Wholesaling

There has been more discussions in the Biggerpockets Forums about "wholesaling" than most any other topic. In hundreds of posts I've made it pretty clear that the methods used have legal and ethical issues. I thought it was about time I clear the air on the subject as to some of the underlying problems with the methods being taught and give better solutions.

THE CONCEPT:

 The concept is not new, a "straw man" sale is hundreds of years old. A "straw man" (without respect to gender) is the brokering of a sale or other transaction where an owner contracts with an agent to facilitate a sale or other transaction with a third party to facilitate the owner's desired outcome. This definition I use, because you can broker the sale, lease, or any service for the owner of personal or real property. 

While this method of agency generally and most often requires a real estate license let's recognize reality. The intent of licensing laws are clearly designed to protect the public from unethical and illegal practices, to protect title rights and the equity of property owners. 

Let's also recognize that it can be very difficult for a property owner who has a "distressed" property or situation to obtain the services of a real estate broker or agent. Here are some reasons why:

1. Timing of a needed transaction required by an owner may not be met by a Realtor through their conventional sales methods. There are many reasons for liquidation sales and the time allowed of given to effect a transaction that may only be met when there is a known buyer or third party. 

2. Market conditions for a distressed property are never under the best circumstances, they are distressed because the property condition, physical, intrinsic or transfer of title, impact marketability. The use of the property may be limited due to condition or title defects.

3. Pricing of a distressed property or pricing under a distressed situation will always be lower than a comparable property due to it's condition, as a distressed situation must be cured in order to increase its value. 

4. Liability assumed by Realtors generally increases with their activities in curing a distressed situation or with disclosures concerning the intended use of a property. Most Realtors avoid known or unknown problems. Understand too, that most Realtors cannot charge 10% commissions on a residential property, nor can they begin to get into legal, accounting, estate planning or advising in financial maters that may be required to cure any distressed situation an owner may have.

5. Specialization is the last reason most Realtors don't break down the door to obtain a listing on a distressed property. While there are Realtors that specialize with investment properties and investors, most do not. A new Realtor who just obtained a license, without other training, will not have a clue as to bidding repairs or construction costs, they probably are not title examiners or a lawyer or a financial advisor. 

Locating a Realtor willing to take on the listing of a distressed property will be a challenge. Locating a Realtor with the required knowledge, willing to contract at a reasonable commission rate for compensation to cure issues, considering a lower price, having access to a market of buyers in a timely manner while accepting icreased liability exposures aren't on the top of any Realtor's list of requirements in seeking clients.

That translates into a market need that is going unserved or under served and is a justification for services by real estate operators, but more so with operators who hold a real estate license.   

THE MEAT OF CONTRACTS:

While we have established a legitimate need in the market to assist distressed property owners, it's not the need causing conflicting opinions about wholesaling, it's the methods employed by wholesalers.

What we have are gurus selling the idea that anyone can wholesale and they can do so without any money, without credit, without a job or without any other educational requirement. Now, to me, this seems to market a program to the some of most misinformed, broke, least trustworthy and most irresponsible in society, really, the guy has no clue, no money, has no job responsibility and his word is reflected by his credit score!  While this target market might be full of nice people, the gurus are playing directly to the uniformed. More on this aspect later.

The methods taught are loaded with legal and unethical tactics. The most common way it appears is for a wholesaler to enter into a sale contract with an owner, then assign that sale contract for a fee to a real buyer. The gurus keep squawking that assigning a contract is legal, well it is depending on the type of contract assigned. Bilateral contracts may be assigned without the specific consent of a party required to act, such as a seller, unless the contract stipulates consent must be given. A unilateral may not be assigned without specific consent by the party who is owed performance, like a lender. This is mentioned to explain why wholesalers cannot assign loan obligations with a sale contract, because they are different types of contracts.

Let's first understand what a real estate sale contract does, when made the contract transfers an equitable interest in the property and legal title is in limbo, it can't be transferred or assigned with the equitable title granted until the contract is settled. 

With a sale contract, the buyer doesn't just have an equitable or financial interest in the contract but also in the real estate as to the rights in title. In contrast, an option contract grants an equitable interest in the contract to buy property but does not grant any interest in the property itself. In a sale contract there is a conveyance of ownership interests granted to the buyer from the seller. 

The amount of the interest is most often recognized as being in the value of the down payment made, a hundred dollar deposit on a $500,000 property doesn't convey an equitable interest in the property equal to $500,000! An agreed value may be stated in a sale contract, this equitable interest may be to the extent of amounts payable in the event of default by either party. The point being, the equitable interest may be stated or implied by contract or it may be limited to the amount at risk, the financial risk associated with the down payment.

Contract law requires that contracts must be entered into in good faith, there must be a meeting of the minds, that sufficient consideration be given along with competency requirements and that neither party is acting to an excessive detriment with the contract having a legal purpose. These aspects of contract law are uniform, they are applicable in all states. 

THE CONTRACT ISSUE WITH WHOLESALERS:

Let's set aside all of the opinions concerning license requirements to facilitate a sale. Instead, let's examine the sale contract more closely. Let's see if we are meeting the requirements for a valid contract under contract law.

We will assume that the parties are competent to contract, that is the assumption of the courts, we will also assume that the value given is sufficient, that selling the property is legal and that neither party is acting grossly to their own detriment or disadvantage. That leaves meeting of the minds and acting in good faith!

Now, read the covenants or promises made in a sale contract. "Buyer agrees to purchase and Seller agrees to sell" it will have similar language. What a sale contract does not say is "Buyer agrees to find another buyer" a sale contract is not a wholesaling contract. 

Good faith is an implied covenant in contract law, it means the parties cannot act with deceit or omission of material facts, things should be understood by both parties in contracting. It also means having the ability to act as promised. If you promise to do something and you do not have the ability to perform, you are not acting in good faith. Frankly, anyone who has no money, no job and bad credit knows the cannot perform in a contract to purchase a property as they contracted!

Meeting of the minds, requires a "mutual assent and consensus ad idem" a legal phrase that requires the intentions of the parties are understood and agreed to, where the contract reflects the common understanding of both parties.

Is anyone drawing any conclusions yet? When a wholesaler executes a contract promising to buy, but they have no intention of buying, nor do they have the ability to buy as agreed in the contract, the contract isn't worth beans, nor can it be enforced, nor were they acting in good faith! If the wholesaler leaves the owner standing with the impression they are buying, you grossly missed the requirement of any "meeting of the minds", you knew you weren't buying but the seller didn't understand that at all. You are deceiving the owner if you do not inform them of your intentions to find another buyer or to market the contract to others! 

Following these guru tactics simply takes you to a position of lying and deceiving the owner, even those who say they disclose intentions, I have serious reservations that such disclosures are simply dancing around the bush and don't really provide a clear picture of the strategy. 

This is what the real underlying issue is with state real estate commissions, the license requirement is an issue but the conduct of most wholesalers is the reason they bring out the big guns nailing someone for not complying with license requirements. This matter was mentioned as the concern by officials of the Ohio Real Estate Commission in an interview this past year.  Since this area of contract law is uniform, it's highly unlikely any state would view this differently.  

TORTUOUS CONDUCT:

A "tort" is a civil wrong and tortuous conduct is any act or failure to act that causes another party injury, either a physical or financial injury. Everyone who deals in real estate must be aware that causing a financial loss by intentionally or negligently acting in some matter or failing to act prudently can be held legally responsible. I'm sure this area of law is applied everyday in real estate matters across the country. It is often the basis of law suits and can lead to opening the doors to other violations of law. 

How can we injure an owner by wholesaling under a blanket of deceit? Very easily, as beginning wholesalers usually are not aware of the difference between dealing with a property that is occupied and one that is vacant.

In either case, occupied or vacant, a loss can be suffered by an owner by locking up a property under a sale contract where the buyer has no intention to buy or the ability to buy as agreed. A property under contract is harder to market trying to obtain any "back-up" contracts from the public, if it can be done at all.

A wholesaler who fails to finish a transaction has caused the owner valuable marketing time, it might be during the peak selling period and their best change of getting a good or better offer, they don't need to prove that really as the law favors the owner over a buyer. 

A prudent seller acts based on the contract they hold, if they believe their property is sold, they may begin looking at other properties, they may contract for another property putting money down contingent on closing or, they may just hope you close as other sellers may not accept such contingencies. 

Occupied owners make plans to move out, they may store furniture, enter into lease agreements, I know of claims won where the owner ate out because appliances were moved, stayed at a motel before moving into a leased premises, had gas expenses looking for another place to live. Dealing over an empty property you usually won't have these additional exposures to liability.

All of these types of things can add up to financial losses simply because a wholesaler mislead an owner and failed to close as agreed. These types of losses are known as consequential damages or special damages that can be shown to have occurred because one party failed to meet a contractual obligations. This goes beyond failure to perform and into losses arising from the failure to fulfill contract obligations.

Without understanding the basics of real estate and how prudent people may rely on your promises, you can not assess your risks and assumed liability in wholesaling!

HOW DO WE AVOID WHOLESALING ISSUES?

I agree, there is a service in the marketplace for specialists to conduct wholesaling activities, however it must be accomplished legally and ethically.

Here is a copy of a post I made today to someone wanting to wholesale a seller financed transaction:                  

        I would not use a sale contract, I'd use an option to purchase. I would not assign the option but terminate my right to purchase for a fee allowing the owner to provide the seller financing with the buyer. I would not contract in anyway with the buyer other than agreeing to terminate my option rights. The seller or the buyer may pay my [release] fee. This way you'll be further away from the issues of wholesaling having agreements between the two other parties and seeking a spread on the price as a commission or fee. I would verbally disclose the intended transaction to the owner. I would also allow at least 3 days to pass holding the option before having the buyer and owner contract. A title company will not have an issue with you simply clearing an encumbrance. Good luck :)

Understand, this is a one time transaction, not wholesaling as a business (which I will cover in another blog). 

By using a short term option contract, I'm no longer in a position to perform anything, I'm not saying I will buy! The owner may not really act prudently in other matters based on my right to purchase. I'm staying away from facilitating a transaction making contracts between the owner and buyer, I'm not entering an agency relationship, they can make their own deal. Someone needs to pay my release fee to release the encumbrance (it's not a lien) otherwise, I could buy later under my option from the other buyer! Title folks don't have any issue with receiving or paying money to release encumbrances. The value of my fee is not based on any service of facilitating the deal, it's based on the value of my option. 

There are even better methods to wholesale by taking title, if you're in the business of wholesaling you will need to learn how to take a title interest instead of dealing in options on a continuous basis, being in the business is much different than doing one transaction.

I'll close for now, hopefully new wholesalers and even the older dealers will start to understand the issues of this game. I'll go into other methods of wholesaling soon, until then, study, learn, do, Good luck! :)