For real estate investors, reputation is everything. When you are buying a house, sellers need to feel confident that you are being honest and are not trying to take advantage of them. Likewise, buyers seeking to acquire a fix-and-flip house want to know that you have actually done the repairs properly, making the property a habitable home. What are some of the common pitfalls? Let’s take a look at some of the ethical challenges that investors face.
Buying “subject to” the current mortgage and not performing.
Some investors use “subject to” transactions to buy a house because they do not have the money available to close on a property. This means that the seller’s mortgage remains in place but the investor actually holds the deed to the property. Although “subject to” transactions, if done correctly, are legal in most states, they are full of risk. One of the biggest complaints is that the buyer does not disclose the true nature of the transaction and the fact that the mortgage actually remains in the seller’s name.
That’s why “subject to” transactions should not be pursued unless the proper disclosures are made, the mortgage holder is notified and agrees to the deal, and the buyer is willing and able to pay off the mortgage in the event that the note is called due by the mortgage holder.
Even if all these conditions are met, there are other ethical issues that arise. Even when the disclosure is made accurately, sellers may not understand what it means until they try to get another mortgage loan and they learn their credit is leveraged, disqualifying them for another loan. Even worse, they could suffer further credit and financial damage if the investor fails to make timely payments.
Misrepresenting options to a seller.
Investors offer value through their ability to purchase the property quickly and “as is,” enabling a seller to sell the house without spending money to make repairs or waiting through the duration of a lengthy sale process. However, some sellers may accept lowball offers from real estate investors because the investor misrepresents the value of the property by showing only certain comparables. Many homeowners could actually get a far greater sum for their property if they went through an investor who provided them with comparables of their home’s actual market value. Helping homeowners in distress through smart deals is a win-win for both the community and the investor. But it’s vital that you do not misrepresent the options available to the seller; they must make an informed decision.
Failing to disclose property defects when selling.
Most states have property disclosure laws, but some investors may be tempted to feign ignorance. It’s not uncommon for an investor to purchase a property at below-market value because it needs a few repairs. The rehab process, however, can be akin to peeling back the layers of an onion. One minor repair can evolve into a much bigger issue than initially expected (and budgeted for). Instead of fixing the problem, we’ve seen investors cover it up and then conceal the issue from prospective buyers. To complicate this ethical issue, some states like New York have laws that actually allow sellers another option to completing a seller’s disclosure document altogether.
Honest investors will do the work required to make the property meet standards and they will inform prospective buyers if there are any remaining issues that need to be addressed.
Acting as a real estate agent.
Investors who connect sellers and buyers without ever signing a contract may find
themselves on the wrong side of the real estate commission, unless they are a licensed real estate agent and acting in that capacity. Indeed, wholesalers bring sellers and buyers together—while profiting in the process—much like real estate agents do. However, there is an important difference that needs to be recognized: Wholesalers are principals to the sales contract. After they contract to purchase the property, wholesalers generally have one of two options. They can sell their contract rights to another investor or complete the purchase and then market the property to other investors for rehab and resell. With either option, their ownership position in the transaction should be explicitly written in black and white. Real estate agents, on the other hand, are a representative for one of the principals and owe a fiduciary duty to their client.
Investors who are not licensed should never connect a seller and a buyer without being a principal to the contract. It can put you in the awkward position of having your allegiance misunderstood by both parties, casting a shadow of doubt upon the entire transaction. In addition, you could get into legal trouble for practicing real estate without a license. It is always a good idea to have contracts that clearly spell out every party’s role and ownership interest in the deal.