Investing in real estate is often considered a great way to build significant wealth. But the problem with making money from real estate is the same problem that comes up with any investing project: Where to find the money to start the process?
There are other options for those looking to get started in real estate without the capital to do deals. One of those options is flipping real estate contracts. Let's take a look at how it works and why some people may be attracted to it.
How flipping real estate contracts works
House flipping and wholesaling are two different investment strategies that are sometimes recommended for new real estate investors. In house flipping a buyer purchases a property, makes repairs and upgrades, and then sells it. This strategy has been over romanticized because it can yield a big profit from a single deal.
However, it usually requires plenty of cash or financing, and the investor takes on substantial risk. If the buyer can quickly upgrade the property and sell it for more than the purchase, holding, repair, and any other costs, only then can they make significant money flipping houses.
The appeal of wholesaling, also referred to as flipping a contract, is that the buyer isn't putting any money into actually securing the house. In fact, a contract flipper might only own it for a few minutes or hours before selling it. The wholesalers's job is to find properties for sale at heavily discounted prices, put them under contract, and then find subsequent buyers.
Buyers are usually people who do house flipping as a full-time job. The wholesaler might, for example, sign a contract that gives them 30 days to close on the property. At that closing the wholesaler will then immediately assign the contract to the buyer.
The key for both house and contract flipping is to secure a deal at a price significantly below market value. The house flipper commits time and capital with the expectation of a big payoff, while the contract flipper or wholesaler commits time to find, secure, and then market a project.
Wholesalers typically make modest returns on a single deal, but they also take on much less risk. Risk is usually mitigated by a contingency clause that allows the wholesaler to back out of a deal if they can't find a buyer in a specified period of time.
Wholesaling initially sounds like an odd strategy. After all, it's basically finding a property to buy that you immediately want to sell. It is important to know that rules vary by jurisdiction, so check with a local real estate agent and real estate attorney about how wholesaling works in your area. Some real estate contracts will explicitly say they are non-assignable. In those cases, wholesaling isn't possible. Additionally, some jurisdictions frown on people marketing real estate they don't own if they don't have a real estate license.
Benefits of flipping real estate contracts
There are two main reasons flipping real estate contracts may be a good option for a beginning real estate investor:
- You don't need much money, which equates to less risk.
- You can focus on a very small part of the real estate process.
Since wholesaling focuses on just buying and selling instead of refurbishing, for example, you can hone a couple of specific skills.
Contract flippers need to learn about their market, including neighborhoods, property types, and how to estimate market prices. That way, you can spot deals that offer a price below the current market price and thus create a profit opportunity. Knowing how to estimate some general rehab costs, too, can give you a better idea of what a house flipper may be willing to pay. You'll also need to learn how to work with standard contracts and on how to communicate with both sellers and buyers.
Another important element of contract wholesaling is building a buyers list. A buyers list is simply a list of people who have expressed an interest in looking at the deals a wholesaler finds. There is some debate about how many buyers should be on the list, but a longer list is probably the way to go initially.
Some wholesalers create a website and advertise properties to attract buyers and then sign them up for a regular mailing list of deals. Others focused on wholesaling will attend local real estate investor gatherings to meet the main buyers in their area who focus on fix-and-flip opportunities.
While the wholesaling process creates the opportunity for a new investor to make money, one of the benefits of this strategy is the minimal risk they take on. In a traditional real estate deal, significant money is committed over a period of time on a single real estate investment. In wholesaling, you're creating a process to bring sellers and buyers together and generating a profit from a successful deal.
Some pundits estimate that a deal can be closed in just a few weeks or within a month. However, that timeline assumes every piece of the process is in place:
- A good price.
- A willing seller.
- A willing buyer.
- The contracts.
While some wholesalers can complete deals in just a few weeks, that sort of timeline generally only comes after gaining a great deal of experience and developing a well-honed process.
Many experienced real estate investors are more conservative, estimating that a new wholesaler should expect at least six months of hard, constant effort before they complete their first wholesale deal.
Challenges of flipping real estate contracts
Flipping real estate contracts is a legitimate way to make money, but it isn't suitable for everyone. To make money in wholesaling, you will have to put a large number of deals under contract, which means first having spent a huge amount of time evaluating potential real estate deals. Some wholesalers estimate that only 1 percent of wholesaling offers are even accepted by the sellers. That's an awful lot of offers to write before you make any money.
And don't forget, if the seller accepts your offer, you will still need to have a buyer who is ready to close on the deal before it generates any money. Developing this list of buyers is time consuming because it not only involves actually finding potential buyers, but also creating some rapport with them.
Many investors report that the real money in wholesaling comes from developing a system that generates leads and then quickly feeds them to buyers. Good systems take time to create, sometimes years.
While building a business to flip contracts, you will need to avoid damaging your reputation. A number of wholesalers find their leads through so-called bandit signs that say something like "I Buy Houses for Cash." Potential sellers, who are often in desperate need of money, may be dismayed to find that in fact it may take a little while to get their money or that the prices they are offered are rock bottom.
Additionally, a wholesaler who creates a long list of people who they have met and constantly pings them with a list of "hot" properties to buy may also be annoying a large number of people who never should have been on the list in the first place.
The best way to protect your reputation is to be transparent with all parties about what your process is, how it works, and how long each step will take.
How much money can you expect to make flipping real estate contracts?
The first factor that will affect how much money you can make wholesaling will be the number of deals you can complete. Wholesaling is a process that includes searching through a large number of deals to find the right ones to get under contract and then having a number of dependable buyers you can sell to.
The second factor to determine profitability in wholesaling is how much profit can be produced on each deal. This is going to be determined by the spread between the price that the wholesaler can acquire the property at and the amount at which they can sell it on to the ultimate buyer. In many cases this spread is going to be just a few thousand dollars. Keep in mind, too, that legal fees are going to need to be paid as well as taxes on any earnings.
Since rehabbers need a steady supply of projects to work on, they will sometimes also agree to pay a wholesaler a small fee on a per-deal basis or guarantee a minimum fee per deal for the wholesaler. However, such arrangements are usually only made after a wholesaler has a track record of finding good deals for the rehabber.
Wholesaling isn't just for those new to real estate investing either. It can also be part of a larger longer-term strategy. Some people start off in wholesaling and then over time learn from their clients who do house flipping. Some supplement their wholesaling income by trying to fix and flip a home on their own. Or, you could use the wholesaling process to find a property that could be added to your own portfolio of rental property.
Wholesaling can be a great entry point into real estate, but it can also be time consuming. Some investors start wholesaling and then move onto other investment strategies that may require more capital but also can yield larger returns per deal.
Whether or not wholesaling real estate ultimately becomes a strategy for you, it is important that all real estate investors understand how wholesaling works, what role it plays in the real estate market, and why it can be attractive to new investors.
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