When investors look into wholesaling a house, they generally already have interested buyers and go in the transaction knowing that they will be able to pretty much immediately flip the house.
If you are a beginner, you want to pay attention to the costs of such a transaction. If you handle everything yourself, then you avoid the commission costs to any agent, which means you can nearly see your income as the difference between your purchase and sale price. However, either way, there are fees.
The basic transaction principal in a wholesale is to not actually purchase the house but become an intermediate to the purchase by another investor.
When you sign a Real Estate Purchase Agreement, you sign a contract. That contract includes many sections explaining how the transaction is going to be processed. The contract can also your own contingencies. In the case of a wholesale, you generally want to include a contingency that allows you to transfer your right to purchase the house to another party and take the difference in price between what you offered the seller and what your buyer is willing to pay.
For example, you find a house which is worth $200,000 once repaired. We call this price the After Rehabilitation Value (ARV). Right now, the seller is asking for $120,000. Let’s say that flippers are looking for houses that are being sold at 75% or less of their ARV:
$200,000 × 75% = $150,000
In other words, a flipper is likely to still consider this house for up to $150,000.
Say the Rehab costs are around $35,000, the flipper will still make money:
$200,000 -$150,000 -$35,000 __________ $15,000
Now the wholesaler wants to offer a sweet deal so he can quickly resale the house to another investor. They offer it to the flipper for $140,000. There is still a $20,000 difference between the seller’s price and the wholesaler’s price:
$140,000 -$120,000 __________ $20,000
So as the wholesaler you make $20,000.
As a flipper, someone who purchases a house to do Rehab and then resale the house within 2 to 3 months, you want to have a buffer.
This means that you may find out that the house needs more repairs than first foreseen while purchasing. This is where having a buffer is important. This buffer allows you to spend more money in case more repairs are needed and yet still make money at the time you sell the fixed house.
Each person has his or her own formula for calculating their buffer. There is one example of such a calculation. As before we start with the 75% and then apply an extra $10,000, just in case:
$200,000 × 75% - $10,000 = $140,000
This shows how the $140,000 price point looks more attractive. It already includes a buffer which the flipper is going to want.
Many times, I see investor examples as shown above. Unfortunately, in reality, it does not work quite that way. Every real estate transaction includes costs. Whether you are a wholesaler or a flipper and whether you use the services of a real estate agent or not.
The costs vary in several ways and especially, you have to pay attention to who pays what in the county where you are making a transaction. In some cases, the seller pays many of the fees and in other cases, those fees are on the buyer.
The most expensive fee is pretty much always the agent’s commission. Since the crash of 2008, the commission has hovered between 5% and 6%. In more rural areas, it is most often 6% because homes do not sell as quickly. In larger cities, banks, the HUD, and some investors often accept 6% contracts.
Taxes & Insurance
The other large expenses are taxes and title insurance. To be safe (better have a good surprise rather than a bad one!), many investors include about 2% for this expense.
Other Expenses in a Real Estate Transaction
The other expenses are very small in comparison to the previous two, but they still are consequent, especially if you purchase a larger item like a $1M home.
Add between 0.5% to 1%. This includes various costs to the title company, the county, and various other parties depending on the transaction.
At the start, to be safe, you may want to use the higher end percentage. Later, as you have more cash and can afford to have a transaction going South, you can lower the percentage.
Here I do not include the costs of having a loan. I suppose that you do transactions with all cash which is what happens in most cases. However, many people have access to a large amount of cash, but not for free. You want to look at having to hold the house for at least 6 months if you have to pay interests and make sure you still make money if you do.
In the worst case scenario, look at how much interests you will have to pay in 12 months and make sure you don’t go negative by then. You may not make any money, but at least you would not have had to pay anything out of your pocket.
Loans vary very much. Note that 0% loans are generally only for people who purchase to live in the property they purchase. I suggest you do not lie about that because you will otherwise be forbidden from any conventional loans as a result. In most cases, investor loans are more expensive than regular people’s loans by about 1%. So if you could purchase a home with a loan at 5%, as a flipper, the same loan is likely to cost you 6%.
In all cases, make sure there is no clause in your loan that would prevent you from selling the house with a few months. Some lenders like to prevent their borrowers from going out on them within the first year or two. However, in most cases, selling the house is an allowed reason for getting out of a loan.
If you are using money from private investors, be careful too. Make sure that the lender is available and will be there when you need to modify or close the loan.
Total Costs to the Flipper
So we talked about 3 main costs, not including the loan costs, which give us:
6% +2% +1% ____ 9%
Note that the real estate agent commission is going to be paid in full whether it is split in your county or not. This is because you purchase and then resale the property. Unless you know of a buyer and don’t need an agent for the sale, you better include it in full for your math to see whether the transaction is worth it to you.
In my example, I get a total of 9% in fees. This has to be applied to the selling price to not have any surprises. Of course, with a good software, you can calculate a closer approximation by applying some of the fees to the purchase and others to the sale. After all, 1% of the purchase price is going to be $1,200 whereas, 1% of the final sale price will be $2,000. However, at this stage, you probably still want to make it simpler than a real transaction.
Now that we have an idea of the costs of a real estate transaction, as far as a flipper is concerned, we can adjust the costs shown above and see that the deal is not as good as first shown:
$200,000 -$140,000 -$35,000 -$18,000 ($200,000 × -0.09%) _________ $7,000
Now your potential profit also called Return On Investment (ROI) is $7,000 opposed to a potential $25,000 as calculated without the 9% fee. This makes a big difference to the flipper!
However, in most cases, flippers are likely to want an ROI of 20% or more. So if they invest $20,000 of their own money, they will want to see at least $4,000 back. Knowing all of these parameters is important to know whether a house can be offered as a wholesale property or not.
Total Costs to the Wholesaler
In contrast, the wholesaler does not pay those fees because he’s just an intermediate in the transaction. The amount that the wholesaler makes is whatever he can get in between the seller and his buyer. More or less, that fee is equivalent to a real estate agent’s commission.
However, in some cases, a seller will not accept such a transaction. The wholesaler may then consider purchasing the house in his or her name and then immediately sell the house to his investor. This is also reasonable, however, additional fees apply to the wholesaler. In this situation, the 9% needs to be calculated against the wholesaler sale price to make sure that the wholesaler will get an ROI. However, this can be reduced if the sale to the flipper is going to be done without an agent. Just don’t do a very first transaction without an agent unless you are versed in similar business transactions.
Could I get help with my equations?
Yes. I’d be glad to help you if you have equations and need to transform them in various ways so they work better for you. Call or text Alex at 916 220 6482.
Note that I won’t help you in getting the equations. You should already have them. I will gladly help in tweaking existing equation to allow you to enter other values.
i.e. you have values A, B, and C and can calculate D. Only to make it faster for you to determine B from a given D, you need to change the equations and you are not sure how to do it. That I can help you with.
For example, in the above examples, you calculate the Return On Investment from the other values. Maybe you would prefer to have a set Return on Investment and calculate the maximum amount you can spend in Rehab.
$200,000 -$140,000 -<costs> (what is this?) -$18,000 ($200,000 × -0.09%) _________ $10,000 ($200,000 × 5%)
In this example, we decide that the ROI should be 5% of the ARV. How do we find out what the maximum <costs> can be? (this one specific example is very easy, now when you have 100 parameters with additions, subtractions, multiplications, and divisions, it makes it a little harder…)
Are Such Real Estate Transactions Even Legal?
Yes, if you are not licensed. (I would not have written such a long article about it if it weren’t legal anyway!)
A licensed real estate agent has to find the one buyer who will make the best offer in a real estate transaction. Therefore, as an agent, you can’t wholesale a house to a buyer who offers more than asking price and only pay your seller asking price (and make the difference on top of your commission).
This is especially true for the listing agent (the agent who works with the seller). However, either agent can work with a buyer who is a wholesaler as long as the final buyer was not known to the agent before the transaction started. (i.e. it is clear that the final buyer was brought to the table by the wholesaler.)
So, when you read somewhere that such transactions are not legal, they are talking to licensed agents, not regular individuals.