Derek and I have been friends since high school. Derek approached me last year and said he wants to be a real estate investor and wants me to help him through a deal. He has become a big fan of Rich Dad Poor Dad and wanted to keep the property as a rental. After discussing the best strategy and approach to his new investing venture we decided to go in on a deal together. Our criteria at the time was simple; after all said and done we wanted a house that is easy to rent with 25% equity and something that will break even or better after all expenses and vacancies. The problem was that neither one of us have the time it takes to find great deals. I put the word out that I was looking for a property and started paying close attention to the emails I received from wholesale real estate investors. We ended up with a house in Aurora North, a suburb or Denver, that actually has a positive cash flow after expenses and we got into it with none of our own money.
I love buying properties from wholesalers. I do this because I like the idea of paying a fee for someone else to do all the work finding a great deal. Half the properties I purchased last year were from wholesalers. As we find it harder and harder to find deals more of us are looking to wholesalers to bring us our projects. Unfortunately we are seeing more and more bad deals than good ones. There are three pitfalls when buying wholesale deals that you need to know:
- Believing the wholesaler’s numbers. This includes the after repair value AND the repair costs. You really need to do your own research and come up with your own numbers. Wholesalers are having trouble getting good deals just like you so be very careful that it really is a deal. I think it is a must to get into the property and have good advisors to help you with the value and the repair budget. A good realtor and a good contractor are must have advisors, especially if you are just getting started.
- No inspection clause. Often times when you go under contract with a wholesaler you do not have an escape clause. In a normal transaction you will have a certain amount of time to do your diligence after you have the contract in place. Many times with a wholesaler you must do your diligence BEFORE you enter into your contract or risk losing your earnest money. For this reason you must move quickly but please don’t substitute quality for speed.
- Not understanding the contract. There are several ways a wholesaler will transfer the property to you. As an active hard money lender we have seen it all. Sometimes they will close on it and than sell it to you but most of the time they will never close. If the contract is being assigned to you, either through an entity transfer or an assignment agreement, you must read andunderstand the contract that is signed by the current owner. There will most likely be two contracts, one between the wholesaler and owner and one between you and the wholesaler. Please read and understand both. Some examples of problems that I see are:
- Cash offer but you intend to use financing (this can create an issue at the closing table)
- Original earnest money not showing up on the settlement statement
- Who pays what at the closing?
- Actual closing dates and other deadlines
When you are part of a double close you want to be sure you are getting good title and everything is disclosed. When dealing with an REO this really should not be a problem since liens should have been removed or wiped out during the foreclosure process. It can be especially risky if you are buying a short sale or property owned by a private owner. In these situations you will want to speak directly with the title company and completely read the title commitment so you can see what the title policy is not willing to cover. This is found in the exceptions section of the title commitment.
Finally if there is an entity transfer, like an LLC, you are buying everything that company owns. This could include judgments or debt. If it is not a reputable wholesaler or a company that is brand new used for this one purpose, I would think twice about agreeing to buy the LLC. Never buy an LLC that has done another transaction or has been in business for longer than a month.
My advice would be to not be afraid of wholesalers but be careful when you do business with them. Wholesalers can be a great way to find solid investments.