In recent years, there has been a growing trend of something called wholesaling. Traditionally, wholesalers were a type of investor, but more recently they have started acting as more of a real estate agent. Let’s get into how they are doing it.
What is Wholesaling?
In the past, and still in a technical sense, wholesaling in the real estate industry is simply buying a property and immediately reselling it for more. It may not make as much money for the investor as fixing the house up and then selling it, but the quick turnover helps them secure a larger quantity of sales.
In recent years however, some clever individuals have found a gray space in real estate law that essentially removes all risk associated with the flip. Now there are dozens of online courses clouding the internet on how to do it, and anyone in search of some quick cash might be eager to give it a try. Because they have removed all risk from the equation, more people are willing to do it.
Traditional wholesaling should help both the seller and the buyer. The buyer got a discount on the house so they could make a profit when they sell it. The seller understood it was a discounted price, but it was worth it because the seller needed to sell the property fast and only a cash transaction without marketing time could provide the speedy transaction they needed.
What is the new wholesaling strategy?
Rather than buying the property itself and selling it, the new strategy is basically selling the right to purchase the property- without the wholesaler ever owning it. It is essentially hiring someone to sell the property for you, but usually an unethical process. With a Realtor, you know exactly what you are paying them and what they are going to do. With a wholesaler, you might be giving them far more for something they never even informed you about. I think the best way to learn about the process is through an example, so let’s go through one now.
Let’s say Susan inherited a small rental property in a nearby city. The house hasn’t been rented in several years, and it isn’t in the best condition just due to being vacant for so long. She doesn’t realize it but the house is still worth $90,000, even in it’s current condition. She doesn’t have a mortgage to pay on it, but the property is just sitting there empty, and she is still having to pay property taxes.
Wholesaler Will finds that rental property using public records, and sees that the owners mailing address is different from the property address, so he knows the owner has another house she is living in. He starts sending postcards and texts to Susan, saying that he wants to buy her house that has been sitting empty.
Susan calls the number on one of the postcards, and she meets Will out at the subject property and they discuss it. Will says he likes the house and would like to buy it from her, or at least, one of his “associates” will if he doesn’t.
Will offers to purchase the property for $60,000, and Susan negotiates him up to $65,000. Will already has an attorney drafted offer to purchase contract, and puts in all the terms of the purchase agreement. Susan signs.
A few weeks later, Susan is starting to wonder why she hasn’t heard much about the property moving to closing. This is because instead of Will trying to purchase the property or showing it to “associates”, he is instead trying to find an investor, most likely a complete stranger, to purchase the contract from him.
He cannot legally sell property because he is not a licensed agent, but he can sell the RIGHT to buy the property- or in other words, he can sell the purchase contract that Susan has already signed. It might as well be selling property, but for whatever reason, it is not, so it’s legal. He has a contract with Susan to purchase her property for $65,000. Will thinks the property is worth more like $75,000-$85,000, so he is offering to sell this purchase agreement for $20,000.
After negotiating, an inventory pays Will $15,000 for the offer to purchase, and then uses that purchase agreement to buy the house, and pays Susan the $65,000 for her property that she agreed to take on the offer to purchase. The investor is paying a fair price for the property at $80,000, but Susan only got $65,000 while Will took a hefty $15,000.
So now you can probably see how wholesalers are acting like real estate agents. Instead of buying the property for themselves, they are going out and trying to sell it for the owner- but in a dishonest manner.
What is wrong with this practice?
The biggest harm is that the property owner is not properly informed. Here are some things they are misinformed (or as I like to say, lied) to about.
First, the wholesaler does not intend to buy the property. They tell the owner they are going to purchase the property, or one of their “associates” will, because if they told them they were actually just going to sell it for the owner, why wouldn’t they just call a Realtor to do that?
Second, they lie about the homes value. Wholesalers will often try to get the property owner to think the property is worth less than it actually is. As a result, the seller gets less than the property is worth when it sells. Or the opposite occurs, where the wholesaler simply does not know the value of the property, and gets the owner believing they will receive a great profit.
My father is a licensed contractor as well as a “fix and flip” investor. There have been numerous times he has spoken to owners of distressed properties (his specialty) that have, for example, a very poor foundation. As someone who has fixed houses for years, he informs them the house is worth $40,000 because the repair costs. The sellers respond by telling him they have another offer for $80,000.
What they don’t realize is that the higher offer is from an wholesaler who doesn’t know what the property is actually worth. Then, the wholesaler gets it under contract and tries to sell that contract, only to find nobody is going to purchase it at that price. Then, naturally, the seller is hurt when the property is not selling, and they can’t sell it to anyone else because they are stuck in the contract with the wholesaler. When you tie up one of these properties for $0, there is no repercussions for telling property owners you will give them more than the house is worth. Worst case scenario, you can simply back out of the purchase agreement, sacrificing nothing but time.
How do Wholesalers differ from Realtors?
To begin with, Realtors are allowed to sell property, while wholesalers cannot. Technically, wholesalers are not supposed to advertise the house, but instead, the terms of the purchase agreement.
The primary difference is that Realtors are honest and straightforward about what they are doing, they are obligated to look after the sellers best interests rather than their own, and they are professionals.
Let’s go back to the scenario with Susan and Will. This time, instead of calling the number on the postcard saying “we buy houses”, she called her local Real Estate professional Aaron Robbins :). See if you can spot the difference.
Susan gives Aaron a call, and they schedule a time to meet at the property to get an idea of the condition. Once Aaron has seen the property, he gets an understanding of why Susan is selling. He reviews some nearby properties that recently sold, and combining that information with his knowledge of the local market, he informs her that her property is worth $90,000.
When Aaron calls Susan and fills her in, she is pleasantly surprised to hear what the value came back at. Since Susan said she wasn’t in a huge rush to sell, Aaron suggests it might be a good idea to list it slightly above $90,000, to try to maximize profit.
They schedule a meeting that evening to review the paperwork. Aaron explains the terms of all the paperwork, including his commission. After Susan has given him the authority to list the property for her, he gets to work immediately. Professionally measuring the property, putting a sign in the yard, high quality pictures, and the rest of his marketing campaign to make sure Susan gets top dollar for her property in the shortest time possible. The property is also listed on the MLS and is shown on Zillow, Realtor.com, and every other housing website out there.
Once they receive their first offer, Aaron emails it over to Susan and calls her when she gets off work to review all the terms of the purchase agreement. She accepts the offer of $95,000, and it also has $1,000 in deposits, so if the buyer backs out, it wasn’t all for nothing.
Aaron coordinates closing with the buying party as well as the lender and closing attorney, and soon the transaction is completed.
How did the two transactions differ?
Let’s go over how those two made up scenarios differ.
First, the Realtor researched thoroughly and used their own market insight to determine the value of the property, and gave the seller the honest number of $90,000 instead of $60,000. He then determines her needs in the transaction, and suggests they sacrifice a bit more time on the market in exchange for a higher purchase price, once again looking after her desires rather than his own.
Then, he uses NC standard contracts rather than attorney drafted contracts, and goes over every detail with the seller, since there is nothing to hide.
After that, he has an arsenal of marketing techniques he uses to appeal to the largest number of buyers possible. The property is also listed online which is a huge advantage of listing with a Realtor. Where the wholesaler might have a hundred contacts to whom they can show the property, the agent has it listed for thousands of qualified buyers to view.
Once they receive an offer, Aaron goes over every detail of the purchase agreement. He also gets an offer with a deposit of $1,000, so if the buyer backs out, Susan will still have something to compensate her for the time the buyer wasted. With Wholesaler Will, when he finds a buyer, he also demands a deposit, but he is the one keeping that money if they walk away, not Susan.
After managing the closing process, Aaron has gotten Susan to closing. Aarons compensation for the work he did was 3% of the purchase price, or $2,850. Susan walked away with just under $90,000 after all closing costs were paid. With Will, he made a whopping $15,000, or nearly 19% of the $80,000 total purchase price, and Susan only walked away with $65,000.
That is the difference between a Realtor and a wholesaler. A Realtor is bound to fiduciary duties, and must look after their clients priorities. A wholesaler on the other hand is working for themselves, at the expense of their client.