Real Estate Wholesale Contracts Explained
In real estate, a wholesale contract is a contract between a buyer (the wholesaler) and a seller who wants to sell the property at a discount. This typically is done when the seller must get rid of their property quickly and is looking for relief from either foreclosure, bankruptcy, or some other financial distress. After the wholesaler puts the property under contract, they can then either transfer the rights to that property to another purchaser or assign the contract to a third party investor, the contract of which is typically more than what they paid under the contract with the seller. Ultimately, the middleman, or the wholesaler, walks away with a substantially higher profit.
A good wholesaler uses the fast-paced nature of a wholesale contract to not only make money for themselves but also provides a valuable service to the seller. For example, if the seller wants to avoid foreclosure, the wholesaler can secure a buyer in the marketplace through advertising and marketing before they lose their property to foreclosure.
Real estate wholesale contracts have become all the rage in the last two years. Consumers have come to know and understand the concept that their house can be bought by an investor quickly for cash. The problem is that a wholesaler usually does not know the law when this concept comes across their plate. If they do not , their lack of knowledge will only lead to them tearing up contract after contract with sellers because they were not able to close the deal a second or third time around.
This is especially true when real estate investors are becoming a much larger part of the real estate transaction in the Florida foreclosure market. The average consumer that is involved in one of these transactions on the short sale or subject-to contract is not always aware of the real estate investor on the other side of the deal. The person purchasing the property from the seller thinks that they are closing the deal with the home buyer when, in reality, the investor is modifying the closing date and either transferring the contract or assigning the contract to a third party. The seller is not really closing with the end user of the property even though, in most cases, the end user is aware of the true nature of the transaction.
Essential Components of a Wholesale Contract
At the core of a successful wholesale contract are the key elements of an assignment clause, purchase price, contingency clauses, and earnest money deposits. Let’s examine each of them more closely.
Assignment Clauses: An assignment clause is a section in a contract that gives the wholesaler permission to sell the contract to another buyer. Many sellers (and many agents) do not understand this concept, and so the wholesaler may need to spend extra time explaining its legality and usefulness to them.
One common mistake made by new wholesalers is putting down a large earnest money deposit hoping to gain the seller’s trust and thereby persuade them to let you assign the contract. Unfortunately, while this tactic may get you some trust, it can get you into a lot of trouble because most sellers will demand that the earnest money deposit be at risk if they are allowing you to assign the purchase agreement.
Purchase Price: You will note from our earlier example that the purchase price is not clearly spelled out on the first page of the contract, but instead is indicated in a blank line under the type of property to be purchased. The reason for this is because many wholesale agreements are created for more than one type of property, such as single-family homes, condos, and multifamily units. By looking at the line above the property type, the buyer can quickly find out who is responsible for paying city transfer taxes.
Contingency Clauses: One important facet of any good real estate wholesale contract is to ensure that the contract contains a contingency clause which gives the buyer a set time in which to conduct his or her due diligence on the property before signing the contract. Because this purchase agreement includes an assignment clause, the wholesaler may not actually plan on purchasing the property, but is merely using the contract to tie it up in order to get prospects interested.
Another crucial clause that you need to include in a wholesale agreement is the price term that gives the wholesaler the right to pay a set price for any repairs. This clause sets the maximum price that will be paid and provides a contingency against any structural defects that may require expensive repairs.
Earnest Money Deposits: Finally, you want to include the amount the wholesaler will be putting down as an earnest money deposit. Because the contract includes an assignment clause, you want to ensure that the deposit is refundable if the wholesaler does not complete the assignment.
How to Draft a Wholesale Contract: A Step-by-Step Guide
When crafting a real estate wholesale contract, it’s essential to take a systematic approach, step-by-step. One of the first things to do is to find a suitable online template for your contract. Make sure that it meets or exceeds the legal requirements of your state for a real estate purchase agreement. If you can’t locate a free template online that will meet your needs, hire a real estate attorney with experience in creating and modifying contracts for wholesale purchases.
The next step is to fill in the contract with property information, including the property address, the owner of record and the encompass all relevant property details, such as listing price, square footage, lot size, number of bedrooms, etc. You also want to make sure to disclose any issues with the property, its structure and/or the land.
Then draft the assignment agreement. The assignment agreement should include all the same basic details as the original purchase contract, in addition to the important assignment details, such as the names of the buyer and assignor, the consideration given and the rights, obligations, expectations and liabilities for each party.
After putting the contract together, proofread and verify that it has all of the needed legal elements in it in order to be considered a valid contract, as follows:
Next, execute the contract. In order for a contract to be valid, both parties must accept all of the contract terms and "execute" or sign the document, thus agreeing to be bound by its terms and to do the work needed to close the sale.
Lastly, you must perform your due diligence in researching the lien status, as well as the land title, boundary lines, etc., which can be done through bank or third party due diligence.
Legal Issues and Other Loose Ends
Navigating the legal landscape is a crucial part of successful real estate wholesaling. In this section, we will delve into the importance of adhering to state laws, the role of disclosure, and how to ensure the legality and enforceability of your contract. The first step to ensure compliance is to know the laws governing real estate transactions in your state. Some states have specific licensing requirements for wholesalers, while others may have regulations regarding the amount of earnest money or the timeline for closing. Failing to comply can result in hefty fines or even disqualification from participating in real estate transactions.
Next, disclosure plays a fundamental role in the legality of a real estate wholesale contract. Full disclosure to the seller is essential to avoid allegations of fraudulent misrepresentation. You must fully explain your intentions to the seller and that you plan to resell the property for a profit. However, the law doesn’t usually require you to disclose that you’re a day trader; the mere fact that you intend to resell quickly at a profit is not in itself an issue, as long as you have disclosed that intention clearly to the seller.
To best ensure that your wholesale contract is legally binding, consider hiring a professional with experience in real estate contracts to review the agreement before execution. They’ll be able to spot potential red flags, such as mistakes, that can make it unenforceable . Even if costly, it’s worth it to hire an attorney to draft the contract to align with state laws. These pros know what the contracts should entail, and thereby are able to draft one that can hold up in court.
In the event that a dispute should arise, there is nothing preventing you from offering to arbitrate or mediate with the seller to settle the issue. Many mediators charge fees that are less than hiring an attorney (a few hundred dollars, versus a few thousand.) Of course, be sure to get any settlement arranged in writing.
It’s not enough to have a signed contract between both parties; for it to be enforceable, it must be entered into knowingly and willingly. If the seller claims that you coerced or defrauded them into signing the agreement, for example, you may not be able to move forward with the transaction. This is why some investors offer a small token as "consideration" when drafting the contract. It could be as little as one dollar, or use another token that is nominally valuable to the seller, such as a small action figure. Whatever the consideration is, this strategy ensures that a contract is created with the seller’s free consent.
Finally, even if everything above is in order, a sale without closing cannot occur. Be sure to line up the funds or financing necessary to close before putting the property under contract. Failure to do so can make you vulnerable to lawsuit.
Best Practices in Wholesale Contract Negotiation
1. Communicate Upfront
Just like any business transaction, it is important to keep all potential parties in the loop during the negotiation process. Perhaps a seller needs to know that your buyer is truly interested before he is willing to make certain repairs. Maybe a buyer has a financial ability to pay more than an initial offer suggests. Remember that the seller/buyer relationship is generally a case of cat and mouse. The seller wants to disclose as little as possible and the buyer wants to know as much as possible. Providing the right amount of information will help ensure a healthy negotiation and relationship.
2. Focus On Your Offer
As a wholesaler, your first offer should be your best offer. If a seller doesn’t respond immediately, don’t sweep the offer under the rug waiting for a counter. It’s always wise to follow-up soon after sending your offer, to see how the seller feels about the terms. Wholesalers are quick to move on from a deal if a seller doesn’t immediately accept. However, the majority of wholesale offers don’t get accepted on the first round. If you can establish yourself as someone who will follow up with a seller, as opposed to simply play the offers back and forth game with a seller, you will have a better chance at creating a successful situation for you and the seller.
3. Close On Time
It is extremely important to set a closing date with your seller and/or buyer and adhere to it. A delayed closing will provide a seller with buyer’s remorse or concerns about your ability to follow-through on the deal; a delayed closing will provide a buyer with the understanding that the property is not worth the original offer and it will allow you to investigate other avenues to purchase the property.
Common Issues in Wholesale Contracting
The path to becoming a real estate wholesaler isn’t always smooth. There are often unexpected obstacles and pitfalls that must be overcome. When you’re the prospective new owner of a property, you have to be aware of any potential landmines. Issues related to the contract itself may be present, or you may encounter other challenges associated with the property or legal aspects of the deal. Here are some common problems that can arise when purchasing a property via wholesale contracts and how to deal with them: Issues with the Purchase Agreement – Sometimes, the purchase agreement that the buyer and seller sign when closing the deal will contain errors or discrepancies. This is why it’s so important to take this document seriously and make sure it is put together properly. It is advisable to have an attorney look it over to ensure accuracy and legality. Hard Money Lenders – You might not find a hard money lender who will provide funding for you on the property you wish to purchase. Be sure to do the proper research and you should be able to find a lender willing to work with you. You can also speak with your attorney to see if there is a viable workaround you are missing. Deed – You also need to be mindful of potential issues that could arise with the deed . Sometimes error can occur in how the deed is recorded. For example, when the names of the people in the deed are recorded incorrectly, it can lead to legal issues down the road. Whenever you close on a deal, consult an attorney to ensure that all of the appropriate paperwork is in order. Co-existing Deeds – You might find yourself in a situation in which two separate deeds exist for the same property. Again, this issue could occur as a result of an oversight, or perhaps the property was inadvertently conveyed to two different entities. Be sure to consult an attorney who will be able to provide guidance to help you deal with this problem. Tenancy – If you find that the property you are seeking to purchase has existing tenancy, you need to assess whether the existing owner intends to honor the current leases and continue to rent space to tenants. If they will not be honoring existing leases and you’re interested in moving forward with the purchase, you need to consider the status of any security deposits and back rent owed. As you can see, there are many potential challenges involved with real estate wholesale contracting. But with the proper forethought and insight you can aim to avoid them.