What is Real Estate Wholesaling, and How Does It Work?
“How would you like to learn to flip real estate with no cash, no income, and no credit???”
Sound too good to be true? Maybe this guy has a bridge to sell us as well.
In truth, this sales pitch usually refers to real estate wholesaling. Real estate wholesalers don’t exactly flip homes — they flip contracts to buy homes.
Essentially, they act as middlemen between motivated home sellers and real estate investors, much in the same way that a merchandise wholesaler acts as a middleman between the manufacturer and the retailer.
And yes, while getting your start as a wholesaler can be challenging, it can be done with relatively little startup capital.
If you want to get into the real estate game and you don’t have credit, income, or the cash for a 20% down payment—or if you just want a creative way to build wealth through real estate—then real estate wholesaling is a business model to consider.
Table of Contents
- How Does Real Estate Wholesaling Work?
- How Good of a Deal Do Wholesalers Look For?
- How do Real Estate Wholesalers Find Deals?
- Real Estate Wholesaling Case Study
How Does Real Estate Wholesaling Work?
Real estate wholesaling is functionally very simple. The process is as follows:
- Get a property under contract.
- Find an investor or homebuyer who wants the house.
- Sell the contract for an extra fee.
Notice that at no point in the process does the wholesaler make a down payment or apply for a mortgage. (S)he just acts as a connector between seller and investor and a temporary custodian of the contract. In other words, no credit, income, or huge cash investment necessary on the part of the wholesaler.
The most cash a wholesaler puts at risk is a non-refundable option fee — usually between $10 and $100 — and maybe a small refundable earnest money deposit (again, as little as $100 or less).
Of course, in order to interest investors and leave room for their fee, a wholesaler must find a seller willing to sell their property for a bargain. This usually means finding a highly motivated seller, sometimes known as a “don’t wanter.”
This kind of seller finds the property more trouble than it is worth. Maybe the property has a major defect that they don’t have the cash to fix. Maybe the owner is behind on his mortgage payments and facing foreclosure. Maybe the property is the subject of a divorce or probate, or the owner has abandoned the property for personal reasons.
How Good of a Deal Do Wholesalers Look For?
As we mentioned before, wholesalers are looking for motivated sellers (“don’t-wanters”) willing to let their property go for below market value. How low are we talking about? What kind of bargains do wholesalers look for?
For fix-and-flip investors, the traditional equation is this:
Strike Price = [After-Repair Value (ARV) – Rehab Cost] x 70%
In other words, house flippers want a property that they can buy for 70% of what they expect they will be able to sell the house for once repaired, minus the cost to repair it. This gives the investor a lot of margin of error—even if everything goes wrong, they might still make a little money, or at least break even.
Of course, a wholesaler is looking for an even better deal. Why? Because there needs to be room in the investor’s budget to pay the wholesaler a fee, and still see the purchase as a good deal.
If a wholesaler wants to charge a $5,000 fee, the equation becomes this:
Strike Price = [After-Repair Value (ARV) – Rehab Cost] x 70% – $5,000
If the wholesaler wants to charge a $10,000 fee, the equation becomes this:
Strike Price = [After-Repair Value (ARV) – Rehab Cost] x 70% – $10,000
In other words, real estate wholesalers are looking for extremely motivated sellers, hard-core “don’t-wanters” who just want out of the property, fast.
Of course, this is just a rule of thumb. Some investors may accept a larger percentage than 85%, so a wholesaler who can network with those risk-tolerant investors has a leg up and can offer higher prices.
Also, this equation applies to fix-and-flip properties. An investor might pay more for a property they intend to use as a long-term rental, especially if the property has good bones and is in a great location.
How do Real Estate Wholesalers Find Deals?
Finding these screaming deals is easier said than done. Real estate wholesalers don’t have to tie up much capital in deals, but they often tie up a lot of capital marketing to find deals. Those with little or no money to spend on marketing must invest a lot of “sweat equity.”
Real estate wholesaling marketing methods that cost money include:
- Direct mail. Some indications of possible seller motivation are matters of public record, like foreclosure and divorce. You can also buy lists of addresses that fit these profiles from list brokers. Once they have their lists, wholesalers might send letters or postcards to these addresses. Usually only practical if the wholesaler has a large list to mail in bulk.
- Bandit signs (those “We Buy Houses” signs stapled to telephone poles, often considered “litter” by city officials).
- Paid Advertising, ranging from Google and Facebook ads to billboards, to car wraps and door hangers, to print, radio, and TV ads.
- Advertising Co-Ops, where numerous wholesalers pay for a certain number of leads that come from an expensive ad campaign, like a billboard or TV ad with “We Buy Ugly Houses” messaging.
Real estate wholesaling marketing methods that cost little or no money include:
- Door knocking. If the wholesaler doesn’t have the budget for direct mail, or if they only have a small list, they might summon the moxie to drive out and knock. Face-to-face connection is one of the best modes of persuasion.
- Driving for dollars. This involves prowling neighborhoods by car in search of abandoned houses, fixer-uppers, and “For-Sale-By-Owner” signs. To find the owner of an abandoned house, you may need a cheap online person-finder service called a skip-trace.
- Cold calls. Instead of driving out to the house and knocking on the door, you could call the phone number included on the list you bought from your list broker. Cold-calling is a hard-sales strategy that professional salespeople spend years mastering.
- Email marketing. Alternatively, you could send cold emails to the email addresses on your list. Don’t use an email address you aren’t afraid to lose — cold-email senders can be marked as spam.
Real Estate Wholesaling Case Study
This fictitious case study demonstrates the mechanics of real estate wholesaling.
Wanda is a real estate wholesaler. She locates Sal, a motivated seller.
Wanda performs a comparative market analysis and determines that, completely rehabbed and fixed up, the house will sell on the open market for $300,000. She also determines that it will take about $50,000 to fix up the property and get that price.
Sal wants out of the house as quickly as possible. He agrees to take only $150,000 if Wanda will buy the property as-is and close within the week.
What would most fix-and-flip investors pay for a house like this? Let’s do the math:
($300,000 – $50,000) x 70% = $175,000
It looks like there’s a lot of room for Wanda to collect a fee. Wanda pays a $10 option fee to Sal to put the house under contract with a purchase price of $150,000 and a closing date in seven days. She sends the contract to escrow.
Wanda then puts the word out to her network of investors that she has a great deal on a house flip. She can set any price she wants, assuming it is a price that someone in her network will pay. The contract is for $150,000, so anything over $150,000 will be her fee.
She knows she could probably find an investor interested at a price of $175,000, but she needs a quick close so she makes the deal even sweeter. She will offer the deal to investors for $165,000. At that price, her investors will be chomping at the bit — and it still leaves $15,000 leftover for her as a wholesaler fee.
Ivan, a house flipper, jumps at the deal. He and Wanda make a separate contract between the two of them, called an “assignment agreement.” Per this agreement, Wanda will replace her name with Ivan’s name on the contract, in exchange for $15,000 paid from escrow at closing.
Sal is not a party to this contract. He may not even know it exists; in fact, wholesalers often have to tread carefully to avoid angering the seller. If the seller finds out that there is a buyer willing to pay more than the contract price, he may try to back out of the deal and cut the wholesaler out.
But Sal just wants out, fast. If selling to Wanda (or Ivan) gets him his seven-day closing period, he doesn’t care about Wanda’s fee. Ivan uses his relationships with private lenders to finance the deal quickly. Ivan and his lender wire $165,000 to escrow. Sal gets the $150,000 sale price, and Wanda gets the extra $15,000 as her fee.