Throughout a bull and bear market, there is always one real estate investment strategy that has always worked for me, wholesaling. It is certainly not without its share of challenges but done effectively, it can provide you with a very nice return without the risks and responsibility of taking title. So how does wholesaling compare with other investment strategies? We discuss the pros and cons.
For those not familiar with wholesaling, it is the entering of a contractual agreement with a seller for the purpose of purchasing property at one price, and then assigning your interest in that contract to your investor at a different (higher) price. The difference between the two prices is your spread or most commonly referred to as the assignment fee. This fee is the money you earned on the transaction and you never actually take title to the property.
FLIPPING
Flipping usually involves a double close. You buy and sell it the same day. Why would you flip instead of wholesale? First, if you are buying from a bank, they never allow an assignment so you must close. Second, if there is a large spread in your deal, then you probably don’t want your investor and seller seeing how much you are making on the transaction.
For example, I had a house in North Miami Beach, FL under contract with a seller for $235,000 and I had it sold to an investor for $315,000. Do you think the investor would pay an $80,000 assignment fee? What happens at closing when the seller sees my $80.000 fee show up on the HUD-1? Of course, when I flipped it, I had double closing costs so I netted $71,000. Flipping solves the problem.
There are risks with flipping:
1. You are taking title to the property and assume all risks
2. The title company may not allow you to use your investor buyer funds to fund your closing with the seller so you may have to use a transactional lender or hard money lender to loan you the money for the day. You can expect to pay 3-5 points for this.
3. If the buyer walks away, you either have to close or if you walk away, you lose your deposit and the seller may take legal action (most never do).
REHABBING
The investor takes title to the property and assumes all risks. They have considerable costs involved including the purchase price, closing costs, renovation costs, holding costs, and marketing costs. Then there are market uncertainties in a bear market like the drop in value during the time the investor own it. There is also the unforeseen challenges such as renovation costs going over budget, hiring and managing workers, pulling permits and the legal liabilities that go along with owning the property.
Why do they do it? If done correctly, an investor can make earn 25% to 50% return or more on his money. I once sold a house in Hollywood, FL for $320,000. The investor put $100,000 into the property and resold it for $525,000 netting him $105,000. Me? I made $30,000 on the assignment fee and was only too happy to take it. Although I have rehabbed a lot of properties, this was one I did not want to tackle so I opted to assign my contract.
SHORT SALE
For a short sale to work, you have to negotiate with the bank to reduce the mortgage amount currently owed on a property, specifically when the mortgage amount is equal to or exceeds the current market value of the property.
Short sales are great at creating equity in the property by reducing the mortgage debt owed and once the bank agrees to your price, you can buy and flip it. My second real estate deal I ever did was a short sale on a house in Miramar, FL. It took me three months to complete it and when I did, I bought and sold it the same day netting me $10,000.
Everyone thinks a short sale is a great strategy but I stay away from them for the following reasons:
1. There is a long negotiating cycle with bank, typically 2-4 month process.
2. It requires close cooperation with the seller.
3. It requires short sale package – financial disclosures, bank statements, tax returns, pay stubs, hardship letters, photos, estimates of damages, BPO’s
4. You cannot assign contract. Must close on the property then resell (double close).
5. There is a timing issue. Your buyer puts down an offer but bank negotiations take too long and your buyer drops the contract or bank accepts the short sale offer but you have no buyer ready to buy. What do you do?
6. Selling retail involves bank financing. You lose control over the transaction.
Every one thought short sales in a bear market was easy money but there are so many properties under water right now that banks are overwhelmed with short sale offers. They take forever to process and most banks can make more money by foreclosing then reselling, especially if the have mortgage insurance.
There are too many moving parts to a short sale and my advice is to stay away from them.
LEASE OPTIONS
An option is an instrument that allows you to purchase a property at a future date but enables you to take controlling interest in the property today.
Let’s look at an example. You agree to purchase a property for $150,000 with a 3-year option and small down payment of $1,000, You have an option and rental payments of $1,300/month. Let’s call this the A to B transaction. Next, you find your own buyer willing to pay $180,000 for a 2-year option with a down payment of $2,500 and rental payments of $1,600/month. This is the B to C transaction.
You just put $1,500 profit in your pocket and now have monthly cash flow of $300. Within two years, if all goes according to plan, your buyer exercises their option to purchase the property for $180,000. You profit the difference between $150,000 and $180,000 minus closing costs.
Sweet deal, right? Maybe not. You have out of pocket rent payments while trying to find a buyer to option and sub-let. When you do find your potential buyer, you now have property management responsibilities. There is also the potential legal liability if an accident occurs or there is damage to the property. Remember, you are legally responsible to your seller. What if your buyer wants to exercise the option to purchase but your seller reneges and does not want to sell?
However, if done correctly, you can make a nice monthly cash flow even if you have the responsibility of managing the property. If the B to C buyer does not exercise the option, you get to keep his option down payment and the monthly spreads. You then cancel the A to B transaction and move on to the next deal
What if you have 10 properties with lease options earning you $300 each month? That is $36,000 per year. Not bad but not good. You have to manage 10 properties and what if you have a full time job. 2-3 wholesaling deals can earn you the same amount or more in a few months without any of the challenges of lease options.
Wholesaling gives you low barriers to entry with a minimal investment. You get in and get without ever taking title freeing you up to do more deals. You take your small assignment fees and make your money on volume.
Assignment Agreement
Used to assign rights in a purchase agreement from one party to another for a fee.
Use: Used in conjunction with a purchase agreement for a single family residence as an addendum to a purchase agreement.
Price: $14.95
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