What is Wholesaling Real Estate?
Investing in real estate is an efficient way to make money and to diversify your investment portfolio. There are many different types of investment strategies that are commonly used to make money in the real estate industry. When people are starting, the difficulty is often “how am I going to invest in real estate if I do not have thousands of dollars saved up?” Wholesaling may provide you with an opportunity to make some money while spending very little out of your pocket. Wholesaling involves an investor entering into a contract with a homeowner for the purchase of their home, then he or she markets that property to other potential buyers. Once a new buyer is found, the investor will either double close on the property or assign their rights under the contract to the new back end buyer. The Investor will then keep the profit of the sales (if double closed) or keep an assignment fee charged by the new buyer.
Once you have found the right property, the objective is to get the seller to agree to the terms of a contract, and to execute said contract. The contract’s contents vary drastically among investors, with each investor incorporating different terms. One fact is for sure, a solid contract is necessary to protect your interests. Using a typical FARBAR contract gives the parties warranties and responsibilities/liabilities that many investors do not want to be incorporated into their wholesale contracts. There is not a one-size-fits-all contract. Investors should be prepared to modify their contract as needed for each deal.
Determining the Price
Investors often have a difficult time trying to determine the price point where they need to be in the contract. If you have a bad price point for your wholesale deal, you will lock down the seller’s property for weeks or months and will be unable to complete the deal with a back–end buyer. The most common way to determine the price point needed for an effective wholesale deal is to use the “70% of ARV rule.” ARV stands for “After Repair Value,” and this value is what the house would be expected to sell for if sold to a retail buyer after all necessary repairs have been made. The general rule of thumb is that an investor who is flipping a house needs to be in a deal with an expected 30% return. This figure also provides a buffer for the investor in case repair costs or other fees run higher than were estimated. To calculate your offer based on the above formula, you take the ARV and multiply this number by 70%. From that result, subtract out the expected repair cost of the property. The remaining figure is the highest amount of money you should offer to the seller. As an example, we will use a house with an ARV of $100,000.00 and an expected repair cost of $20,000.00:
($100,000.00 x .70)= $70,000.00
$70,000 – $20,000.00= $50,000.00.
In order to fix and flip this house, the investor would ideally need to get this property under contract at $50,000.00. Cutting the margins any shorter may lead to a loss on the flip, although it can be done. For a wholesaler, in order for you to find a back-end buyer, you will need to offer them this property at or as close to the $50,000 figure. If the wholesaler can get the property under contract for $45,000, they can assign that contract to a flipper and easily make a $5,000 assignment fee. The shorter you cut the margins, the harder it will be to find a back-end buyer.
Assignment vs. Double Close
An assignment occurs when a wholesaler gets a property under contract, then finds a new buyer. The wholesaler and the new buyer execute an assignment agreement in which the back-end buyer replaces the wholesaler under the original contract. Accompanying this agreement, the back-end buyer tenders a non-refundable assignment fee to the wholesaler. A double closing is two closings. The wholesaler closes on the property with the seller, then immediately sells that property to the new buyer. Typically, the wholesaler will negotiate and contract with the back-end buyer to have as much of the closing costs as possible paid on their behalf. Whether to assign a deal or double close on a deal is typically dependent on the facts of the individual deal. An assignment is often preferred because the investor will have fewer overhead expenses since they do not have to close on the deal. Doing a double closing may also benefit the wholesaler if they are making a lot of money on the deal because the seller will not know how much money the wholesaler is making off of the back-end buyer.
Wholesaling Real Estate, is it right for you?
The idea behind wholesaling is that the wholesaler is the middleman between the seller and the back-end buyer. In most cases, the houses contracted for are off-market properties, so the wholesaler is actually finding the property and relieving the back-end buyer of this responsibility. For this service, the wholesaler charges a fee, typically as an assignment fee. Wholesaling has received a bad rap because many people will nickel and dime the sellers, who are often disadvantaged in some way or another, in an attempt to make the most profit possible. Wholesaling provides a great source of income, and it is a good way to keep properties cycling. The profits can also be dumped back into the marketing budget to drum up more properties. It is possible to wholesale ethically if you take the time to learn the process and reach an agreement with the seller that is beneficial to both of you.
This blog does not cover all of the intricacies involved in a real estate transaction, but it should serve a good starting point for your ventures. If you would like to know more about wholesaling, The Orlando Law Group, PL has knowledgeable real estate attorneys to help you navigate the process.