For most of us, the term “wholesale” refers to the lower price that a business pays for items, compared to the retail price that they sell to consumers.
It turns out that real estate wholesaling works exactly the same way. But in the case of wholesale real estate, the business owner is the real estate investor, and the retail consumer is homeowners.
The difference? Real estate wholesalers never actually own anything. They simply serve as a middleman connecting low-price real estate contracts with investors looking for good deals.
And for their efforts, they often earn a quick and pretty penny.
What is Wholesaling Real Estate?
Real estate wholesalers flip contracts. They put homes under contract for a low price, then find an actual investor who wants to buy that home.
Like a retail wholesaler who functions between the manufacturer and the retailer, a real estate wholesaler’s profits depend on the difference in the purchase and sale prices of their asset. Their margin lies in the difference between the contract price for the seller, and the contract price with the buyer.
In practice, a wholesaler of real estate typically finds desperate sellers willing to accept a low sales price, and put the property under contract. In the period between contracting and closing, the wholesaler finds a buyer who agrees to pay a higher price for the property than the wholesaler’s contract with the seller.
For example, if the wholesaler puts a property under contract for $95,000 and finds an investor willing to pay $100,000, the wholesaler walks away with $5,000 in cash as their margin.
Is Real Estate Wholesaling Legal?
In most states, individuals do not need a real estate (or any official state-issued) license to participate in wholesaling real estate, merely an unofficial right to make money from his effort and negotiating prowess. However, some states have challenged the use of assignment or finder’s fees as illegal schemes to avoid having a real estate license.
Other regulatory bodies may limit the language and methods to be followed when soliciting distressed property for purchase. According to attorney Brian Pendergraft, Maryland’s Protection for Homeowners in Foreclosure Act (PHIFA) prevents anyone acting as a potential buyer from claiming they are “assisting the homeowner in preventing foreclosure.”
Rather than blunder into a lawsuit or an unpleasant experience with regulators, potential real estate wholesalers should consult a real estate attorney to understand their state’s regulations.
Two Critical Skills for Wholesaling Real Estate
Success in real estate wholesaling requires your mastery of two unique skills: (1) identifying desirable properties at a discount, and (2) finding willing buyers (investors).
Finding Spectacular Off-Market Deals
There are dozens of strategies for finding motivated sellers, from homeowners in foreclosure to frustrated landlords to driving for dollars. Even in hot markets, wholesalers and investors can find good deals on real estate, particularly using tools like Propstream, REI Property Pro, and Deal Machine.
A few other strategies include:
- Use of “bird dogs.” Many wholesalers employ assistants – usually college students part-time – to canvass neighborhoods and knock on doors to find potential sellers. The “bird dogs” typically work on a commission basis, being paid if and when the wholesaler puts a property under contract and profitably wholesales it.
- Scouring public records. Tax filings and divorce court proceedings to identify potential properties that are likely to be on the market quickly is a common wholesaler strategy. For example, many homes of older people are structurally sound but lack updating to current market tastes. Motivated sellers, such as out-of-town beneficiaries of an estate, might prefer to avoid the expense and time to bring the house to market conditions and would be willing to sell. Likewise, couples amid a divorce are usually anxious to move on with their lives. They may be willing to take a discounted price for a quick and sure sale.
- Bandit signs. While not legal everywhere, those “We Buy Ugly Houses!” or “We Buy Houses for Cash!” signs do still work in many markets. Just make sure it’s legal in your city before you throw them up on every street corner; it’s not exactly hard for the police to find you, with your phone number in huge letters across the sign.
Building a Network of Buyers
We’ve all heard the old joke about the dog who chases cars until he finally captures one, prompting him to wonder, “What do I do now?”
To avoid a similar predicament, wholesalers invest time and energy to identify and pre-qualify a network of local real estate investors who can move quickly and decisively on a purchase. After all, wholesalers don’t intend to buy the property themselves. They need a long list of prospective buyers.
Most buyers of distressed or undervalued real estate either intend to renovate the property to flip or keep as a rental through the BRRRR method. Accordingly, investors usually prefer to buy property in specific locations and price ranges. Knowing each buyer’s criteria and preferences beforehand eliminates wasted time and effort for a wholesaler.
Many house flippers rely on wholesalers as their sole source of deals. Using a wholesaler avoids the hassle of finding deals on their own.
Other buyers may be found in local real estate investing clubs or online groups. SparkRental’s own Facebook group for real estate investors is one of the largest online, with nearly 30,000 members. Remember that the more you network, the more likely that you will meet potential buyers and sellers, lead sources, partners, and even mentors.
Wholesaling Is a Team Sport
In addition to bird dogs and an attorney familiar with real estate laws, successful wholesalers typically rely on several trusted professionals to facilitate their wholesale transactions:
- Contractor. A knowledgeable contractor can evaluate a property and identify and price needed repairs or remodels necessary to increase market value. This knowledge, even though the wholesaler is pricing the property “as is,” is an added benefit to potential buyers.
- Appraiser. The ability to act swiftly is often the difference between acquiring a property or waiting on the church steps. Working with an appraiser who is available on short notice and understands the wholesaler’s objectives ensures that the purchase price and projected sale price leaves room for a profit.
- Title company. Wholesalers need title companies familiar with real estate wholesaling and assigned contracts. In some cases, they may opt to do double closings (more on that shortly), which requires an investor-friendly title company.
How Do I Structure a Wholesale Real Estate Contract?
In addition to the standard clauses, a purchase contract used by a wholesaler should include the following provisions:
- Assignability. The goal of a wholesaler is not to own real estate, but to have an exclusive right to purchase it at a specific price. This right is then sold to a buyer who will take possession of the property on closing. Accordingly, the purchase contract must be transferable to a third party without limitations. Any restriction on the right to assign reduces the value of the right to purchase.
- Exit or Contingency. Wholesalers do not want to take ownership of their purchase-contracted properties. As a result, purchase contracts agreed to between a seller and wholesaler include a clause that allows the wholesaler to walk away under certain conditions, in case they can’t find a buyer. Securing an exit option may require sacrificing the earnest money deposit, so wholesalers should minimize this to reduce risk.
When & How Do Wholesalers Get Paid?
Wholesalers can structure their deals in several ways. One option involves conducting two settlements: one in which the wholesaler buys from the seller, and an immediate second settlement where the wholesaler sells to the real estate investor.
It’s an imperfect option for several reasons. First, it leaves the wholesaler having to come up with the money to buy the home. Two settlements also mean two rounds of closing costs. Finally, the wholesaler risks the buyer failing to settle, leaving them stuck with a property they had no intention of owning.
But it comes with one huge advantage: it keeps the seller and investor completely separate, so neither objects to the wholesaler’s margin.
Some investor-friendly title companies allow a double closing, where the buyer-investor’s money funds the seller without the wholesaler having to come up with the full purchase price. Each title company handles these differently, so talk to as many as possible and find the best deal.
Alternatively, wholesalers can simply assign the contract, and let the investor buy directly from the seller. That leaves the wholesaler with a conundrum about how to list their fee without angering sellers and lenders. The easiest option is simply to list an “Assignment Fee” on the settlement statement (more on this momentarily).
Depending on the terms of the two contracts (the seller/wholesaler and wholesaler/buyer), the wholesaler may be paid in either of two stages of the process:
- Buyer’s purchase of the wholesaler’s contract with the buyer. The buyer pays the wholesaler when the buyer assumes the legal rights of sales contract, or
- The closing of the transaction between seller and buyer. When funds and title of the property changes hands, the wholesaler receives his fee.
Most investors prefer the latter stage to limit their expenses until the closing of the final sale. But wholesalers should always collect a deposit from the investor, to cover their own deposit and other costs in case the investor proves unable to settle.
How Should I Take My Fee?
Decisions about the nature and timing of a wholesaler’s profit (or fee) generally depend on the regulation of real estate transactions in the state where the property is transferred. The more common methods include:
- Listing an assignment fee on the settlement statement. In these cases, the title company will pay the charge at an integrated closing, i.e., the buyer of the property replaces the wholesaler to create a single transaction between buyer and seller. However, some states consider an assignment fee as a disguised real estate commission and may require the wholesaler to have a real estate license to receive payment. For example, contracts to purchase HUD-financed homes or foreclosures generally aren’t assignable in any state. Wholesalers can sometimes get creative with what they call their fee, listing it as something obscure like “Buyer Acquisition Outreach Fee” so a not to anger sellers or lenders.
- Receiving the profits from back-to-back transactions. In some states, a wholesaler must participate in back-to-back closings, the first to purchase the property from the property seller and the second – a transfer from the wholesaler to the final purchaser. This method may significantly increase the wholesaler’s costs since each transaction is likely to require double payments for a title search and real estate transfer taxes. In some cases, the wholesaler will be required to deposit his own funds to close the purchase before receiving funds from the subsequent sale. He may be required to take a short-term loan from a transactional lender.
- Taking the Fee Separately from the Seller or Buyer. In some instances, a wholesaler might act solely as an agent for one of the two principals – helping the seller find a buyer and vice versa. The fee for the service may be fixed, or a percentage of the sales price and is usually contingent on the transaction occurring. The agreement between the contracting party and his agent must be carefully drawn to avoid potential regulatory problems.
(article continues below)
Purchase Options vs. Purchase Agreements
In my younger years, I aggressively pursued a wholesale strategy with commercial warehouses and raw land, using 12 to 18-month option-to-purchase contracts. In most cases, I paid the property owner a fee equal to 2-5% of the purchase price for an exclusive right to buy the property over a specific period, the price for option depending on the contracted sale price for the property. With the option in place, I searched for buyers, never taking ownership of the property itself.
In my case, some options expired at a total loss, others I sold for less than my cost, and some I sold for various levels of profit. Overall, my strategy was profitable. In hindsight, probably due to the particular market environment of the time. Commercial properties in Dallas had been significantly over-built, financed by naive investor groups expecting a sure thing. Rather than ride out the cycle, they preferred to take tax losses and move on to the next “hot” investment.
The use of options typically requires more capital than a purchase agreement with a walk-away contingency clause. Still, there are times when they can be useful.
What If I Can’t Find a Buyer?
Real estate wholesalers share a collective nightmare: putting a property under contract then failing to find a buyer. Practically speaking, a wholesaler who cannot find an offsetting buyer has two choices:
- Defaulting on the purchase contract. The wholesaler can refuse to close the purchase transaction, preferring to be liable to contract provisions that might include the loss of his earnest money. However, the best way to avoid such situations is to always include an exit contingency clause in your purchase contracts. This provision enables you to extinguish your obligation if you cannot find a buyer between the contract and closing dates. Any portion of your earnest money that can be recovered in such cases is a win.
- Close the purchase and become a real estate “wholetailer.” Real estate professionals refer to wholetailing as a cross between wholesaling and flipping. Whereas some wholesalers inadvertently acquire properties, others intend to take possession (close) quickly, perform minimal rehabilitation or remediation necessary to list for sale, and remarket it. Wholetailing is typically practiced in states where disclosure of real estate sale prices is not required, and the purchase price will not affect the appraisal value.
Real estate wholesaling can make an ideal first step for building a real estate fortune because of its low capital requirements, the reduced risk of asset ownership, and the opportunity to learn the nuances of real estate ownership at your own pace. Unlike investing in the stock market or buying a bond, your success is wholly dependent on your effort to find properties and negotiate effectively.
If you can find good deals on real estate, and you can build a list of investor-buyers, you can earn good money as a real estate wholesaler.
Have you ever wholesaled real estate? How did you structure your deals?