This article is based upon one that I published on Brownstoner in 2013. The article specifically referred to renovated houses in that neighborhood, but it really could apply to any flipped house anywhere. Things in that neighborhood have gotten a little more above-board in since then, but this article is still relevant. The ideas here tend to be especially prevalent in “up and coming” neighborhoods, where profit margins for builders are pretty tight, which highly encourages corner-cutting.
“Flips” are buildings purchased by an investor, substantially renovated (often with new plumbing, heating and electrical), and flipped (resold in short order).
For some people, the prospect of purchasing a renovated flip is probably better than purchasing an old house that needs a lot of work, because of time and resource constraints. By and large, it may end up being a better deal in the long run. But you should still set some money aside for repairing stuff that the seller has no interest or ability to repair.
Perhaps it’s useful to outline the real estate investing business for those who are not familiar with it. The seller is often a general contractor or an investor who oversees a general contractor (GC). It is the job of the GC to coordinate the various trades that do work in the building. Trades are fairly specialized and as many as 10 to 20 different trades may be involved in any project, such as heating technicians, plumbers, electricians, tile setters, flooring installers, roofers…to name a few. The GC hires each of these trades to do their part and they are known as collectively as subcontractors, or subs. Since profit is the main motivating factor, subs are often hired based upon the lowest bid and, as we know, the guy who charges the lowest price knows how to cut the most corners. Never mind that the construction field is rife with unlicensed amateurs – the people who inhabit the lowest rungs of the bidding ladder. Oftentimes the wallboard hanger who “knows electricity and plumbing” will run pipes and wires even though he’s nowhere near qualified to do it.
In flips, the most attention to detail will usually go into bathrooms, kitchens, and floors — areas that catch the eye of most buyers immediately, and less attention to detail goes into other areas, especially areas to which many laypeople are oblivious, such as roofing, plumbing, electrical, chimneys, heating, and insulation.
The main thing I have observed in these flips is that they are far from perfect, but they are being sold as perfect. I routinely find water leakage, electrical problems, heating problems, amateur work, and the list goes on.
So who is responsible for rectifying elements that were installed incompetently or deficiently? Of course, in my opinion, and in the opinion of most buyers, it would be the seller. But some sellers have been known to disagree with that position. Ultimately, buyers and sellers arrive at the table voluntarily, so it’s a negotiation. In other words, you don’t have to buy the building and the seller doesn’t have to sell it to you. And in a hot real estate market, buyers tend to be less discriminating…
A Certificate of Occupancy (C/O) essentially states that a finished building complies with prevailing building codes and is legally habitable. The main thing I see over and over again is that the seller is trying to sell a substantially renovated building without a C/O, by standing on the idea that because it’s an old building, it doesn’t require a C/O. This could not be farther from the truth. Building codes provide a minimum standard for building occupant safety. If an investor is replacing the electrical system in a building, for example, it MUST conform to modern-day building codes and be verified as such through visits by municipal building inspectors. The same holds true for new plumbing and HVAC systems, as well as structural modifications, additions to the the building, etc. The certification process most importantly includes these inspections prior to finished walls being installed. Post-construction, pre-purchase inspections that are provided by people like me cannot verify full adherence to building codes because the walls conceal too much. Therefore, if the construction is largely finished and no municipal inspections have been done, there is a problem. Verification of building code compliance could involve opening up walls. If you’re interested in a place in New York City, you can see for yourself what, if any, permits and violations are on file for any building by entering the address into the NYC Department of Buildings website: http://www.nyc.gov/html/dob/html/home/home.shtml
In these types of purchases, I often hear that the seller will discount the house if the buyer agrees to purchase without a C/O. Purchase of the building without the C/O involves considerable risk, because it is often impossible to determine what the City will need (i.e. what it will cost) to confer a final Certificate on that building. Let’s say that the seller offers a $20,000 discount, but what if it costs $50,000 to bring the house into compliance? Most (but not all) attorneys will strongly advise against a buyer client closing on a building without a C/O. I once saw a new 6-family apartment building in the Bronx many years ago that the buyer had purchased without a C/O, due to poor advice from her attorney. The building had serious problems and 6 families living there, technically illegally. I was retained after the closing, so the buyer was in a greatly weakened negotiating position. Of course, your ability to negotiate is strongest prior to signing a sales contract and that is an important conversation to have with your attorney.
This is usually what unfolds: As part of my inspection report (aside from recommending the seller provide a final C/O), I provide a list of items that, in my very humble opinion, the seller might be responsible for correcting, i.e. anything they installed or replaced. The list could contain anything from a sticking door or window to roof leaks or non-functional heating equipment. If my list contains 30 items (not uncommon), the seller might agree to correct 10 or 15. When I am sometimes hired to return to the property after “repairs” are rendered, I often find that only half the items on the agreed list were actually addressed.
The thing to consider is, if the GC or his subs couldn’t do something correctly to begin with, is there wisdom in having them perform the fixes? It depends upon the thing being fixed. A sticking door should be no problem, but maybe not so much with improper electrical wiring. So there are cases where it is probably better for you to hire your own people (licensed professionals) to render these repairs and corrections. In these cases, some of the sale proceeds could be left in an escrow account to pay your own contractors directly. Once the work has been completed, the remaining funds go to the seller. This way the seller only pays exactly what repairs cost. Of course, the seller’s own cost for doing repairs himself would always be substantially lower to him because he already has subs on call. Therefore, this arrangement would be highly subject to negotiation. Seller corrections to items that were done wrong to begin with would then absolutely have to be verified as correct by a third party if you as a buyer did not have the expertise to assure that work was performed correctly.
In closing, it should go without saying, but I’ll say it anyway: No old building, whether in vintage condition, new, or newly renovated, should be purchased without a thorough building inspection prior to signing a sales contract.