What Is Wholesale Real Estate?
One term frequently used in real estate is wholesale. However, what does it mean in the context of real estate? In the world of real estate, the term wholesale can mean a couple of things, but it is often used in a single-family homes investment context to refer to a process by which an individual finds a buyer for property, and that individual is compensated, at closing, for finding the buyer. This process may be contrasted with that of a real estate agent, who is paid in connection with the sale of the property, but who also represents those in the process of selling the property, whereas the wholesaler predominantly represents the buyer.
A wholesale real estate deal generally has extra layers due to its complexity. The goal is for the wholesaler to identify a distressed property for cash purchasing and then find a cash buyer for the distressed property that the wholesaler can connect with the seller. The wholesaler then takes the difference between the closing amounts between the sale-House A and sale-House B and makes a profit, so long as the closing price from sale-House B exceeds the sale price of A .
This practice is quite different from an ordinary person advertising their property to sell. A wholesaler finds people looking to sell houses. Then, they negotiate a sales price for that property. The buyer can purchase the property outright or can raise funds. The two parties will then sign a purchase agreement. Once the sale closes, the wholesaler will collect on the difference in the two closing amounts, making a profit for their efforts.
That about sums up the process in basic terms. There are incentives to wholesale that are provided by some states, such as exemptions from real estate licensing requirements. However, in recent years, wholesalers have come under increased scrutiny by enforcement agencies within the Department of Business Oversight and by the Office of the Commissioner of Corporations. If you are considering wholesaling, it is important to have an attorney review your specific situation before proceeding.
Components of Wholesale Real Estate Agreements
The key components of a wholesale real estate contract are similar to a traditional real estate purchase and sale agreement, but there are some important differences that are unique to real estate wholesaling.
First, the parties to the contract need to be identified. Like in a traditional transaction, the parties involved in the contract include the buyer and the seller. However, the parties should be carefully identified so that the contract is clear on who has the right to purchase the property. The common terminology to use in a wholesale real estate contract to identify the party that is purchasing the property under the contract is "Buyer or Assigns". This will make it clear in the contract that the party purchasing the property could assign the property to someone else under the terms of the contract.
Second, the contract needs to clearly describe the real estate that is being sold. Again, this is similar to a traditional real estate contract but there are some important distinctions. When identifying the property, it is best to either attach a legal description of the property or the property’s tax assessor number. In a traditional real estate contract you might have the property described as "the single family residence located at 2229 24th St." You would then typically have the city and state and county where the property is located listed. For a wholesale real estate contract you would have the property described as "the single family residence located at 2229 24th St., Stockton, California, San Joaquin County, Assessor’s Parcel Number 123-456-789." This will help make it clear that the property identified in the contract is located in Stockton and is identified on the official tax rolls of the county assessor as APN 123-456-789.
More often than not, the "Purchase Price" is not the same as the final price that the investor pays when they flip the property. It is important in a wholesale real estate contract to have the "Purchase Price" listed as a specific dollar amount. If an investor contracts with a seller to buy their property for $200,000 and plans to do a quick flip where the investor pays exactly $200,000 at the close of escrow, then $200,000 is written as the "Purchase Price" and there is no assignment of the contract. However, if the investor plans to assign the contract and it is unclear how much the actual closing price is, it might be better to write "The Property will be assigned to an "Assignee" for a Purchase Price of $10.00 and the difference between the Purchase Price and the closing price, if any, to be paid at close of escrow." The Investors will then be able to recoup their marketing, repair, and other investment costs by having the "Assignee" pay the "Seller" a set amount at the close of escrow.
The contract should also have the "Assignment Clause" so that an investor may assign the contract to a "third party" and still receive their monetary profits from the contract. This will allow the investor to recover their money invested before the close of escrow. Almost all wholesale real estate contracts have an Assignment Clause in them.
How to Create a Wholesale Real Estate Agreement
Successful wholesale real estate deals begin with comprehensive contracts that protect the investor’s interests. There are four basic steps you should follow when drafting a winning wholesaling contract.
Step One: Choose Your First Template
You may be thinking about using a template drafted by someone else as the basis for your wholesale real estate contract. This is generally a good idea – provided that the template is properly written, up-to-date, and clearly in your favor. Additionally, you can also use the template of a legitimate seller who is in a hurry to sell their property, provided you make sure you’ve taken the time to talk about the contractual elements you require.
Step Two: Understand the Parties
Once you have the template you’d like to use, you need to begin customizing it for the specific deal you’re attempting to complete. You’ll want to establish who the parties are – for instance, you need to identify yourself (as the wholesaler) and the entity or person to whom you are selling the property.
Step Three: Add in Essential Elements
The essential elements of a real estate wholesale contract include:
- The property address
- The current price
- The type of transaction (for instance, is it an assignment, double closing, or simultaneous closing?), and how you will make a profit (one of several ways includes purchasing the property for less than you sell it to the new buyer). Make sure to take into account how much you must pay to the seller, as well as other costs such as legal fees, repair costs, closing costs, and even taxes.
- A description of what happens before, during, and after the sale
- Eviction procedures (in the case of a tenant-occupied property)
- Contingencies that may allow either party to cancel the agreement without penalty (such as the property failing to pass a home inspection)
Once the aforementioned element are established, you should clearly state all relevant performance deadlines. In most cases, these will include:
Failure to meet these timelines gives the other party the right to terminate the contract (without penalty) or pursue damages – so make sure they are reasonable timelines.
Step Four: Protect Yourself
During the process of buying the home, the seller will be investing a great deal of trust and money in you. For that reason, you need to protect yourself as much as possible while continuing to make sure the seller feels secure in the contract. The following steps are typically recommended:
Keep in mind that your aim is not to control the entire process, but to protect everyone involved.
Common Provisions in Wholesale Agreements
Wholesale real estate contracts typically contain many of the standard clauses you typically find in any real estate purchase agreement. Among these are provisions relating to purchase price, closing procedures, title work, and the delivery of possession of the real estate. In addition, standard wholesale agreement clauses often include an "assignment clause" allowing them to assign the agreement to a third party.
There are a number of other common clauses we find in wholesale agreements. These are intended to address time periods for the buyer to inspect a property and list mechanical provisions covering the consequences of a buyer’s failure to make required deposits or to close a transaction within a specified time period.
Inspection Period
This clause in a wholesale real estate contract typically provides the buyer with a certain period of time to perform all desired pre-closing due diligence activities, such as conducting inspections of the property, assessing the condition of improvements, and preparing for any renovations or repairs.
We recently conducted a survey of our real estate related blog readers. A substantial percentage of you reported that a ten or fourteen day inspection period is generally satisfactory for your needs.
These 10 or 14 day time periods align with typical requirements under FHA and other agency guidelines for uniform loans.
Many times a wholesaler will want to move quickly, to ensure he or she does not lose a great deal of time or money for a transaction or property they end up backing out of. Accordingly, this is a critical component to look for. This amount of time will depend on your particular circumstance.
Closing Provisions
In addition to how long a buyer must complete their assessment of the property, a wholesale real estate contract usually also specifies when and where a closing will take place. It also generally provides the seller with mechanisms to terminate the agreement in case the buyer fails to timely close or defaults in making required payments.
Consequences of Failure to Close
Once the parties have agreed to a closing date and place, it may be advantageous to address what will happen if either party fails to appear at the closing on that date. A wholesale real estate contract will often include provisions detailing how a seller may proceed against a buying party that fails to appear at closing.
If a wholesaler has agreed in advance to their closing date, it may make sense to have in place a provision detailing what happens if they fail to appear.
Termination of Agreement
When parties to a wholesale real estate contract wish to include provisions relating to the early termination of the agreement by either party, they will typically provide for the payment of a damage deposit. This deposit, paid at the time of signing, is returned to the defaulting party if no default occurs. However, the parties can require that a defaulting party forfeit the damage deposit if they cancel the agreement without good reason.
We recommend parties provide a certain amount of time (ten days or so) for a party to remedy.
Examples of Wholesale Real Estate Agreements
To start, a wholesale real estate contract has the same basic framework as most real estate purchase contracts. There is a list of the parties and the property, along with signatures and the like. For clarity, let’s examine a sample:
"1. PARTIES: This Purchase and Sale Agreement (the "Agreement"), dated as of _____, 2015 (the "Effective Date"), is by and between (a) Seller ______________, an Individual (the "Seller"), whose address is __________________ and (b) Purchaser _______________, a (State) ___________ Limited Liability Company (the "Buyer" or "Purchaser"), whose principal place of business is ________________ (collectively, the "Parties.")."
"2. PROPERTY: The Property that is the subject of this Agreement is legally described as follows: _____________________________________________ (the "Property"). The "Property" shall include, and this Agreement pertains to, all of the following: (i) all buildings and other Improvements (as defined below) now or subsequently attached to, located upon or situated upon the land described above or any improvements thereon; (ii) all rights, title and interest now or subsequently related or appurtenant to the Land and Improvements; (iii) all rights, title and interest now or subsequently derived from easements, covenants running with the land, agreements, restrictions, or other rights, if any, pertaining to the Land and Improvements; and (iv) all oil, gas, and other substances such as coal, which may be extracted therefrom . As used herein, "Improvements" includes, without limitation, all fixtures, structures, lighting, trees, shrubs, plants, landscaping, paving, and grading. The Property shall not include the following: ________________."
The biggest difference in a wholesale real estate contract typically occurs in the money section. For example, the Florida Realtors’ Purchase and Sale Contract (Residential) (7th ed. 2015) defines the deposit as a ". . . nonrefundable deposit of $ ____. If deposited with Listing Broker, then . . ."
Another paragraph discusses what happens if the seller terminates after the deposit is made. The language reads: "If Seller terminates this Contract within the Inspection Period because of Buyer’s failure to deliver a fully executed Contract as required, the Deposit is refundable."
The standard form also has a rollover paragraph. It says "Unless otherwise agreed in writing, this offer will expire at 5:00 pm on _________ (see Section 2(e) for the effect of a counteroffer on the delivery of the Deposit)."
In a wholesale deal, the seller makes a true sale to his buyer. Then that buyer sells to an investor. In between, there is always a long chain of books and records that will give a title company, and an attorney, something to figure out. So, there is a certain risk that your wholesaler will be unable to close. If he is unable to come up with the funds, or to write down a bigger profit, you are still stuck with your original buyer.
Legal Issues in Wholesale Real Estate
When it comes to wholesale real estate deals, there are a number of legal considerations that must be taken into account. Firstly, it is important to note that there are state-specific laws that govern the assignment of contracts, and these can vary widely from state to state. As such, it is important to understand the laws in your state, and to seek out the counsel of an experienced attorney if you have any questions or concerns.
In addition to state laws, due diligence is key in any wholesale real estate transaction. This means conducting a thorough investigation of the property in question, as well as any encumbrances or liens that it may be subject to. Failure to do so can lead to serious legal problems down the road.
Finally, it is important to avoid a number of common legal pitfalls when it comes to wholesale real estate. For example, many states require that any assignment of contract fees be disclosed to the seller, and failure to do so can result in hefty fines or even criminal charges.
Tips for Using Wholesale Agreements
One of the best tips for using wholesale contracts is to always maintain transparency with all parties. As a wholesaler, your end buyer wants to know that you have a legal contract on the property, and the seller should not be under the impression that you are purchasing the property when they sign the contract with you.
You should work on being as normal with the seller as possible, while not investing so much into the transaction that you risk losing the deal if you don’t have another buyer.
Many new wholesalers run into issues where a seller decides to sell directly to the end buyer if they get a better price, or is unclear that they should be working with you in the middle . You should be clear with all parties that you are a wholesaler or "bird dog" and that you need to find an investor or want to assign the contract to someone else for a fee. By being upfront, you will avoid issues later on. Even if they find another buyer, oftentimes you can renegotiate the deal with them if there is additional equity available.
It’s also important to make sure that all agreements are enforceable, especially the assignment agreement. If the seller doesn’t understand what you’re doing with their contract, they may try to back out of it or go around you. Many states have legal guidelines in place for wholesalers to follow, and you should be aware of any regulations in your state.