If you’ve been searching around the interwebs for real estate investing information, you have been inundated with various get rich quick schemes, hot deals of the century, killer leads, and no money down ventures. Fix and flips, wholesaling, lease options, contracts, and short sales may be some other “real estate lingo” you’ve come across. Our blog here at AssetRover deconstructs real estate investing down to its simplest levels so you can learn. Knowledge is power and education will make real estate investing easy for you to understand over time.
Wholesaling Real Estate
One of the topics we often hear around the proverbial “real estate water cooler” is people talking about wholesaling real estate. The art of wholesaling real estate has its pros and cons just like any other real estate tactic, and education is key. We’ll tell you what wholesaling is and what the challenges are: this is in order to help you decide whether you should do it. We have no reason to try to bias you towards wholesaling, so we’ll give the details to you straight.
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“I always hear about wholesaling on the Internet, and you just mentioned it. What is wholesaling anyway, and why should I care?” – Inquisitive Investor
Wholesaling real estate is locating and finding a below market property or negotiating a deal on a property for sale to get it far below market value. Instead of purchasing the property outright, you put the property under “contract”, which means you make an offer to the seller and he/she accepts it. A lot of times you have 60-90 days to sell the property.
Getting a property for a deal and turning around and selling it again sounds a lot like flipping, right? In a way, yes, but not quite. With wholesaling you are essentially flipping the contract rather than the house itself. A wholesaler is not interested in repairing the property or holding it for rental. This type of investor wants to exchange it quickly and sell it “unimproved”, within the contract “due diligence” period. This allows the investor to make a profit without actually owning the property.
The 70% Rule: A Simple Flipping Calculation Guideline
In order for a wholesaler to sell a property to a flipper or prospective investor, general calculation guidelines such as this 70% rule for flippers and the 1% rent rule for buy and hold investors should be well understood. In order to price your property, you’ll want to know the types of deals that other investors are in the market for.
What does the “70% Rule” mean? It means that a flipper should generally not pay more than 70% of the market value, minus repairs, for a property. What does this mean?
$100,000 market value * 70% = $70,000
The 70% figure of $70,000 is known as the After Repair Value (ARV). Now subtract your repairs…
$70,000 – $25,000 repairs = $45,000
So in summary, a flipper should not be paying any more than $45,000 for a $100,000 property if there is $25,000 of repair (i.e. rehab) to be done to it. This isn’t a hard and fast rule, and in most cases, you’ll want to consider closing costs and other necessary expenses.
Note: If you plan to market your property to retail buyers or if there is little repair needed, you could consider raising the rule to 80% of ARV.
How Does a Wholesaler Make Money?
Take the 70% rule above and subtract your “assignment fee” from the $45,000 example shown. A wholesaler gets paid by means of an assignment fee, which is cash the wholesaler receives by connecting a seller to a buyer. As a wholesaler, you’ll be doing marketing, speaking to sellers, and calculating the cost of rehab which make the seller’s life much easier.
A lot of times, the assignment fee could be around $5,000-$10,000. Of course, this depends largely on the price of the property in the first place. The wholesaler will need to focus on a fairly low margin as an assignment fee for locating a seller for the property. Wholesalers typically make money from a great many wholesale deals within a given year.
Challenges to Overcome
It’s tough to make money: Wholesaling real estate is not easy and not everyone should do it. Despite what the late-night infomercials tell you, it’s difficult to learn how to successfully wholesale investment properties. The easy barrier to entry and the low money down approach makes it enticing, but the success or failure that results is entirely up to your level of education, your skills, and patience.
You have to get crazy good deals: It is typically not easy to get a seller to take low-ball offers on properties to achieve the 70% ARV. A motivated seller is essential when it comes to wholesaling real estate. It’s likely that the seller is going through a foreclosure or other hardship that makes it difficult or impossible for them to sell at market rates. The houses you want to target are also likely to be in ill repair, so “normal people” won’t want anything to do with them.
It’s a second job that takes a lot of time: We love to talk about passive income and buy and hold real estate. One reason for that is the flexibility and the ability to use “other people’s time” such as property management companies. Wholesaling real estate is another job and you only get paid when you are out making deals happen. The low margin requires you to be constantly turning over contracts.
You need to understand the legal processes: If the contract isn’t filled out correctly, you could end up obligated to purchase the property after a certain period of time. This could be true even if you haven’t found a buyer for the property yet. If you set the contract up correctly with the seller, you can put a contingency in the contract to null and void it if the property doesn’t sell. Of course, that typically gives the seller the same luxuries. Keep reading!
The seller could back out at any time: In some cases, the seller might decide to cancel the contract days or minutes before settlement. Usually if you are able to back out of the contract as a buyer, the seller will also have the same luxuries. The marketing costs and all of the time you spent could be wasted if the seller no longer wants to go through with the transaction.
It fails 50% of the time for new wholesalers: The law of averages will tell you that half of new wholesale deals don’t work out. This isn’t meant to be discouraging, but intended to show you that you really need to be prepared before jumping in. Nothing brings the odds in your favor quicker than solid real estate education and market experience.
One thing to keep in mind about wholesaling real estate is that there really aren’t good or bad types of investments in real estate…there are only good or bad investors. If you do your due diligence, learn as much as you can, and practice sound risk management, wholesaling could be a profitable venture for you, despite the naysayers. Just like anyone can make money off of wholesaling, anyone can fail when wholesaling real estate too, so heed the warnings in the challenges above.
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The information presented does not consider your particular investment objectives or financial situation and does not make personalized recommendations. This information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, AssetRover recommends consultation with a qualified tax advisor, CPA, Financial Planner or Investment Manager.