Real Estate Dealing or "Flipping" --A Low-Capital Entré Into The Business

Newcomers to Real Estate often must find ways to get started with little working capital and sometimes less experience. For some, real estate "wholesaling" is presented as an easy way to get started. And indeed it is, but the need for preparation cannot be emphasized enough. There are both legal and practical considerations to be understood and taken into account.

Legal consequences can be serious...

Street Wisdom seems to hold that when one takes the initiative to locate a piece of property of interest to an investor or prospective home buyer who then purchases the property, the finder of the property – the presumed "wholesaler" -- is entitled to a fee for their effort; some simply call it a "finders fee" (because that sounds professional...).

Well, in the State of Illinois and elsewhere across the country, to solicit or collect a fee or commission for "helping" someone locate and purchase real estate (or even rent an apartment, house or storefront) requires a real estate license. To ignore this legal requirement is effectively breaking the law. In Illinois the penalty for violating the real estate license law is a fine of up to $25 thousand for each violation (in the event there is more than one); and the wholesaler's customer is likewise subject to a similar fine for their participation in the transaction.

The Right Way To Wholesale Real Estate–

So what is the "work-around"? Is one forever barred from earning money in real estate without a real estate license? Not at all. The most important thing is not to pursue fees for your services; that's what licensed real estate brokers and agents earn for their services. That reality notwithstanding, it is possible to wholesale real estate legally (and profitably) without a license. You simply have to act as a Principal, not an agent. I will explain–

In real estate an individual or entity participating directly in a transaction as a Buyer or Seller is considered a principal in the transaction (as distinct from an agent who represents others). It follows then, that the simplest form of wholesaling is to simply purchase outright properties likely to be attractive (at a higher price) to others; and, in turn, resell the property to an investor or end-user. It is a simple matter of buying low and selling high, or at least selling at a price that assures a profit to the wholesaler. Of course this takes not only market savvy, but serious working capital as well.

A viable alternative to actually buying and reselling real estate is to deal in contracts. When one enters into a contract to buy real estate, as a principal, that buyer thereby acquires “contract rights” to the property in question. He or she does not own the property; what is owned is the Right to Buy the property under the terms and conditions detailed in the Purchase Agreement or contract. The property is identified, a price and/or terms are established together with a timeline  to “close” the deal. What is interesting here is that for the cost of the Earnest Money deposit an “interest” in the property is secured. And we call that interest “Contract Rights”.

The distinction here, and it is an important one, is that while temporary control of the real estate has been acquired the real estate itself remains the property of the seller. No real estate has changed hands until the time of closing where actual title is passed to the buyer. The prospective buyer (in this example our wholesaler) owns contract rights subject to stated terms and conditions. And these contract rights (defined by the contract itself) are not real estate, they are “personal property” and, as such, have a value somewhat independent of the real estate itself.

What does the wholesaler then have to sell? Not the real estate; he or she does not own the real estate. The wholesaler has (owns) contract rights which will have a market value independent of the real estate. If the contract is prepared properly, giving the purchaser the “right to assign” his interest, the contract rights may be sold to any other individual or entity interested in ownership of the real estate in question (and willing to pay for it).

How much will the purchaser of contract rights pay? That will depend on how deep a discount is represented by the purchase price. The investor will not pay more than the difference between the Contract Price and the price he would expect to pay had he found the property on his own initiative. The investor is willing to do this because the wholesaler has saved him time and effort; the negotiation is accomplished, and all that remains is to close the deal: For the investor it is efficient. In terms of dollars, “price” of the Contract Assignment will range from perhaps a thousand dollars to five or ten percent of the purchase price (often more than a standard sales commission).

Savvy wholesalers will restrain themselves from being too aggressive in pricing if there is some prospect of the investor becoming a repeat customer. And don’t forget, it is the investor who is undertaking the risk and committing the credit and capital necessary to perfect the deal. In other words don’t be greedy or, shall we say, “overreach”.

There are specific documents that must be prepared and executed to transfer the contract rights, but they are brief and well established in practice and in law. A lawyer should be consulted for the proper documents and instruction as to their use.

An experienced wholesaler dealing in contract rights will have a firm understanding of the laws governing real estate transactions and licensing and take care to operate within the boundaries set by these regulations. Secondly, they will know real estate market values appropriate to the properties and neighborhoods in which they are dealing; this will provide the guidance needed to negotiate favorably discounted prices when buying. Importantly, the wholesaler will be knowledgeable about costs to repair and renovate, again to aid in negotiation and to accurately describe the “opportunity” to his investor or customer. Here’s where preparation counts, separating the wanna-be wholesalers from the professionals.

Conclusion

Real estate dealing and wholesaling can be a rewarding pursuit. The practice may be followed full- or part-time. The income potential can be substantial depending on the expertise, determination and marketing abilities of the wholesaler. It takes a well defined ongoing marketing effort to maintain the client base necessary to efficiently buy and sell contract rights; it is foolhardy to wait for contract rights in hand before seeking out prospective clients. Properly managed a wholesaling business combines limited risk and great opportunity for creating a sustainable business with a growing clientele. That is, for those who prepare…

– Philip Elmes