I’ve been investing in real estate for more than 20 years. No matter where we are in the market cycle, people are always looking for a deal. I’ve been asked on a consistent basis if I know any good wholesalers. And every time I hear that question I wince.
My response to pretty much anyone who’s asked me is the same. Over and over again, I say, “I have not met a single person in the NYC area who’s worthwhile as a wholesaler.”
I explain further that in my opinion:
- They can be greedy.
- They can’t calculate repair costs.
- They sometimes cherry-pick comps that show the properties in the best light and disregard less-than-flattering comps (many of which appraisers would use).
And that’s just the beginning of the story.
IMO, Wholesaling Isn’t the Way to Go
My opinion is that many who wholesale on a regular basis dabble in gray areas in terms of the law. In my area, I see bandit signs all the time offering people “cash for their property.” I also get calls and text messages from wholesalers asking me if I want to sell one of our rentals. The majority of the time, what most people don’t realize is that person putting up the signs or calling and texting you has zero intention of actually purchasing the property themselves. So, from the get-go, there’s a dishonest motive to their actions.
What I realized is, in the end, there are wholesalers who are only in it for themselves and no one else. Despite what some of them think, they aren’t out there providing a good service for real estate investors.
As real estate agents and members of the National Association of Realtors (NAR), we take an oath which binds us to act as a fiduciary for our clients, who are buyers and sellers. I’m not going to claim that all Realtors actually live up to this oath—unfortunately, they don’t. There are a number in the industry (of more than 1.3M) who are only concerned with themselves, too.
However, I do think they are the minority. And there is a difference between someone who’s a licensed agent and those who are members of the NAR: members take the oath, while licensed agents do not. But non-members still have to do business based upon state laws, which restrict their actions. In most states, net listing a property is clearly illegal.
You might be thinking: Wait a second, Darren. I thought you were talking about wholesaling a property?
Yes, I am 100%. But to understand wholesaling, you also need to understand net listings. So, let’s dive in and look at both through a fictional example.
What Is a Net Listing in Real Estate?
Susan is an elderly homeowner. She’s been in her home for more than 25 years and has not been able to keep up all the typical homeowning duties. So, there’s a lot of deferred maintenance (to say the least).
Susan wants to move to a place where the cost of living is less or where she can be closer to her children and grandkids. She calls up Allen Southgarden, who’s the most famous local real estate agent she knows. Allen comes to Susan’s home and sees that it’s ripe for a remodel in today’s tight inventory. He sees an opportunity here to profit, so he asks Susan all the standard questions: (i.e., where she’d like to move, when, etc.). Then, Allen asks her what she thinks her home is worth.
Susan replies she thinks it’s worth $260,000. Allen asks if she would be happy if he was able to net her $260K for the home, and she confirms she would. So, Allen guarantees her she’s going to receive $260K for the home (outside of any legal fees and taxes associated with the sale).
Susan is happy. Allen, being the sharp agent he is, knows that Susan’s home is worth at least $410,000 in the current market. With an investment of $75,000 in repairs, the home could be worth at least $650,000 based upon the comps he knows of. So, Allen shops the property to his list of investors and cash buyers who can close quickly and shows the home to those interested.
More than one jump on the opportunity Allen has presented. The home gets bid up to $428,000. Meanwhile, Susan is completely unaware. All she knows is that she’s getting a buyer to pay her $260,000, and she can move closer to her grandkids.
At the closing table, Susan is shocked. She was completely oblivious to the fact that Allen was actually selling the house for $428,000, equating to a payday of $168,000 for him. She’s furious—and rightfully so.
Allen was not acting as a fiduciary for Susan. He was acting in his own best interest. This is an example of a real estate agent doing a net listing. You can see why it’s against the law in most states.
What Is Wholesaling in Real Estate?
So, what if Allen was a wholesaler and not a real estate agent? Here’s how that scenario would look.
Allen purchases a list of homeowners who’ve been in their home greater than X number of years. Susan is in the same scenario described above: sitting in her home with lots of deferred maintenance. She gets a call from Allen. He says he’s interested in purchasing her home all-cash. He’s been looking to find a place to live in the area. Would she consider selling to him directly?
Susan, as mentioned, wants to live closer to her grandkids, so she says yes. Allen comes over and does a walkthrough. On the spot, knowing the home’s potential, he asks Susan what she wants for the home. She tells him $260,000. Allen agrees to buy it for that amount.
Allen has Susan sign a contract to sell her home. However, he tells her that he’s not sure how he wants to close on the home. He may want to close in an LLC to protect his privacy or purchase it with some friends or family members if he can’t get a mortgage on his own. So, he makes sure that the contract is assignable to another entity. Susan agrees.
Allen also explains to Susan that he’s going to need to take some photos and have his contractors walk through the home on several occasions. He’d also like to walk through with some of his “students” in the housing industry. That way, he can teach them what he plans to do with the home. Again, Susan agrees to let those things happen and locks herself into a binding contract she’s now beholden to.
Then, Allen gets to it. He creates an estimate of the repairs necessary: only $48,000. He scours Zillow and Trulia to look at sales of homes in the area, decides to ignore some of the sales that actually took place on Susan’s block, and determines that the after-repair value of the home would be $710,000.
Allen prices the property at $450,000 and creates a marketing sheet with all the numbers and photos of the property. He uploads them to Dropbox so that they’re easily accessible to anyone. He reaches out to his cash buyers and those who can close quickly with hard money.
Due to the limited inventory available at the time, demand from the list is high (especially with the numbers he put out). He sets a date for the walkthrough. Allen lets Susan know that he’s going to have his “students” come on the following Saturday, and she agrees. He asks if it would be possible for her to not be there; she says she can find something else to do at that time.
Allen has more than 20 parties show up, and he parades them around the home. Many are interested. He winds up getting multiple offers but none are near his asking price. It seems they were aware of the actual average price of recent home sales on this specific block—only $650,000. He agrees to work with a buyer he’s done business with in the past; the offer price is $418,000.
The buyer wants to do a home inspection on the house, so Allen lets Susan know he’s “sending his contractors through the home.” Upon inspection, there is some structural work needed. The buyer wants a credit of $10,000 to take care of the necessary repairs.
Allen goes back to Susan, letting her know that he’s now unable to give her the $260,000 because he wasn’t aware of the issue. He can only give her $250,000. She reluctantly agrees because she wants out of the home.
Come closing day, Susan goes to the title company and is greeted by more people than anticipated. She quickly learns Allen decided not to purchase her home directly—someone else is through the LLC that Allen set up. Allen is just there to collect a check made out to him for $168,000.
Susan is furious, and there’s nothing she can do. She’s in a binding contract.
What’s the Difference Between Net Listing and Wholesaling?
So, what’s the difference between the two situations? Both resulted in a $168,000 payday. However, one is against the law in almost every state, and the other is not.
Personally, I see no difference between the two ethically and morally. Yet I will admit that the prospect of making that type of cash from a transaction—or even half or a quarter of that amount—is quite alluring. But in my opinion, both are taking advantage of someone else.
Whether a seller is completely unaware this is going on or a seller is in a tough situation financially that they need to get out of, Allen isn’t doing what’s best for them. In both cases, he was only thinking about himself and his payday.
How is it that one is legal to do and the other is not?
My opinion is it’s a mere technicality. In each instance, Allen didn’t take possession of the property, and the net effect was the same. It seems that the state of Illinois has recently caught onto this fact and put measures in place to reduce this practice by requiring wholesalers to now have real estate licenses if executing more than one transaction a year.
But I don’t think that’s going nearly far enough. At some point, I believe all states should make the practice of wholesaling illegal. Sure, there’s a big difference if one wanted to purchase a property then suddenly could not and they were trying to salvage a deal somehow. But the systematic approach of doing what Allen did over and over should be outlawed—at least, I think so!
Wholesaling Tactics I Personally Am Not OK With
Wholesalers, unlike real estate agents, can say or do whatever they like to get you interested in a property.
It’s funny—I even got an email from a wholesaler as I was writing this. In it, they describe the property as such: “This project is ideal for an investor looking for a medium level of renovation on a project in the desirable XXXX market! Properties are selling quickly and values continue to rise as investor activity grows in the area.”
Well, the data that I can see tell a different story. Prices over the last 12 months are down, not up. What gives?
A licensed agent is not allowed to mislead. We can get sued. Every brokerage is required to carry something called E&O insurance, which stands for errors and omissions. That right—real estate brokers get sued often enough that we’re required to carry this insurance as agents. In fact, many agents don’t start their own brokerages because of E&O risk. Existing brokerages do whatever they can to reduce the E&O risk by making sure that all required documentation is signed off on by buyers and sellers.
This is also why most brokerages don’t allow agents to wholesale. Wholesaling is the Wild West of real estate transactions. Agents who do it put the brokerage at incredible risk. Those brokerages that allow it, I actually question where their heads are at.
You also can’t rate wholesalers on Zillow, Trulia, or any major real estate website or app. Google, Facebook, or other possible ways—yes. But who’s rating them there? If someone is, it’s most likely their favorite investors who “got a deal” from them and not the property owner as most likely would be the case on Zillow or Trulia. People can’t track the performance of the wholesaler and read reviews written by who matters most: the person whose property was exchanged.
As licensed agents, our deals are scrutinized daily. Wholesalers can be here one day and gone the next. They can operate in any state and not have any knowledge about the area. I believe many are simply trying to make the largest spread they possibly can on every deal they put out.
Real estate agents are (in most cases) required to sit in classes to get licensed. It can take anywhere from 70 up to 150 hours. We’re fingerprinted and have to do continuing education every 2 years, which always, always, always includes classes on ethics.
With the advent of the SupraKey we get tracked on every home we key into so it’s known who goes in and out of every residence. And since the advent of the COVID crisis, we have additional forms here in New Jersey that we need to have buyers and sellers sign.
Wholesalers? They don’t have to do anything. Zero. They report to no one. Anyone can get into wholesaling today and be gone tomorrow.
Maybe you don’t feel how I do: But Darren, there are some good wholesalers out there that do provide a good service to others. They’ve helped a number of homeowners get out of a tough situation and move forward with their lives. And they actually tell the homeowner what they’re doing ahead of time, when they first meet them.
That may very well be the case. My opinion is similar to what I said earlier about Realtors who act outside the oath they make. Wholesalers who actually conduct their business in good faith with respect to the seller are among the vast minority.
To the wholesalers: why not get your license and do exactly what you’re doing in a way that’s responsible?
I think those who aren’t willing perhaps feel that the commission rates—which average 5%,6%, 7% for agents—are just not enough for them. Plus, they’d have to do more as an agent to earn the same amount to boot. And they’d have to report to someone else. All this means they’d need to be accountable to their state finance boards and their clients, and there are some who just don’t want any part of that.
So, as the saying goes, “caveat emptor” to all of you who think you’re getting a deal from a wholesaler. And more importantly, “caveat venditor!” Seller, beware.
What’s your take?
Join the discussion below.