Century 21 In Town Realty Managing Broker Mike Hofer joins Matt and Adam to discuss “shadow flipping”, assignment sales, and the ethics of real estate.
For the cited article on assignment flipping, click here: http://www.theglobeandmail.com/news/investigations/the-real-estate-technique-fuelling-vancouvers-housing-market/article28634868/
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Tell us about yourself.
I was born and raised in Vancouver, on the east side. At 14 years old, I moved to Coquitlam where I still am. I got my license in 1989 and sold for 7 years before getting into management. This is my 27th year as a manger. I’ve managed in almost every market of the Real Estate Board of Greater Vancouver, except Tsawwassen. I worked for a number of brokerages, managed close to 1000 realtors, and have been responsible for over 20,000 contracts representing billions of dollars worth of real estate sales.
Shadow flipping: this is a term maybe recently invented. Have you heard of it before?
Not in that context. “Assignment” has been around for awhile; it came into prominence in the mid-2000s. On the issue of shadow flipping, the article said most of the flips are not advertised or listed; that’s because you need permission to list them on MLS from the original seller. Shadow listings is a relatively new term.
Can you give us a working definition of an assignment?
You’re selling a piece of paper: buying the contract. The person buying the assignment doesn’t get to renegotiate the contract and must take it as-is with all the risks and everything else implied. It’s a commodity that trades like anything else. We’re focused on assignments because people are yielding profits thought to belong to the original homeowner. While I’m not in total disagreement, assignments have helped people get out of situations where a bank has pulled financing or the market has gone down, and they need to get out of the deal and are assigning at a loss. So, it’s not that assignments are bad, they’re inert – it’s what people do with them that can be construed as good or bad.
The Globe piece outlines a few situations that have got people riled up. Why are people so upset?
I think they feel duped. There’s a bit of bait and switch. In the article, they referenced the Rappaports who sold their property for $5.2 million and someone sold it for $6.2 million within three months. My question that the article doesn’t address is why didn’t the Rappaports use a realtor to help determine the proper value of their property? Why didn’t they go to market where everybody competes for those properties? In reading between the lines, what’s not said is that the Rappaports were trying to avoid paying commissions of $125,000 on their $5.2 million sale. By doing so, not realizing the extra profit on the $6.2 and even with calculating commissions on that, [they are] walking away from $840,000 to save $125,000. It’s ironic that if they’d hired a competent realtor, in all likelihood they would have realized the $6.2 and now they’re beating up their realtors for not hiring them.
People are upset about what you just outlined. Another issue is tax avoidance.
The CRA is an honour system. The assignor – the person selling the assignment contract – has an obligation to report their proceeds (or “the lift”) to CRA under the capital gains provision. 50% of that profit should be taxed as income. Since the Canadian system is an honour system, people don’t report it unless its found out.
With property transfer tax, how do you feel about that since it’s being paid once but the property is switching hands two or three times?
Some people think it should be abolished and it’s punitive. When you look at an assignment, a piece of property is not being transferred – you’re buying a contract – so the tax should not be applicable. If a limited company exists just to hold properties and you affect the share sale of a property, you avoid property transfer tax provided the company is kept in tact.
So, property transfer tax applies when name transfers on title?
Yes, when the property actually transfers as a result of the contract that’s been assigned.
This is the thing about the article – it talks about avoiding property transfer tax, but the transfer only takes place once, at the end.
That’s right. They thought it was a cost savings. They might be paying capital gains on what they make on the sale, but they’re avoiding property transfer tax.
I’m going to put a different spin on that. If the property transfer tax was paid and they went back to market and calculated property transfer tax as an expense and added it to the profit, they would only be making affordability worse as they’re adding that to their expenses and still claiming the same amount of profit. The price point is being driven up higher. When people flip property, the amount of soft costs they pay in property transfer tax, lawyers, etc. adds up pretty quickly.
That makes me think of the title of the Globe expose which was flippers and realtors are fueling the market (with the associated costs). What’s your read on that?
The real estate market is like an engine. The engine isn’t broken. If you want to slow down the market, you put less fuel in it – and the fuel is money. There are a couple of other good articles that help put it in perspective. It sucks that we live in the best place in the world and that we don’t have any more land, but it’s supply and demand. Back to that article, it says on the west side there are 250 properties assigned, and on 11% of them a realtor was involved on one side of it. So, that’s 27.5/250 properties – how much can 11% fuel? Are speculators fueling it? I’d suggest the market is allowing them to profit from it. Investment is risk vs. reward. When people are buying these properties before they intend to assign them, or even if they intend to at all, they’re legally responsible to complete the initial deal.
After the financial crisis at the beginning of the year, experts predicted double-digit increases again but at the end of the year they were saying no. The market can turn but not that quickly. It’s the money coming in and people’s desire to be here. If there’s an opportunity to make money, people will figure out a way to do it. Immigration consultants approach relators for 50% referral commissions if they feed them overseas clients. They instruct them, they’re listened to and the clients buy. If you have all this money and go into a store where everything’s cheap, you’ll still buy stuff you don’t want or need. The article has a lot of half-truths. Being a realtor is simple: if we don’t yield a result for our client, we don’t get paid. We can work for months on something and if it falls through we don’t get paid. We’re not fueling anything except giving clients good advice. If you hire a professional to help you make money and they do, I don’t see how that’s wrong.
I’m unsure of the specific case of the couple in the article, but one thing that came up is disclosure of interest in trade. As a realtor buying property, what is your obligation to disclose that you’re a realtor and disclose your intentions with the property?
There’s one court case where someone bought a dilapidated condo and renovated it with the intent to rent it out, but then the market went up. So, instead they put it on the market and yielded a profit. There was a complaint and the realtor was taken to court. The realtor had to reimburse commissions and forfeit profit off the proceeds of sale. In that instance, the disclosure of interest was filled out to say they would rent the property, not resell it. As a licensee, if you or your spouse is acquiring a 5% or greater interest in a property, you are required to disclose the fact you’re a realtor because we’re deemed to have extra expertise. This is the burden and as this example shows, it can have dire consequences. Enforcement isn’t an issue; getting the initial complaint is the issue. I spent six years on the conduct committee with the real estate board, and I always saw people complaining that organized real estate wasn’t doing enough. But people didn’t want to go through the complaint process as it takes too much time. I don’t think you can have it both ways. We live in an area of North America that’s probably the most difficult to obtain a real estate license, and we operate what’s generally seen as the lowest commission structure in North America: it averages out to 3% on a one million-dollar property. In other areas of Canada, they’re 5-7%; in the US, they’re 4-7%. I’d suggest that the majority of people assigning and flipping are not realtors, and that a real estate license would get in the way.
So it’s more difficult to do this when you have a real estate license.
Yes. The article also mentioned to avoid FINTRAC, the realtors were listing the brokerage address for the address of their clients. It’s ridiculous. FINTRAC audits are not pleasant and the penalties are so severe.
What is FINTRAC and what is the goal of having the brokerage address on the paperwork?
FINTRAC (Financial Transactions and Reports Analysis Centre of Canada) is for money laundering purposes for terrorist activities and organized crime. We’re required to track monies we come into contact with and identify clients we’re dealing with. If someone is from an at-risk country, we’re obligated to report it. I imagine putting in a more convenient address like the brokerage’s is what that’s about. It’s ludicrous when you have the federal government oversight that we do.
We have a real-life example toward the end of the 2000s where banks weren’t funding new sales and projects. People were assigning at a loss to get out of deals. For instance, let’s say I sell you my home as an individual and I purchase something else based on the proceeds of that sale. You then have a turn of events where you can’t complete on the purchase. Is it better to say you can’t assign that contract and our deal doesn’t complete, putting me in a situation where I can’t complete on my new contract, or is it better to give you a relief valve and sell it to Matt? If you sell it to Matt, I can still do what I want to do, the person I’m buying from can too, and so on.
So assignments provide flexibility when the market goes up or down?
An assignment is an instrument to convey an asset. An asset is a contract. The problem is not what we can do to hamper realtors – as we said, in that article 11% were involved in the flipping. Why not educate people and tell them to take their properties for proper exposure? Tell them although you’ll save some commission, you’ll lose 5-7 times that amount if you don’t take it to market. If you’re so focused on pennies you’ll lose sight of the dollars. The engine isn’t broken and no system is perfect but we need to look at what’s going in and what’s coming out. The market is supporting us because there seems to be unlimited funds coming into the country with a limited supply.
Real estate has been very good to me. I do mourn for the opportunities for young people to buy properties. The market takes on a life of its own. Real estate is like a slow-moving stock market, like a commodity that’s bought and sold. Its ironic, in 2009 when we had the financial meltdown, I attended an investment seminar of TD Bank’s and they showed a line graph with the relative value to zero of the increase and decrease in stock values, and they overlaid another graph showing peak buying and selling cycles. Most stock was purchased at highest value and most sold at lowest value. Why don’t we talk about protecting people from making stupid business decisions? In this case, it comes down to educating. If you’re concerned about all this money being earned tax-free, there’s no obligation for brokerages to report assignment lists to Revenue Canada.
It doesn’t sound like you think government intervention is necessary and assignments are an instrument useful in all types of markets, hot or slow. In what circumstances, if any, is it unethical to use them?
It’s ethics vs. morals: as a self-regulating profession, we can enforce ethics, which are the rules. If rules are there and we’re following them, we’ve done everything we can, ethically. Convincing someone to sell their house when they could realize another $840,000 in profit comes down to morals, and I don’t know how we can regulate that. It’s not just in real estate, it’s anything.
But in that example, it’s also not clear whether they had an idea the value of their house was less or if they’re in a market that’s rising very quickly.
That gets back to key purpose of education. If I’m disposing my asset worth $5.2 million, you bet I’m going to get educated about it’s true value. Realtors cannot buy their own listings; they must ensure the seller gets representation. You cannot have a real estate services act or real estate board that governs morals.
If you don’t know the market and don’t understand the value of the asset, get more than one opinion.
Yes, or an independent appraisal with no stake. Appraisals don’t account for much of anything; they assume the house is in good shape. Deficiencies get negotiated after the fact, much like in a regular contract and typically with subject to inspections. It doesn’t consider commissions or costs incurred. The market decides what stuff is worth. Market value is defined as an arms length transaction between a willing and able buyer and a willing and able seller, where neither side is under duress or pressure. There are two sides to the story and the truth is usually somewhere in between. Education and hiring competent realtors with [the clients’] best interest at heart could have avoided the loss.
Is the ability to reassign a contract a clause in the standard MLS contract of purchase and sale, or is it something that must be inserted into the contract?
Every standard contract used through the web forms, and by extension through CREA (Canadian Real Estate Association) and through BCREA (BC Real Estate Association), is inherently assignable. This is Clause 17, called Plural. It refers to stating a party, including many definitions of that party and assignment, is in it. Can you take that out? I’d suggest anyone that has a contract assigned on them consider if they would have received the money they did without it. Would you be hampering your market value by giving fewer options for the property? The only rule for a real estate contract is that it be in writing. You don’t have to use that form.
So if you remove the clause, you’re removing the ability for the contract to be an asset itself?
I don’t totally agree with that. If you remove the assignment clause it means the contract is not assignable (unless you have mutual consent). The commodity has less value. Avoiding extra tax payment reduces the cost of the assignment. People will still flip without assignments and you may have more foreclosures and lawsuits because people can’t complete their deals.
It’s the flavour of the day and the market supports it right now. You can complain about the market all you want. Just get some and hold onto it. Get in, sit down, shut up and hold on.