When it comes to acquiring properties, rehabbers have different potential avenues to pursue for good deals: buy direct from property owners, purchase from a wholesaler (who is flipping the contract to you via assignment or a double close), buy at auctions, etc.
When a wholesaler flips a real estate contract, he is transferring the rights of a purchase agreement to another buyer (you). The process involves finding a property for sale, signing a contract for the real estate, then flipping that contract to a new buyer to make a profit.
Rehabbers looking for good real estate leads, i.e. identifying motivated sellers who are prepared to sell their property below current fair market value, can be very expensive. High qualify leads can cost hundreds of dollars each. Unless you have a highly sophisticated lead-gathering system in place, you can spend large amounts of money and wind up with bad or no results. So, one big advantage of buying from wholesalers is that they do all the legwork finding deals, for which you pay them a fee. That way the rehabber can concentrate on what he does best: rehabbing (repairs, painting, cleaning up).
A. Dealing with Wholesalers
Suppose you find a property you really want to fix/flip, but it is under contract with a wholesaler? Now what? Here are some options to contemplate:
1. Tell the wholesaler that it is vitally important that you deal directly with the property owner, and to be able to view the property from the inside.
2. Through discussions with the wholesaler, find out how much profit he is looking to earn from the assignment of the contract. For example, let’s say the wholesaler is looking to earn $5000 as his assignment fee on the property in order to flip (assign or double close) the purchase contract to you.
3. Incentivize the wholesaler to cooperate with your needs to meet in person with the property owner, inspect the house, etc. Offer the wholesaler a substantial bonus (i.e. another $5000), to be paid to him once the property has been rehabbed and sold several months from now. NOTE: This is on top of the $5000 he will earn when you actually buy the property from him, via an assignment/double close. The extra $5000 bonus is secured with a junior mortgage/trust deed note on the property. To summarize, by cooperating with you now (in order to deal directly with the seller, view the inside of the property, etc.), the wholesaler winds up earning $10,000 total: $5,000 when you initially purchase the property and an additional $5000 when the property is subsequently sold to a new buyer. Win Win!
B. Pitfalls That Rehabbers Need to Avoid
1. Contractual Issues. The rehabber needs to be aware of the total picture with a contract flip. For example, it is likely that there may actually be TWO contracts that need to be dealt with: one between you and the wholesaler and a second contract between the property owner and the wholesaler. Be sure to read & understand both contracts. For example, who is paying closing costs? Be sure everything is disclosed and you wind up with good title.
2. Inadequate Rehab Budget and ARV Estimates. Often wholesalers underestimate, sometimes by a wide margin, how much the total and complete renovation will actually cost. Result: Your margins on the deal can be badly compromised. Incorrect After-Repair Value (ARV) estimates can be caused, for example, by outdated comps or recent changes in the real estate market such as the impact of interest rates on housing prices. As a precaution, run your own numbers to ensure that the deal math is sound.
3. Daisy Chain Contracts. This can occur where more than one wholesaler is involved, each one assigning the contract to the next wholesaler down the line, at a higher and higher price each time the contract turns over, making the (final) flip to the rehabber too expensive in some cases. Things can get complicated, i.e. the last one in the chain lacks direct control over the deal and may be unable to arrange for you to tour the inside of the house and/or meet with the owner of the property.
4. Entity Transfer Precautions. Are you dealing with an entity transfer, like an LLC or corporation? IF so, then you are buying everything that company’s LLC owns. This could include lawsuits, debt, judgments, etc. Make sure the LLC is brand new and has never been used before.
5. Lack of An Inspection Clause. You should always try to build in some kind of escape clause in case unforeseen problems arise with the contract flip. With normal real estate transactions, you are allotted a certain amount of time to undertake needed Due Diligence (DD). This DD “contingency” clause may be absent with contract flips. That means you must do your DD before you enter into the contract or risk losing your earnest money deposit. Try to build in safeguards so you don’t lose money due to unforeseen circumstances arising. This only underscores the need to meet the property owner and inspect it before committing to a contract flip with the wholesaler.
6. Title Problems. There may be issues that the wholesaler does not know about or doesn’t fully understand. Issues such as clouded title, liens and junior loans can delay or kill a deal. When in doubt seek out appropriate legal counsel before proceeding any further.
7. Unattributed Debt Service Costs. The majority of rehabbers use hard money lenders for the bulk of the purchase price and rehab money. A lot of wholesalers fail to take hard money debt service costs into account when touting the potential net profit available in a property they have under contract; these costs should be acknowledged in the overall cost estimate since they can amount to tens of thousands of dollars by the time the property has been rehabbed and sold to a new buyer.