REO Danger – Avoid Fannie Mae if you want to Wholesale or Fix-and-Flip for a Profit!

Post written by Mike Lima. Follow me on Twitter.

For most investors, finding good REO deals is hard enough. It gets abundantly harder when you’re trying to strike a deal with Fannie Mae.  Yes, the same Fannie Mae that is a government-sponsored enterprise that was chartered by Congress.  The same Fannie Mae received a pledge of $200 Billion by the US Dept. of Treasury in Sept. 2008, to provide liquidity to the housing/mortgage markets.  Surely such a government-backed organization will try to encourage properties to be revitalized so the housing market can recover more quickly.  Read on, my investor friends…

If you find a bank-owned property that’s in good condition and at a good price, chances are you won’t get it, because owner occupied buyers get the first crack at them, through Fannie Mae’s First Look program, which gives those buyers a 15 day advantage to lock up those deals.  Fair enough — if a family is willing to buy the property and make it their primary residence, I think they should get a head start over investors to do so.

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But if you find a distressed Fannie Mae property at a good price, that maybe has no flooring and no kitchen (cabinets & appliances have been removed), you can avoid the owner occupied buyers, because they generally don’t want to take on such a big project, and a house in such condition won’t qualify for conventional financing anyway.  Such a property would be perfect for you as a Wholesaler or a Fix-and-Flip Investor, wouldn’t it?  Probably not.

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Fannie Mae wants to make sure that no one can efficiently flip one of their houses for a profit.  Why?  I don’t know.  I guess they are so afraid that a savvy investor will turn a quick profit — that they would rather have the property just sit there and not get purchased, fixed up, and made into a contributing member of the neighborhood.  So they do the unthinkable in what used to be a free enterprise environment — they require that the lucky buyer of their property accepts a Deed Restriction that expressly limits the sales price the investor can sell the property for, regardless of how much money they invested in the trashed property to fix it up.  What??!!

We first tripped across this a year ago, when we were in contract to buy a newer house from a wholesaler who was completing his purchase from Fannie Mae.  It was a nice house, with some glaring issues; it had no kitchen (previous owner had stripped the kitchen of the cabinets, countertops, and appliances) and both A/C units had been ripped out.  Accordingly, this property would not qualify for conventional financing and it was highly unlikely that any owner occupied buyer would buy it in that condition anyway.  It needed to be sold to an investor that had the crews to efficiently restore the property.  We opened escrow in the normal manner, but when we received our preliminary title reports, we noticed that Fannie Mae’s deed to the wholesaler had a 3-month restriction on it, allowing us to sell it for only $3,784 more than what we were buying it for!  Add closing costs to buy it, roughly $15,000 of repairs needed, and then costs to market and sell the property, and Fannie Mae was making sure that a highly efficient investor couldn’t be rewarded with a profit.   Here’s the excerpt from the actual deed:

Notice  that the restrictions “run with the land”, meaning that they would transfer from the wholesaler to us and we would be stuck.  We had already sent our contractors into the house to provide quotes to make the repairs, and we had a buyer lined up to buy the property once we fixed it up.  Our plan was to get it remodeled within 2 weeks and have the investor close his purchase 2 weeks after that.  That’s efficient, and that’s how a Fix-and-Flip Investor can make a fair profit while also giving their buyer a good deal.  But to wait another 2 months, just to be able to sell the property for a realistic price, would have added additional cost and risk to our transaction, as our buyer didn’t want to wait that long, and who knows what lending guidelines would have changed by then?  (As it turned out, the HVCC rules went into effect during that timeframe, so we probably would have been victims of the chaos and artificially low appraisals that seemed indicative of that time period of May/June 2009).

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We tried to reason with the bank’s agent, reminding them that the repairs needed to make the house inhabitable would far exceed the deed restriction ‘allowance’ that Fannie Mae was allowing us to sell it for, but they indicated that Fannie Mae would not be flexible at all.  So we backed out of the deal and recouped our earnest money.  And vowed to stay the heck away from any Fannie Mae properties.

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That strategy worked for nearly a year.  Two days ago, I was driving to a property that we were completing a rehab on and were preparing to sell, and I saw another house in the same neighborhood that was distressed but was available at a good price.  I asked a realtor friend to put in an offer for us to buy it, and as luck would have it, we found that it had just become available again as another investor had just backed out.  You guessed it – this house also happens to be owned by Fannie Mae and they are still insisting on Deed Restrictions — this one is for 20% (or $11,000) more than our purchase price.  Too bad it would cost at least $15,000 in rehab and closing costs to get the house into respectable condition to sell.  No thanks — we really aren’t in business to take losses just for the pleasure of rehabbing a Fannie Mae house that they don’t have the guts to rehab, and that’s in such poor condition that they won’t even give a buyer a loan on the property, even though Fannie already owns it and should want to get it off their books!

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Conclusion: If you’re a Wholesaler or a Fix-and-Flip Investor, you should make sure that Fannie didn’t own the house in the recent past, as you’ll be stuck with a nasty, nonsensical deed restriction.  If you’re a Fix-and-Hold Investor, then this probably won’t bother you, but we’re seeing fewer and fewer of those investors these days.  Sure seems like Fannie would get a higher price and would sell their properties faster if they pulled their heads out of the sand and removed these deed restrictions.  Or at least adjust the deed restriction ‘allowance’ to accommodate for reasonable repairs required to rehab the property in conformance with the neighborhood’s standards.  Hopefully the government and Fannie will realize that this policy is creating unintended consequences.  Until then, steer clear of Fannie’s properties!

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