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house_flip_remodelIn both up and down markets, flips of property have become a revenue-generating cottage industry for investors. In the classic flip situation, an investor will acquire a fixer upper, remodel it, and put it back on the market within three to 12 months, depending on the extent of the remodel.

These transactions have been prevalent during the recession when investors were buying REO properties as individuals or as part of a “foreclosure fund,” and flipping them after doing cosmetic upgrades. They have also been happening in the rising market and high-end market, where investors were doing major remodels and seeking large profits.

In these transactions, real estate licensees should be mindful of several things. If they represented the investor as a buyer and observed the property before the work was done, then an obligation may arise to disclose the condition of the property prior to the remodel.

For example, if there were cracks in walls, stucco or the foundation, water stains, or other observable defects which were patched and painted, this information could be material to a new buyer who may wish investigate the causes of the cracks and/or stains. In one case, a buyer’s agent was accused of negligence for not reviewing the MLS photographs at the time of the pre-flip purchase to determine what changes were made in the remodel. In another, it was alleged that the agent should have investigated whether all of the work was permitted.

Some real estate standard of care “experts” (usually those who are hired by unhappy buyer claimants) will testify that if a listing agent knows that a seller has remodeled the property, then it is the listing agent’s obligation to ask the seller for copies of the permits and invoices covering the work that was done so that they can be provided to the buyer.

The same experts will also blame the buyer’s agents for not asking the seller for these documents or failing to tell the buyer to hire a contractor or other construction experts to inspect the work. Many states have forms that advise the buyer to perform due diligence, but these “claimant” experts will say that the forms are not enough and the agent should tell their clients orally as well. Not all experts agree that this is the “standard of care,” but real estate licensees should at least be aware that these are potential risks to avoid being put in the position of having to defend against these types of claims.

A more significant issue occurs when an agent participates in a flip, and then acts as the listing agent in the sale of the property. Not only does the agent then expose himself/herself to liability as a seller (hopefully shielded in an LLC) but also as a licensee. Licensees should be aware that many insurance companies will not insure a real estate brokerage where the agent is an owner of the property, either directly or indirectly (e.g. holding an interest in an LLC that owns the property).

There are some exceptions to this rule, but brokers should check their insurance policy to determine if coverage is available, or if certain conditions must be met to have coverage when agents are participating in ownership. Failing to do so may result in a rude awakening if a claim later comes in from an unhappy buyer.

For more information, visit www.norman-spencer.com.

 

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