If you’ve ever been in the unfortunate position of having to take part in a wholesale real estate transaction, you know that real estate wholesaling is flipping paper – not properties. Last fall I wrote about the risks of selling property to a wholesaler (Beware Of Wholesale Home Buyers!). Wholesaling is simply the process of buying a property far below market value and then selling the property to someone else for a profit before escrow closes. In the typical scenario, a wholesaler identifies a desperate seller and gets them to accept an offer far below market value. As soon as the deal is signed, the wholesaler begins marketing the property to find another buyer willing to pay more than the wholesaler is paying. The wholesaler assigns his purchase contract to the new buyer. When both transactions close simultaneously, the wholesaler profits by the difference between the two prices.
Wholesaling is certainly legal almost everywhere and some say it’s ethical because it helps sellers who might otherwise be unable to sell their property. The property is often physically damaged to the extent that mortgage lenders will not lend against it, making the only alternatives for funding a purchase either cash or a private lender. Sometimes the seller needs cash fast and a wholesale cash deal is their only option.
So, if wholesaling is a useful option for some sellers, why re-hash the risks? In Beware Of Wholesale Home Buyers! I focus on risks to sellers. Today, let’s look at risks to entrepreneurs. Several property flipping gurus are currently running radio ads to recruit entrepreneurs to “join their team” and learn about “how to flip properties through wholesaling.” Is wholesaling flipping properties? The wholesaler never takes physical ownership, makes no improvements or in any other way adds value to the property. That’s why I say wholesaling is flipping paper, not properties in a way that most people understand flipping (buy, improve, sell).
Wholesale transactions are similar to what Wall Street traders call arbitrage, which is to trade without risk by buying a financial product low and selling it high simultaneously. Wholesalers set up a form of arbitrage by obtaining the right to buy a property and then selling that right without every having to pay for it. Is the transaction without risk? Wholesalers reduce their risk by including favorable cancellation clauses in their purchase offers. In a typical contract, wholesalers have the right to back out of the deal and have their deposit returned all the way up to the day escrow is scheduled to close. This eliminates their purchase risk if they are unable to find a second buyer or if the second buyer cancels. The seller is exposed to the most risk, since their time is wasted if the sale fails to close. Risks to the wholesaler are similar. If unable to close the sale on schedule, the wholesaler may have to ask for a contract extension so they have more time to find a second buyer. If the seller won’t extend the contract, the wholesaler has also lost time – and time is money.
The biggest risk for entrepreneurs considering wholesaling is time, plus any fees they pay for training and costs incurred for marketing their services to potential sellers. The vast majority of properties changing hands are sold at market value. Some go below market value, but very few sell at such a big discount that they can be re-sold to others who are also looking to buy at a big discount. Most sellers realize that it costs nothing up front to hire a broker to sell their property at market value, even if that market value is reduced to allow for condition of the property or to make a quick sale.
Entrepreneurs should do their homework to determine if wholesaling has profit potential in their market. There are wholesaling success stories, certainly, but the rate of success should be considered before investing time and money to enter the business. Also understand that real estate wholesaling is flipping paper – not properties.
Have questions about why real estate wholesaling is flipping paper or other real estate topics? Make a comment below or drop me a line: Contact Us.
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Each week Real Living with Broker John™ provides innovative tips and information regarding all aspects of owning, buying and selling real estate. John Souerbry is Broker/Owner of Cordon Real Estate, a full service brokerage in California’s San Francisco Bay Area (CalDRE License 01370983). Contact John with questions or comments regarding Real Living or real estate in Wine Country/North Bay, East Bay and Silicon Valley.
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