Flipping commercial real estate contracts is a low-cost and low-risk investment strategy that any real estate investor can explore.
You have probably heard about how profitable it can be to flip commercial real estate when done right. Well, learning how to flip commercial real estate contracts can also be financially rewarding for those who understand it.
Flipping houses or CRE requires that you have access to enough capital to buy and improve properties so you can sell them for a profit.
But what if you don’t have access to that kind of capital?
Does it then mean you cannot profit from the CRE market? No!
With real estate contract flipping, you don’t need to purchase the property of interest; you only need to enter a contract with the seller that gives you a right to buy. Then, you can find a seller and assign that right to them. The wholesaler fees paid by the end buyer is your profit.
It’s an investment strategy with low barriers to entry.
While flipping of real estate contracts is low-cost and low-risk, compared to the flipping of real estate, making money here also requires some foundational skills like identifying good properties and negotiating prices.
In what follows, we will consider what real estate contract flipping is all about and how you can do it successfully. We’ll cover:
[Do you need to pay earnest money to sign contracts with sellers as a wholesaler? Don’t worry, Duckfund has you covered. Sign up now to get fast, low-interest earnest money for all your real estate deals.]
Also referred to as wholesaling or wholesale real estate, real estate contract flipping is a strategy where a middleman connects motivated sellers to interested buyers by signing a contract with the former and assigning it to the latter.
To make it easier to understand, let’s contrast real estate contract flipping with real estate flipping and also show how wholesalers differ from real estate agents.
Flipping houses or CRE requires that the investor purchases a property, improves it, and then sells it for a profit.
Here, the investor will part with cash (however it is financed) before they can take ownership of the property in question. On the flip side, the investor will collect cash from the end buyer. In the end, the investor’s profit is the difference between the sale price and the buying price (plus any other improvements).
In contrast, the wholesaler in real estate contract flipping does not pay any money to the seller. Rather, they negotiate a price for the property and then write up a purchase contract that gives them the right to purchase the property at that price.
Also, the wholesaler does not receive any money from the end buyer. Instead, they assign the contract (that is, the right to buy the property at the agreed price) to the end buyer at a higher price (the difference, also called wholesaler fee or assignment fee, being their profit).
The whole process is illustrated in the chart below:
To summarise, while property or house flipping involves two flows of money (seller to investor, buyer to investor) and two contracts (between seller and investor and investor and buyer), real estate contract flipping has a single flow of money (end buyer to seller) and a single contract (between the seller and the investor, who then assigns it to the end buyer).
Though wholesalers also receive a fee, they are not the same as real estate agents.
First, an agent does not receive a right to purchase the property. The agent is only interested in connecting a buyer to a seller and vice versa.
Second, agents must have real estate licences to operate whereas wholesalers are categorised as investors, thereby typically needing no licence to sign or assign contracts.
Third, while the wholesaler is not the end buyer, they negotiate as if they are. This is because the ease of finding an end buyer depends on how juicy the deal is. In contrast, real estate agents typically find buyers that are willing to pay the seller’s price rather than negotiating the best deal with the seller.
So why are real estate contract flippers valuable in the CRE market?
There are two main reasons.
First, they help motivated sellers get buyers quickly. Motivated sellers, as used here, is another term for distressed sellers. There are different reasons why property owners might want to sell their properties quickly – foreclosure, relocation, no money to maximise its value, cash needed for other investments, etc.
Wholesalers typically have a list of buyers who are interested in these types of properties. By negotiating good deals with property owners, they can easily and quickly move the contract to one of these potential buyers.
According to Columbia Redevelopment, a real estate investment company in Portland, wholesalers can “close a sale faster than a real estate agent.” “This is because a wholesaler is often able to facilitate the sale of a property that may be priced under market value, and work on a faster timeline.”
Conversely, they help CRE investors get better value for money.
By negotiating better prices (from the end buyer’s point of view) with sellers, they provide investors with more room to earn higher returns on investment (irrespective of whether it is an investment property or rental property). In addition, they also take the stress away from flippers, who can then focus on selling (or leasing) the property for a profit.
How can an investor flip commercial real estate contracts successfully?
Below is a step-by-step guide:
Like real estate flipping itself, successful real estate wholesaling starts with identifying the right properties.
Typically, the best properties are those with motivated sellers since it is easier to negotiate good prices that will interest the end buyer.
Some investors have found success in checking default filings at the local courthouse or working with organisations that compile the list of distressed properties.
However, not all distressed properties are equal. It is also important to ensure that the property is in a good location and that it can be sold profitably (or held for a profit) by the final buyer.
The sales-worthiness of a property can be determined by looking at the local real estate market. The questions to ask include: how are comparable properties selling? What is the vacancy rate for these types of CRE in that specific area?
As Robert Kiyosaki, real estate investor and entrepreneur, puts it, “The problem with real estate is that it’s local. You have to understand the local market.” No wonder that one of the top mistakes beginners make is to focus on the national market to the exclusion of the local market.
If the wholesaler’s buyers are primarily flippers, then they should focus on Class B properties since their value can be significantly enhanced with minor repairs, renovations, and improvements here and there.
In addition to finding the right properties, wholesalers must be able to negotiate good prices. This boils down to understanding property valuation.
There are two popular valuation methods that wholesalers can use to cap the amount they are willing to pay for the property.
The first is the 70% rule which states that “you shouldn't buy a distressed property for more than 70 percent of the home's after-repair value (ARV) — in other words, how much the house will likely sell for once fixed — minus the cost of repairs,” according to Bank Rate, a personal finance website.
Wholesalers can find the after repair value by considering the price at which similar properties (that are already improved) are selling for in the local market. They can also use the services of an expert to estimate how much repairs and improvements will be needed to bring the property to the desired level.
Suppose the average ARV of comparable properties is $1,000,000 and the repair costs add up to $200,000. In this case, the 70% rule requires that the maximum purchase price should be $500,000 ([70%*$1,000,000] - $200,000).
The second method is the Maximum Allowable Offer. Here, the maximum offer for a property is the ARV minus the fixed costs minus rehab costs and minus a desired profit or equity (a percentage of the ARV).
Fixed costs in this formula include “real estate agent fees, title fees, holding costs, taxes, insurance, and utilities associated with carrying the property,” according to Real Estate Skills.
Suppose these add up to $100,000 (continuing with the above example). Let’s also assume that the wholesaler’s end buyers look for an average of 10% profit (which will be $100,000 or 10% of $1,000,000).
In that case, the MAO will be $600,000 ($1,000,000 - $200,000 - $100,000 - $100,000).
Whatever the method used, the point is that wholesalers must approach the seller as an investor, ensuring that they get good prices based on the value of the property.
Note that the formulas we have used are for determining the maximum offer, not the actual offer. Depending on the desperation of the seller and the negotiation skills of the wholesaler, the actual price can be far lower than the maximum allowable offer.
Having a list of potential buyers is one of the most important parts of learning how to flip commercial real estate contracts.
As we have seen, it is optimal that the wholesaler enters into every agreement with a good idea of who the end buyer will most likely be (will it be a flipper or someone who will buy and hold?). This will help in determining the price that should be offered since flippers and buy-and-hold investors will tend to value properties differently.
Similarly, the appeal of wholesalers is their ability to help motivated sellers move their properties quickly. If they have to spend months looking for a buyer, then how are they better than agents?
This is why “building a network is one of the most important things you can do as a real estate investor,” as Kent Clothier, CEO of Real Estate Worldwide, a resource for real estate investors, puts it.
The contract between the seller and the wholesaler is called an assignment agreement (or assignment contract) as it assigns the latter the right to the property.
These contracts must clearly specify what the nature of the relationship is to avoid future legal complications. It is crucial that a real estate attorney be involved in the entire process.
To protect their interests, wholesalers should include contingency clauses that will make it legal for them to opt out of the contract. These can include financing clauses (that allows the wholesaler to opt out if it can't find a buyer willing to pay) and inspection clauses (allows the wholesaler to opt out if significant defects were discovered).
The most important point is that the contract must clearly state that the wholesaler has intentions to assign the contract to a third-party.
The wholesaler should also suggest that the end buyer engage a title company that will do due diligence to ensure that the property is truly owned by the seller and that it is free from liens and any legal disputes.
Let’s now consider why you should consider learning how to flip a commercial real estate contract by identifying some of its benefits:
Nevertheless, there are certain downsides that we must also highlight:
Some sellers may insist that the wholesaler pay earnest money (which is a percentage of the property value) before negotiation for the contract can continue (even when they know the intention is to reassign the contract).
Thankfully, with a platform like Duckfund, you can get earnest money funding for all your real estate transactions. With this financing solution, you don’t need to be so liquid to function as a wholesaler.
To understand how Duckfund can help you, consider the recent case of Deraaff Capital, a real estate investment company who had to pay $50,000 as earnest money for 14 properties cumulatively worth $10,275,000. With the real estate business becoming more competitive, they needed to get a foot in the door as soon as possible.
After applying for Duckfund’s funding on July 31, they got the funding required on August 14. Due to this quick response, they were able to lock in the deals before anyone else did.
Furthermore, Duckfund uses a risk-free system that makes it even more attractive to investors. After a successful application, they open an LLC that will sign the Purchase and Sale agreement (PSA). The earnest money is deposited into an account created on behalf of this LLC from which it goes to escrow.
If the deal succeeds, then you will purchase the LLC by repaying the amount borrowed. If the deal falls through, you can exit the agreement without incurring any liability.
If you want to sign multiple contracts as a wholesaler, then having a guaranteed earnest money provider that is accessible, low cost, and risk free like Duckfund can be a game changer.
[Do you want to sign more CRE contracts so you can make more money by flipping them? Don’t let earnest money stop you. Sign up to Duckfund to get earnest money for all your deals in a timely and cost-effective way.]
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