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MEET A, B, AND C

The term “wholesaling” has gotten a lot of attention in the last 15 years. Those that dream of striking it right in real estate investing but struggle to find the capital necessary to take their turn at the plate often turn to wholesaling in order to get into the game. What is “wholesaling” and what role to wholesalers play in the marketplace? Let’s also discuss the A to B, B to C transaction.

Wholesalers are marketers that are great at knocking on doors and turning over rocks to find people that are willing to sell their property, but haven’t listed it publicly for sale. The wholesaler will enter into a real estate contract to purchase the property from the seller, but they will use an “assignable” contract to do so. Most standard real estate contracts have a box to check that says something like “this contract is assignable.” This allows to the wholesaler to assign his or her right to purchase the property to another party. In such a case, the wholesaler is paid an assignment fee by the investor that they assign the property to and then the go off in search of more properties to wholesale to well-funded investors.

What if the contract can not be assigned? That’s where the A to B, B to C transaction comes in. Party “A” represents the seller of the property. Party “B” is the wholesaler that enters into a contract to purchase the property from Party A. Unfortunately, they don’t have the money to close on the transaction. At this point, they go out in search of Party “C”, an investor that would love to purchase the property. Good wholesalers not only search for property, but they also build a stable of willing investors to take good deals to. B, the wholesaler, enters into a second contract with C to sell the property for more than what they are buying the property for from A. They get a sizable, not refundable deposit from party C for the “B to C” transaction and have it placed in escrow at the closing agent, usually the same agent that is doing the A to B transaction. They then take that contract to a fourth party called a transactional funder. This entity will provide a very short-term loan to Party B in order to complete the first A to B transaction with the idea that they will immediately be paid off by from the B to C transaction. Transactional funding isn’t cheap, but it gets the deal done. In most cases, the A to B and the B to C transactions occur within a day or two of each other…many times they occur on the same day.

The whole process is nerve-racking, but it is certainly a way for someone with little or no money to join the lucrative real estate market.

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THE IMPACT OF BORROWING ON A FLIP

To borrow or not to borrow, that is the question. Real estate investors have long sought hard money loans to fund their projects, but what is the impact of using hard money loans on profit? Unlike most of the articles on the site, this one is going to have us doing a lot of math together. My apologies in advance for bringing back bad memories from your high school Algebra I class.

Let’s say that an investor purchases a home for $120,000 and puts $30,000 into the rehab of the project. Let’s look at the impact on profitability if the investor obtains an 80% hard money loan at 9% interest with 2 points. For the $120,000 loan, the investor would automatically owe $2400 as soon as they sing the loan papers due to the 2 points. They would also be paying $900 per month in interest on the project. For illustration purposes, let’s also not take into account any closing or other costs to compare apples to apples.

The deal looks pretty good if the investor is able to sell the home for $200,000. If they were to simply pay cash for the deal, they would make $50,000…a very respectable 25% return on investment. Let’s say, however, they use the above-mentioned financing scenario and it takes them 6 months to buy, rehab, and sell the property. They would pay a grand total of $7800 to the lender in interest on their $30,000 cash injection ($150,000 purchase price and rehab budget minus the $120,000 loan). The profit drops to $42,200, but you make a whopping 140% because you only injected $30,000 of your own money into the deal. So far so good with using hard money, but what happens if the profit margin is much thinner or if it takes a much longer time that you expect to sell the property?

Let’s start with examining a scenario where we only sell the property for $165,000. If we paid cash, our profit is $15,000, or a somewhat respectable 10% return. If we borrow, however, our profit drops to $7200 (due to the $7800 we had to pay the lender) for a return of 24%. The percentage return is quite strong, but margins are getting quite tight when it comes to dollars and cents. Let’s use that same $165,000 sales scenario, but let’s imagine that it takes 12 months to sell the property instead of six. Our lending costs eat up almost all of our profit.

Borrowing money to finance projects is a risk…a risk that should be analyzed for every deal that you do. Be sure you have built a great model and you’ve built in enough to handle the unexpected if you are borrowing.

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UNSECURED LENDING

Question: Doug, I have been lending out of my IRA for some time and I have a friend that wants to borrow money from me with no collateral. Is this a good idea?

 

Answer: No. Unless you are sitting on a sizable pool to lend out and you are only lending out small bits and pieces and very high interest rates, then I would certainly avoid loans with no collateral, or unsecured loans. Larger lenders that have thousands of loans on the books know that a certain percentage of their loans will historically default. They can risk it. Most smaller lenders or individuals can’t take that kind if hit. I would require collateral.

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SEVEN QUESTIONS TO ASK PRIOR TO STARTING YOUR HOUSE FLIPPING BUSINESS

Getting started in real estate investment isn’t for the faint of heart. It takes courage, knowledge, guidance, and most of all…money! It has been said that you can’t take a long journey without taking that first step, but where should you start if you are trying to break into the fix-n-flip business. Here are 7 things you will need to think about before you start your flipping adventure:

 

  • What You Do Know?: I’ve worked with general contractors that decided to start flipping houses and I’ve worked with people that don’t know the first thing about real estate. The key is to “know thyself.” What are your strengths? What are your weaknesses? Do you know construction? Do you have a background in finance? Do you have tons of cash at your disposal? Figure out what you know and don’t know and seek to fill in the blanks.
  • What team do I assemble?: Did Nick Fury take on Thanos alone? No. He assembled the Avengers. In order to start a fix-n-flip business, you’ll need to assemble your own team of super heroes…your very own Real Estate Avengers. Instead of Thor, you’ll need a great contractor. A great real estate attorney will become your very own Tony Stark and a top-notch real estate agent that knows the market is your Black Widow. No one knows everything. No one can be everywhere at once. A huge key to building a successful business is to know when to delegate. Of all of your assets, your time is the most important asset you have. Know how to use assemble a team of super heroes and know how to use them.
  • Where are You Financially? Are you the heir to a dot-com fortune or are you barely scraping by? Do you have an 800 credit score or do you have charge-offs all over your credit report. Understanding where you are financially will allow you to plan what to do next. You might need to find friends, family, or an angel investor to help you on your way. Diving in without having your financial house in order, however, can lead to tragic results.
  • How will you finance your deals? Here’s a little secret. Banks hate providing loans to investors. Bankers are programmed to see real estate investors as a lower form of life. There are, however, several ways to leverage, or borrow money, for your real estate investments. Often times, however, those loans can eat up all of your potential profits. Understanding your “financial stack” is very important and should not be ignored.
  • How should I structure my business?: Should you buy your first property in your name, set up an LLC, or create a trust? Will you have partners or go it alone? What paperwork and filings will you need to do to be “legal”? Your business structure will impact your ability to get financing, taxation, banking, and many other issues. Choose wisely.
  • How do I find deals?: Finding deals is easy. Finding good deals is another thing entirely. Even the most seasoned real estate investors struggle to fill their pipelines. As a new investor, you might be tempted to jump in and grab the first deal that crosses your computer screen. You need to be sure you understand what you are looking at. Finding trusted advisors to help you hunt down great deals will make or break your flipping business. You just have to know where to look.
  • Who can be my Sherpa?: You wouldn’t climb a mountain without a seasoned guide that knows the terrain. Why would you undertake your first flip without having a shepherd to bounce questions off of? Someone that has been there, done that, and bought the tee shirt will keep you out of the poor house. Find a trusted Sherpa and listen to them.

 

The answers to these questions will vary from investor to investor. They are also not the only questions you should ask when preparing to enter the world of real estate investment. Find a good, experienced advisor to bounce thoughts off of. You will