As real estate investors consider different investing strategies, they often hear about wholesaling. One of the most important parts of completing a wholesale deal is to assign the process to another investor. So how do assignments work?
Assignment, a legal process, entails granting—or assigning—one party’s rights and responsibilities in a contract to a third party. This third party “steps into the shoes” of the person they replace, fulfilling the remaining contract responsibilities through the real estate closing process.
In the following article, I’ll expand on real estate assignments and how they relate to wholesaling. Specifically, I’ll cover each of the following topics:
- What Are Real Estate Assignments
- How Assignments Relate to Wholesaling
- Advantages to Real Estate Assignments
- Disadvantages to Real Estate Assignments
- Final Thoughts on Assignments
What Are Real Estate Assignments
As stated above, assignment constitutes a specific legal action involving contracts. Prior to executing an assignment, an actual contract between two parties must exist. After signing a contract, one party (the “assignor”) transfers—or assigns—his or her obligations and benefits under the contract to a third party (the “assignee”). In simple terms, the assignee “steps in the shoes” of the assignor and assumes all associated contractual rights and responsibilities.
While assignment can occur with any type of contract, it plays a key role in real estate investing. You may not think much of the phrase, but when a property seller and buyer go “under contract,” they have, quite literally, entered a legal contract. As such, the potential for contract assignment exists, with the buyer assigning his or her rights and obligations regarding the home purchase to a third-party buyer. Following assignment, this third-party buyer then becomes responsible for the remainder of the closing process, purchasing the property him- or herself.
NOTE: I say the potential for the assignment above, because if a contract explicitly prohibits assignment, then buyers cannot assign their contract rights. When purchasing a bank-owned property, the bank-seller typically includes this sort of clause in their sales contracts.
How Assignments Work in Wholesaling
The above process of assignment serves as the foundation of the real estate wholesaling strategy. Broadly speaking, wholesalers make money by getting a property under contract and then assigning it to someone else for a fee. Here’s what it looks like, step-by-step:
- Step 1: The wholesaler goes under contract to purchase a home, typically a distressed property.
- Step 2: The wholesaler then shops the contract/deal around to potential buyers, generally house flippers.
- Step 3: With a third-party buyer confirmed, the wholesaler assigns the new buyer the contract rights and obligations, and this new buyer then carries out the remainder of the closing process and actually purchases the home.
For example, assume you go under contract with a seller to purchase a property for $100,000. If your goal is to wholesale—and not actually purchase—that property, you can then find a motivated buyer (typically a house flipper), and assign him or her your contract rights for a $5,000 assignment fee (the actual fee amount will be driven by your market and the nature of the deal). This buyer (the “assignee”) then continues the closing process in your place. In this scenario, you earn a $5,000 fee without the risk associated with buying, renovating, and selling a property—an appealing prospect.
Advantages to Real Estate Assignments
The above description should definitely make some of the major advantages to assignments and wholesaling obvious. If you’re considering this strategy, here’s a fairly comprehensive list of the benefits of wholesaling:
- Speed: With a wholesale deal, you’re only involved for as long as it takes to find a third-party buyer to whom you can assign the contract. Typically, it only takes one to two weeks to collect your check.
- Simplicity: Unlike house flips, with wholesaling, you only need to 1) make an offer, 2) assign the contract to a third party, and 3) collect your check—a straightforward, simple process.
- No rehab period: While home flippers typically command higher profits than wholesalers, the actual rehab work can be a tremendous pain, often requiring more time, money, and effort than initially budgeted.
- No financing requirements: As wholesalers don’t actually purchase these properties, they don’t need to apply for financing and meet the associated requirements. No loan deadlines or interest payments exist with wholesaling.
- Profit: Even though wholesalers don’t command the same returns as home flippers, these deals still result in solid profits. They take far less time and work, which means that, relative to your actual time commitments, you’ll realize great returns.
- Fewer out-of-pocket costs: With a wholesaling deal, in addition to your general marketing expenses, you’ll only need to put down some earnest money for the deal. However, $500 will generally more than suffice, and you can add a clause stating that you’ll only provide your earnest money once the seller accepts the offer, meaning you know the deal will move forward.
Disadvantages to Real Estate Assignments
While plenty of advantages exist to real estate assignments and the wholesale investing strategy, investors should also have a thorough understanding of the associated drawbacks before diving headfirst into a deal. Here are some of the potential pitfalls to consider:
- Not having a buyer: It seems obvious to state, but a successful wholesale deal depends upon actually finding a buyer to whom you can assign your contract. Most contracts have a specific date by which the wholesaler’s new buyer needs to close. If wholesalers fail to find a buyer within the designated timeline, the deal falls apart and they lose their earnest money.
- Unpredictable income: This drawback actually applies to a house flipping as well, but it’s worth noting here. If you don’t complete any wholesaling deals, you don’t have any income. And while established wholesalers can build up a pipeline of deals, somewhat smoothing income, it takes time to reach this status. During these initial stages, new wholesalers need to remain particularly diligent with their finances.
- Massive marketing efforts: Successful wholesalers don’t just casually ask around about potential deals. To build an established system, people need to undertake significant marketing efforts to find both motivated sellers and future investors to whom you can assign contracts.
- Legal compliance: When dealing with contract law and assignments, buyers face a host of compliance issues not necessarily relevant to a standard deal. For example, listing a “property for sale” instead of “interest in a real estate transaction for sale” could possibly lead to an illegal transaction.
Final Thoughts on Assignments
For many new real estate investors, the initial capital requirements of building a property portfolio can seem absolutely prohibitive. Understanding the assignment and wholesaling world represents a great strategy for these folks. With little up-front capital, wholesalers can begin finding and executing profitable deals. And while these deals may not bring in the same returns as a house flip, if done successfully, wholesaling can be an outstanding strategy for building that initial capital.
Furthermore, wholesaling doesn’t represent an either/or strategy. In other words, if you build a successful wholesaling system, you can still flip houses or undertake a buy-and-hold strategy on the side. This actually represents a great hybrid investment strategy. By funneling a portion of your wholesaling profits into down payments for a portfolio of rental properties, you can generate current cash flow while still reaping the long-term wealth-building benefits of having tenants pay down your mortgages.