“What is wholesale real estate?”
That’s a very easy question to answer. But first, I want to talk about why you care about that answer.
There are two universal truths in real estate:
- Location location location!
- You make your money when you buy.
I’ve never found the first rule to be very helpful besides the obvious of not buying where I’m likely to get shot, and no long-term plays on eroding waterfront (I may write some time about how I dodged that bullet). Even then, I think there’s still such a thing as a “right price” even in a wrong location.
The second rule, however, is one that is taken far too lightly among most investors that I know, and specifically the vast majority of buy-and-hold landlords. I hear stories of people competing to pay more than everyone else at the peak of a market just so they can get a break-even cash flow deal, or worse. These people don’t realize that they are LOSING money when they buy!
How can buying a house mean that I’ve lost money? I just got what I paid for!
Well… no, you didn’t.
If you got what you paid for, you’d be able to sell it the same day you close on it and end up with the same amount of money that you started with. Get it? Let me explain all the ways that you DON’T get what you paid for.
First, you likely found a property on the MLS. This means right away that there’s a seller who wants top dollar, and a Realtor making sure that everyone who will pay that top dollar hears about.
Second, if you’re in the London market right now you’ve probably just outbid fifteen other people. Why does that matter? Well, because YOU are the person who was willing to pay the most! So if you tried to sell it today the best offer that you’re going to get for it is the second highest bidder (if you’re lucky).
Third, you’ve just paid quite a bit of money to acquire this property above the purchase price. Land transfer tax, lawyer fees, home inspection, possibly an appraisal and mortgage instantiation fees. Plus you have utility hook-up fees, and whatever else is necessary to have the property showable after the previous owner moved out. Everyone wants a little piece while you’re acquiring that new “investment”.
Fourth, you are likely going to want to sell with a Realtor so that you, too, can create a feeding frenzy and get back that second-highest bidder. That guy that you just “beat out” by paying more than he would. That realtor is going to cost you 4% off the top.
Fifth, you’re going to have to wait to sell the property if you want top dollar. The highest bids usually have 60-90 day closing so the bidder can sell their own house. So you’ve got a quarter of a year’s worth of property taxes, natural gas (not just in the winter! There’s delivery fee in the summer, too!), electricity (again, they charge you even if you use NONE) and water (yep, they charge you for your vacant house, too). Oh, can’t forget insurance! And the bank needs a piece of that pie, too, so even if you have an open mortgage that you can break without fees you’re still out the interest charges.
So, how much are you going to get back at the end of this? If the market doesn’t do anything crazy, the cost of acquisition and sale is approximately 10% of the price of a house. That is to say that a house that you sell for $200,000 at top market value will net you $180,000 after buying and selling it again at top market value.
So now that you’ve just paid $200,000 for a house that’s really only worth $180,000 in your pocket what are you going to do? You plan to rent it out for $200/month positive cashflow? Great, it’ll only take 100 months to recover your initial loss at purchase! Awesome investment?
Okay, soooo…. what’s wholesale real estate?
So, that’s where a wholesaler comes in. Wholesalers are the people that make sure that you buy right. They scour the streets and their networks (no, not the MLS) to find REAL deals. Deals where there’s lots of opportunity to recover your money the day you buy it or better, put you in a positive equity position.
By definition, a wholesale price is below the net proceeds of retail sales. That applies whether it is a house, a car or a plunger at Home Depot.
That’s it. That’s what a wholesaler does for you. They find houses that are priced far enough below market value that you can sell the day you buy and still make a profit. There’s lots of noise about wholesalers selling dilapidated houses to flippers, or getting portfolios under contract and breaking them up. Yes, that’s all true, but those are just tools that a wholesaler can use to create value for the end-buyer to achieve the goal of not starting behind the 8-ball, 10% down on your profit margin. Always, and especially in a flip house situation, the wholesaler leaves some money on the table for you to make your margin.
But, why would a wholesaler bother to sell at a discount? Why not just sell it retail themselves, or flip it for huge gains?
Well, there’s a few different reasons why wholesale real estate makes sense.
First, finding deeply discounted deals is really tough work (I’m sure you’ve noticed). To do it enough to make steady profit requires running a marketing company. A wholesaler has to put a great deal of time and effort into finding deals. If he or she is unfocused and busy trying to raise capital, renovate houses, manage tenants and unclog toilets, there just won’t be enough time and energy left in the day to consistently find great deals.
Second, closing and reselling at full market value isn’t free, so all that extra effort and chaos is not being well rewarded. If the wholesaler is going to make a $5,000 spread on the $180,000 wholesale price, he’ll still have a $5,000 profit if he goes through the whole purchase and sale process that we discussed to sell it for $200,000! (But at least he didn’t pay $200,000 in the first place like the retail buyer!)
Third, wholesale is very much about scalability, networking, finding the niche to serve and serving it with extreme focus. Realtors do ONE thing, they transact houses. Property managers do ONE thing, they manage properties. Flippers do one thing, they flip houses. Everyone does their part to help everyone else profit.
Making money is a team sport!
Which brings us to another point. How much does a wholesaler make?
The answer to that, in my opinion, is “As long as I, the end-buyer, make the margin that I want to make, I don’t care what anybody else makes.” I have personally paid a wholesaler $10,000 for a deal that I made $10,000 on. I did all the work of raising capital, managing the flip and disposition, and I risked my money and my reputation because the deal was a first-time joint venture with a money partner. The wholesaler was referred the deal by someone and just negotiated a great price and told me about it.
Was that really worth $10,000!?
I knew that with the price I was given I could make the money that I needed to make, and that’s all that matters.
That’s why it doesn’t matter how much the wholesaler makes. If I can pay $150,000 to make the returns that I want and the wholesaler has it under contract for $60,000 then I’m HAPPY that they just made $90,000 wholesale fee! I am happy because guess who they are calling first when the next deal hits?
So, stop competing on the MLS to be the guy who gets to lose the most money on the buy. Start finding deals under market value. You can either do this by copying the tactics of some successful wholesalers, or by getting in touch with as many wholesalers as possible to build a strong relationship as a committed buyer.