in the interest of the homebuyers and no others. While other parties may serve other interests and may be part of the property flipping schemes, home inspectors are hired solely by the homebuyers. Home inspectors’ sole allegiance is to their homebuyer clients. Home inspectors report solely to the homebuyers. And home inspectors have no personal financial interest in the outcome of transactions.

Home inspections are not currently required to obtain FHA financing. However, HUD is on record recognizing the value of home inspections to homebuyers. HUD encourages homebuyers to obtain home inspections before they buy.  HUD would not be departing from existing policy in any way by modifying the proposed rule to further encourage voluntary home inspections as a useful tool to deter property flipping, and to explicitly clarify that it will favorably consider home inspections in case-by-case departmental reviews in Provision #3.    

Conclusions
While the six-month time limitation on FHA eligibility is based on a property flipping risk factor that should trigger greater scrutiny, the proposed rule is a remedy that lacks specificity and does not address the core characteristic of property flipping – an unknowing homebuyer succumbing to fraud or deceit. The rule would be greatly improved if it were modified to use the six-month eligibility restriction as part of a “carrot and stick” approach that encourages mortgagors (not only mortgagees) to voluntarily take widely-recognized consumer-protective actions, such as obtaining home inspections to discourage property flipping. The rule should allow that if mortgagors obtain home inspections and all detected major defects affecting value are repaired or eliminated, then the sales should be eligible for FHA financing.

Provision #3 allows for case-by-case exceptions based on demonstrations by mortgagees and sets forth certain criteria for HUD to consider in making such exceptions. To promote additional protective actions to be undertaken by homebuyers who want access to FHA programs within the six-month restricted period, Provision #3 should be modified to recognize specific actions by mortgagors to justify exceptions to the
six-month restriction, and should explicitly include obtaining home inspections as a favorable factor for HUD to consider.

Recommendations
ASHI recommends that Provision #3 be modified as follows (new language bolded and underlined):

3. Exceptions to property flipping restrictions. While HUD wishes to assist FHA borrowers in avoiding predatory sales practices, HUD is also aware that justifiable circumstances may sometimes exist for the quick and profitable resale of a recently acquired property.  HUD does not wish to prevent the ability to use FHA-insured mortgage financing for the purchase of properties acquired through such legitimate transactions.  Accordingly, new § 203.37a would authorize HUD to grant exceptions, on a case-by-case basis, to the proposed property flipping restrictions where the mortgagor and/or mortgagee demonstrates that the sales price of the property corresponds to its market value. Such documentation may include, but is not limited to, evidence that the sale price reflects a rapidly appreciating real estate market, that the seller has made improvements that result in a corresponding increase to the value of the property, that the buyer has obtained a professional home inspection and that any defects affecting the value of the property detected by such inspection have been repaired or eliminated, or that the property is being sold at below market value due to a distress sale or at a tax sale.  

Thank you for this opportunity to present the views of the American Society of Home Inspectors, Inc.