How do the Pieces of the Wholesale Puzzle Fit?
By Sara G. Valenz, Esq.
Reality TV is filled with flips, renovations and fabulous rehabilitated properties. Whether they are being updated for the current owner or as an investment and later re-sold, one real estate reality show I haven’t seen involves wholesale transactions.
Most people are familiar with various ways of making money in a real estate context, including both as an investor and a developer. In these situations, real estate investors may take title to property, fix it up and sell it at a profit or hold it as a rental. Another way is when a developer creates an entirely new space or use of the property, builds, subdivides and changes it in countless different ways. Neither of these would fall into the category of wholesaling.
A wholesale real estate transaction generally differs from the standard investment and development transaction in that it usually does not involve improving, changing or holding real estate. In the wholesale transaction, money is usually made acquiring property or contracting to acquire property at a price below market value. The property is then immediately placed under contract or sold to a third party at a higher price. The wholesaler makes their money one of two ways: Either by buying the property and almost immediately flipping it at a higher price point; or by acting as an intermediary between the seller and the buyer via assignment (and fee).
Some of these transactions take root from real estate investment clubs. Many of these clubs advertise that club members can make quick money without having to invest any funds from the start. They may also advertise directly to homeowners and even knock on doors recommending that those homeowners can sell their home at a set price for quick cash. The result may be a distressed homeowner seeking to sell a property quickly, even if it has liens, encumbrances or other title issues.
From a title insurance perspective, we sometimes encounter deals like this being shopped around, and they may be riskier for a few reasons.
They often proceed without real estate agents, so there is no independent third party to address any valuation inconsistencies.
Additionally, many of these transactions do not have the ability to act independently from each other.
How Do These Transactions Unfold?
Usually one of two ways. The first is when the wholesaler finds a seller and executes a contract with an assignment clause to purchase the property. The wholesaler may already have an end buyer in mind at the time of this contract execution, or they may seek out a buyer once this is signed. When this transaction closes, the wholesaler takes the price difference between the first and second contract as their “assignment fee” and title is never conveyed to or vested with the wholesaler. The assignment fee may be a lump sum or a percentage of the sales price.
For example, Bob contacts homeowner John and says he will buy his house for $100,000. John agrees and contracts to sell his house to Bob or Bob’s assignee. Bob contracts with Sally to sell her John’s house for $125,000. The transaction closes with a deed from Bob to Sally for $125,000, and Bob walks away with a $25,000 “assignment fee” for setting up the deal.
The second way is when the wholesaler is conveyed the property with transactions scheduled back-to-back for the same day and usually at the same location. The first transaction, from the vested seller to the first buyer, proceeds as a “dry closing.” The second transaction, for a higher amount, closes later that day, and those funds are then used to pay the original seller their amount due along with any property liens.
Here again, Bob contracts with homeowner John to buy his house for $100,000. Bob is deeded the house at closing, but no money goes to John. Later that day, Sally buys the house from Bob for $125,000 and title ultimately vests with Sally. Sally’s funds are then used to pay John his sale price, and Bob retains the difference in price of $25,000. The risk here is obvious. The first transaction cannot occur without the second taking place. This is an illegal flip and is not insurable.
Our title concern is the deal being set aside at a later date by the courts. If we insure a transaction that is set aside, it could result in a complete failure of title.
Red flags to watch for:
- The transactions are not able to proceed independently of each other;
- There is no disclosure to the end buyer or any lender that the intermediary is not the actual vested owner of the property;
- The first transaction needs to be completed as soon as possible so the end buyer doesn’t find out about it;
- There is a back dated deed; or
- You are being told it will work out if the end buyer doesn’t know about the money with which the intermediary is walking away.
In what circumstances can these transactions be insured?
- Transactions can occur independently of each other. If the second one falls through, it does not affect the first transaction;
- Both transactions must be fully funded and “closed;” No closing without disbursement of all proceeds;
- There is full disclosure between all the parties as to both transactions, liens of record and any financing involved. This includes disclosure to any lenders in writing. Some may have timing restrictions which must be adhered to;
- The disclosure also includes notice to the end buyer that the seller (the intermediary) does not own the property, but will be making money from this transaction and how much; and
- There is no prohibition on any assignment fee that may be paid or other mechanics of the transaction in the state the transaction is taking place.
It’s always wise to keep in mind whether a transaction actually makes sense. If the pieces of the wholesale puzzle don’t fit together, why is someone trying to complete the transaction?
And remember, NATIC/Doma underwriting is here to help. Please contact us at [state][email protected].
Sara G. Valenz is Vice President, Northeast Regional Underwriting Counsel at NATIC/Doma.