Wholesaling products has been a profitable business for quite a long time. Wholesaling real estate entered the spotlight with the boom of real estate investing in the early 2000’s, though it has been around for much longer. It is essentially no different than wholesaling any other product. There is a stigma, however, associated with this type of transaction in real estate. It is sometimes thought to be either illegal or unethical. So, lets explore exactly what wholesaling is and how it works.
What is Wholesaling?
Wholesaling exists all around us in the modern world. Any time that you go to a retail store, whether in person or online, and purchase a product, from groceries to clothing to computers, you are the buyer of a wholesale product. In a wholesale transaction a manufacturer produces a product, for example a T-shirt. He then sells this product to a retail store for, let’s say $10. The retail store then sells the product to a consumer for $15. The retail store made a profit of $5 for selling a product that they neither altered nor improved in any way. These transactions take place hundreds of thousands of times a day in every city in America. This is known as the wholesale-retail model and it can be applied to virtually any product. This process is used in real estate when an individual sells his home to an investor who then assigns their interest in the contract to the ultimate buyer at a higher price.
What About Ethics and Legality?
There is absolutely nothing illegal about this process. If there was then Wal-Mart, Target, Kroger and thousands of other companies would cease to exist. With real estate, ethical questions are raised, often times, as a result of the sizable profits investors can make on theses deals. Some feel that investors have a duty to inform the seller that they intend to assign their rights to another buyer at the time of closing and will be making a profit as a result. While wholesaling is not a shady secret, it is often not discussed during negotiations in the same way that a retail store does not inform consumers that the product they are about to buy for $15 could be purchased directly from the manufacturer for $10. The profits made with wholesale deals could be thought of as a “finder’s fee”. The investor is playing the role of the middle man and brings the seller and the buyer together when they otherwise would not have found each other.
How Does a Real Estate Wholesale Deal Work?
In real estate, a wholesale deal begins with an investor finding a property. Generally, these properties are distressed, need significant repairs or the seller needs to sell quickly for a variety of reasons. The investor evaluates the property and has in mind what the property’s current market value is, how much needed repairs would cost and what the after-repair value would be. The investor and seller then negotiate a price.
For example, a seller has a property which needs significant repairs and he is unable to afford to make these repairs and without them the house would not be marketable through traditional means with a realtor. The seller and an investor negotiate based on the current market value and the cost of needed repairs and the investor offers $100,000 for the property which the seller accepts. An agreement is singed with various contingencies. The agreement is not necessarily legally binding but rather ethically and morally binding to the consciences of both parties. In this agreement is a stated due diligence period. This time allows for the investor to back out of the agreement based on the stated contingencies. Frequently this includes inspection of the home, title search, etc. similar to contingencies placed on any standard purchase offer agreement. Once these terms are met and the investor does not terminate the agreement, an official real estate offer is signed. Once the official offer is signed the property is considered under contract and the seller may not entertain any future offers without penalty. This contract will include a closing date. Also at this time, the investor must submit earnest money to a third party for holding until closing.
Ideally, before an investor enters into the first agreement with the seller he will have a buyer lined up. If not, the investor has from the time of the signing of the offer contract to the closing date to find one. Sometimes this can be as little as 7-14 days. If the investor cannot find a buyer, he will be forced to either purchase the property himself or terminate the agreement and forfeited the earnest money. The goal for a wholesale investor is to never, at any point, actually own the property. When the offer contract is signed the investor signs as the buyer but also includes the phrase “or assigned” behind their name. This gives them the legal right to either buy the property or assign their place at closing to someone else who would actually purchase the property in place of the investor.
There are two ways in which closing will happen: a single closing or a double closing. A single closing is when all three parties come together at the same time and everyone is able to see what the other is selling or buying the house for. This is the idyllic way for closing to happen because closing costs are only paid once in this case. With a double closing there are actually two separate closings. First, the investor purchases the property from the seller then immediately, usually only hours later, a second closing takes place where the investor sells the property to the buyer. Typically, a double closing will only occur if the seller is likely to be upset by the profit the investor will be making creating the risk that he may terminate the deal.
With small profit deals a double closing is generally not prudent but when the investor stands to make a 10% or higher profit it is typically in the best interest of the investor to hold two closings. This prevents the seller from knowing what the property will ultimately be sold for and prevents the buyer from knowing what the investor purchased the house for. This is where the question of ethics comes in but is, in fact, no different than buying clothing from a retail store. When you purchase the clothing, the store is under no obligation to inform you of how much they purchased the items for. As stated before, double closing will result in closing costs having to be paid twice which could significantly cut into the profit of the investor and so it is typically not done with low profit deals.
To continue our example above, an investor offers $100,000 for a house and then assigns their interest at closing to a buyer for $110,000. The investor would then make a profit of $10,000 minus closing costs which are typically paid for by the investor.
Investors also stay away from double closing when possible because the goal of this transaction is to never own the house. At a single closing the investor simply signs over their place at the closing table and never actually purchases the property but rather is paid a fee by the buyer for their seat at closing. With a double closing, however, the investor will own the property for a very brief time. It may be hours or days but because of this, they must now purchase homeowner’s insurance. Typically, the shortest policy possible is for one month, meaning the investor must pay for a month of insurance and may only need it for six hours which further cuts into profits.
Wholesaling real estate works in the same way as wholesaling food, clothing and other products. A middle man, in this case an investor, receives a fee for bringing a buyer and seller together. This may sound extravagant being as the investor does nothing to improve the property but consider that the investor must find and negotiate with the seller, perform all inspections and clear all contingencies then find a buyer and arrange for closing. There is a lot of leg work that goes into making a wholesale deal. Work that many buyers are more than willing to pay a small fee to not have to do themselves.
Wholesale deals are most often seen with investment companies. For more information on how a wholesale works contact a real estate investment company like Emmaus Property Investments, LLC and ask how it works. These deals may appear to only benefit the investor but in reality, the seller is able to get out from under their mortgage and sell a home that would likely not sell on the traditional market and the buyer is handed a property to rehab without having to put effort into finding or researching the house and its ability to be fixed and sold. Wholesaling real estate has great potential to benefit all parties in different ways.