You’ve probably heard of the term “lipstick on a pig.” In house-flipping parlance, it means doing basic cosmetic upgrades that camouflage the underlying issues beneath the paint and Sheetrock.
California house flippers will have to put their makeup away and bring out the heavy machinery because a new law—Assembly Bill 968 (AB-968), effective July 1—mandates a comprehensive disclosure of repairs and renovations from sellers who flip one-to-four-unit properties within 18 months of buying them. The intent is to protect buyers from undisclosed and unseen property conditions.
However, it’s not just a comprehensive scope of work that needs to be supplied. The new law could have wider ramifications.
Key Provisions of AB-968
Single-family or small multifamily (under four units) house flippers need to be meticulous about their house-flipping work and who has done it. The details the law requires are:
- A record of all repairs, major and minor, that cost over $500.
- A copy of all related permits.
- If permits are unavailable, the seller must assist the buyer in obtaining them from associated third parties (usually the DOB at City Hall).
- The name of each contractor associated with each permit and their contact information.
How the New Law Will Impact Residential Flippers
Many house flippers take on general contracting work themselves, hiring subcontractors and paying cash for specific jobs, particularly unskilled labor. While they still might be able to get away with that, when it comes to more skilled work such as plumbing and electrical, everything needs to be by the book, with licensed contractors’ permits and inspections. That means no hiring of undocumented workers, regardless of their skills.
The end result could increase costs and add extra time to a job, where speed is usually the name of the game.
Lawsuits and Compliance
Fines and lawsuits await sellers who fail to comply with AB-968. Should work be discovered that was not disclosed, or disclosed work was not completed, a buyer would have grounds for rescission of the sale and damages. So, trying to skirt the new law is not advisable.
Flippers Need to Lawyer Up
With the high price of California real estate, flippers shouldn’t leave anything to chance. The cost of hiring a lawyer is well worth ensuring a seller fully complies with the new laws when they list the house. Preparing disclosures, updating permits, and addressing possible issues before they arise means hiring a lawyer long before a house flip is completed is a prudent move.
California Laws Are Targeting Flippers
Bill AB-968 comes hot on the heels of Assembly Bill 1771, proposed in 2022 by Assemblymember Chris Ward (D-San Diego), in which house flippers could have been taxed 25% of their profit under the California Speculation Act. The bill ultimately failed to advance from the Assembly Revenue and Taxation Committee. The additional tax revenue would have gone to the newly created Speculation Recapture Community Reinvestment Fund and used for local governments for such expenditures as schools, affordable housing, infrastructure, and transportation.
“We’ve heard of people getting into their first home getting beat by cash offers” from investors, Ward said at the time. “When investors fall out of the buying pool, that will give regular homebuyers a chance to buy a home.”
Supply Is a Major Issue
California’s contentious relationship with house flipping points toward a more significant issue in the state: a chronic shortage of houses. In recent elections, voters overwhelmingly supported the construction of new homes across the state, but a recent poll found that most people surveyed in Los Angeles remained skeptical about its effect on easing housing pressures. When asked what they thought the effect new housing built in their neighborhood would have, 49% agreed with the statement: “It will drive up the cost of housing and push residents out.”
The poll, known as the 2024 LABC Institute Housing Affordability Survey in Partnership with the Los Angeles Times, surveyed 600 registered voters in LA between April 3 and 7. Results showed those surveyed overwhelmingly backed substantially increasing homebuilding in the city, with 8 in 10 surveyed favoring the construction of income-restricted affordable housing generally and apartments for veterans, public service workers, low-income seniors, and low-income families with children.
California Is Fertile Soil for House Flippers
According to a study from Highland Cabinetry, California ranks seventh in the nation for the most profitable states to flip a home, with an average remodeling price of $83,382. The national average is $67,791.
“The latest numbers show that investors still face an uphill climb to clear significant profits after expenses,” ATTOM CEO Rob Barber said in a press release regarding the organization’s 2024 US Home Flipping Report. “They, like others, also face tenuous times amid a housing market boom that’s cooled down over the past year. But we now have a year’s worth of a trend showing that things have started to turn around for the flipping industry, with clear signs of increasing interest flowing into the market.”
LA’s “Mansion Tax” Hurt the Bottom Line for Luxury Flippers, But Has It Helped the Housing Crisis?
Like New York, Los Angeles imposes a “mansion tax”—formerly known as Measure UL—of 4% on all sales above $5 million and 5.5% on sales above $10 million. However, unlike LA, New York’s mansion tax starts at 1% on sales of over $1 million.
While the mansion tax is unlikely to directly affect flippers buying homes that first-time homebuyers would compete for, the proceeds from the tax directly address LA’s housing crisis. Measure ULA has raised roughly $215 million in its first year, according to the LA Housing Department.
It has been a contentious issue among LA’s real estate pros, who have claimed that it has hurt all elements of development, including multifamily developments and commercial properties—as it is levied on all sales above $5 million—which ironically could help ease the housing crisis.
“My clients are leaving LA,” said Jason Oppenheim, a luxury real estate agent who stars in the real estate reality show Selling Sunset, in an interview with the Los Angeles Times. “We can’t keep pushing the wealthy out of our city. This tax has not had the effect that was promised, and it’s time for everyone to put aside their egos and realize this was a mistake.” A spate of celebrities sold their LA homes before the tax took effect, including Mark Wahlberg, Sylvester Stallone, and Brad Pitt.
It’s estimated that the mansion tax will net the city around $300 million this financial year. “Despite litigation, despite the chilled market, despite the wealth defense industry designed to help the rich protect their money from taxes, that’s $300 million for housing and homelessness initiatives,” said Greg Good, a senior advisor on policy and external affairs for the LA Housing Department, to the Los Angeles Times.
Final Thoughts
It seems pretty obvious that the city of Los Angeles and elsewhere should add some nuance to their tax laws. Enabling sellers of multiunit apartment buildings who agree to build more apartment buildings, possibly through a 1031 exchange, to be spared the mansion tax seems logical.
The new house-flipping mandate only reinforces what should be supplied in the sales disclosure anyway. Being forced to name contractors eliminates, to a certain extent, unlicensed contractors working under the table for cash, which could undoubtedly hinder the bottom line for smaller flippers and bring cash workers into the tax system.
The obvious workaround is to have a licensed contractor sign off on the job for a fee, which is nothing new. However, the legal costs and time to supply the documentation could hold a closing back, but not in an insubstantial way, should a flipper keep a tight rein on the correct documentation as the job progresses.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
