Wholesaling Real Estate - The Basic Idea

By Steve Gillman - 2007

Why should you consider wholesaling real estate? To start with, it can be a great way to get into real estate investing without much capital. Wholesaling is also low-risk when done properly. However, you can't necessarily do it anywhere you want. This works best when there are investors ready to buy those wholesale properties you find, so it works best in larger towns and cities.

Let's look at what it means to wholesale real estate. It is essentially just buying cheap to sell for a profit to another investor. It is the other investor who will then retail the property.

Of course, if you actually buy and close on a house or other real estate, you have transactions costs. Then there are more costs when you sell to the next investor, and even more transaction costs when he sells the property. These costs would mean that you have to buy really cheap to leave room for a profit for you and the next investor.

Let's say you have a seller who really wants to sell fast, with a house worth $190,000. You close, hold the property for some time, and sell, paying as much as $8,000 in various expenses. Suppose the other investor uses a real estate broker to sell, so his costs total $12,000. In this case, for you to make $5,000, and the other investor to make $10,000, you would have to get the house for $155,000 (subtract all the costs and profit from the eventually sales price of $190,000).

Let's face it: you won't find many deals like that. The owner can probably sell it fast just by dropping the price to $175,000, so why sell to you for $155,000? But then, this isn't how real estate wholesaling is typically accomplished.

To begin with, you don't want to close on a property. You sell the contract to the next investor instead, to avoid all the costs associated with your buying and selling it. Also, wholesaling real estate works best with fixer-upper homes. Owners can't easily sell these without doing the necessary repairs, so they are often willing to sell cheap "as is" to get rid of their headache. Keeping these two things in mind, lets look at a more realistic example of wholesaling.

An Example of Wholesaling Real Estate

First you look at the market, do some research and decide that you may be able to wholesale properties in your town. At the local real estate investor's club you get to know some investors. You get the names and phone numbers of at least several who can make a decision quickly and want to buy fixer-upper properties. Make a note as to the type of properties each is interested in and how much profit they each expect to make on a deal.

With this preparation completed, you go out to look at houses. You find a motivated seller who is asking $190,000 for a dirty house that needs work. Comparing it to others in the area, you determine it will be worth about $235,000 when it is cleaned and ready. The house needs about $15,000 worth of work, and other costs, including a low-cost real estate broker, will run about $15,000, based on a holding time of about three months before it is sold and closed on.

You decide you want $5,000 for your time. According to your notes, your most likely investor wants around $20,000 profit for a project. You subtract these and the costs, to arrive at $180,000 ($235,000 - $15,000 - $15,000 - $5,000 - $20,000 = $180,000). That is the most you can offer for the house, so you start with an offer of $173,000. Eventually the seller agrees to $177,000.

In the offer, after your name as the buyer, you put the words "or assigns" or something similar (ask a real estate lawyer or agent for the language that is usually used). It gives you the right to assign the contract to another investor - the one who will take your place and actually close the deal. Tell the seller that this is so you can bring in a partner if necessary, to be sure that the deal closes. In other words, you want to make this a good point rather than something that scares the seller.

Have a financing contingency with specific terms, like "This offer subject to buyer obtaining a fixed-rate 30-year mortgage loan at 7.5% annual interest or less." You might also have a clause that requires the approval of your "partner" or some other clause that lets you cancel the contract if necessary. You can also include a clause that makes your deposit "liquidated damages," meaning this is all the buyer gets if you back out for any reason (ask an attorney for the wording). Proper clauses mean that all you risk is your time, and perhaps a $500 good faith deposit.

You call an investor who will take your place, complete the repairs and retail the house. He agrees to pay $7,000 for you to assign the contract to him, but will only pay you when the deal closes, which sounds fair to you. Eventually, he sells the renovated property for $240,000, for a profit of $25,000. This is good news. Remember that the more he makes, the more likely it is that you can wholesale real estate to him again. You make a $7,000 profit, which requires very little investment or risk.

When wholesaling real estate, speed matters. Your offer probably allows for only a few days or a week to find an investor. Also, the investor needs a property that sells fast to avoid holding costs and market risk. This is why you need a list of investors before you start looking for houses, and why you should focus on the houses that are selling fastest - most likely those that are near the median price where you are.

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