In retail, a wholesaler is a person or company that purchases products directly from a manufacturer and then sells them to stores who in turn sell the products to the consumer. In other words, the wholesaler is the middleman. A real estate wholesaler is similarly a middle man. A wholesaler contacts home owners directly to determine if they are willing to sell. The wholesaler then puts the property under contract and either assigns the contract to another investor or closes on the sale and then sells the property to an investor. That investor then rehabs the property and sells it to the end buyer.
Challenges for Wholesale Closings
The biggest challenge for wholesale closings is that many times they require a “double closing.” A double closing is when the sale from the property owner to the wholesaler is completed at the same time as the sale from the wholesaler to the investor. There is nothing inherently wrong with closing two transactions at once, but the bigger challenge is that wholesaler often doesn’t have the money to close on his or her purchase, and thus is relying on the funds from the second transaction. In doing this, there is a break in the transaction because the wholesaler can not close on the purchase without the funds and it can not sell the property to the investor until it owns it. For this reason, most title company underwriters (e.g., Old Republic, First American, etc) do not allow double closings.
The Solution to Double Closing Issues
The solution to this issue is for the wholesaler to never close on the purchase of the property. Instead of purchasing the property and then selling it to the investor, the wholesaler assigns the original purchase contract to the investor who pays an assignment fee. Instead of two closings, the assignment fee is paid to the closer out of the proceeds from the closing between the property owner and investor.
Other Advantages to Using an Assignment as Opposed to a Double Closing
In addition to making it easier to close, there are other advantages to using an assignment as opposed to a double closing. For example, when a wholesaler takes title to the property (even if for a brief second in a double closing), it is now the owner of the real estate. As such, the income received from the sale to the investor is profit on the sale of real estate, which is subject to the capital gains tax. In contrast, if the wholesaler assigns the contract instead of a double closing, the income is ordinary income taxable at the normal income tax rates. Every wholesaler’s team should include an real-estate oriented accountant and every wholesaler should consult his or her accountant on the impacts of the above statement to his or her taxes. With that being said, it is generally advisable to avoid capital gains tax whenever possible.
Another advantage of assigning contracts as opposed to double closings is that the wholesaler can take its assignment fee at anytime instead of waiting until closing. Many wholesalers will collect the assignment fee at the time the contract is assigned and then can get completely out of the transaction from that point forward. It is then the investor – and not the wholesaler – that takes the contract through to closing.
Drawbacks to Assignment of Contracts
The main complaint that is cited when discussing the assignment of a contract is that the investor will see exactly how much the wholesaler paid for the original contract. This, however, should not be an issue to the wholesaler. If the wholesaler is selling to the investor at an honest price, the value being paid for the sale is what was paid and the investor should appreciate that the wholesaler is entitled to a profit for his or her efforts to find the property.
Moreover, the idea of anonymity in real estate is often mythical. Depending on how the closing is structured, the funds being distributed to the wholesaler and property owner is often on the closing statement for the second closing. Moreover, if things are done right, a deed should be recorded from the property owner to the wholesaler, and then from the wholesaler to the investor. When a deed is recorded, it is required that a document be filed with the sale price. Moreover, an investor can also just ask the property owner, who will often tell them. Therefore, if an investor really wants to know what you purchased the property for, he or she will find that information.
Drafting Wholesale Contracts
If you would like us to assist with creating your appropriate wholesale purchase contract and assignment documents, Rick Davis Real Estate Law would be happy to do so. Rick Davis Real Estate Law charges a flat rate for drafting these documents, and you can learn more about retaining a lawyer to draft your contracts and our pricing on our contract drafting webpage. Please note that these documents can be prepared as forms to be used in all of your wholesale transactions. Moreover, if you already have purchase contracts in place, a lawyer can draft the contracts as amendments so as to allow you closing to happen smoothly.
Guidance for Wholesale Investors
Alternatively, Rick Davis Real Estate Law offers a monthly subscription service that provides access to both standard wholesale and purchase contracts and unlimited schedule calls with an attorney. These calls can be invaluable for a wholesaler as he or she wade through the legal challenges of this investment strategy. You can learn more about this program by going to the Guarded Pockets™ webpage.