Beware of the “Wholesale” Scam

This article was first written in 2006, but now that the market is coming back, this scam is again rearing its ugly head!

Every newbie investor hears that it is imperative to buy real estate “wholesale”, not retail. The problem is, most newbies don’t know what a wholesale deal is, and there are a number of operators out there scamming newer investors with what they are representing as “wholesale” deals. Consider this a public service announcement and something to think about…

The following is a common scam I am seeing:

1. Scam-Investor makes a deal with a builder or developer on 30 new homes that are “appraised” at $215,000, but really worth $200,000 (if they were worth $215,000, they’d be selling regularly at $215k) Scam-Investor can buy them “wholesale” from the builder for $185k

2. Scam-Investor approaches newbie investor and says, “You can buy wholesale homes with no money down”… and I have access to lots of them!

3. Scam-Investor buys home from builder at $185k and flips to newbie investor for $195k Using a charade of fake down payments and passing money back to the buyer under the table (which is loan fraud), newbie investor ends up with a property worth $200k, with a “no money down” loan for $195k

4. Scam-Investor walks away with $10k, newbie investor has a house with almost no equity, and he thinks he has $20k in equity.

5. Newbie investor can’t rent house for break even cash flow, then tries to sell it for $215k, finally coming to the realization property is only worth $200k Newbie investor dumps property for $180k, losing $15k

This kind of activity is very profitable for the fast-talking scam artists who prey on the lazy, uneducated newbie investors. I deplore such scammers who prey on people, but I also must warn the newbie – “Buyer Beware”. There’s no shortcut to getting rich in real estate, and there’s no substitute for hard work, education and doing your own homework. If you trust others to find you wholesale deals without knowing what wholesale is, you deserve the lousy deals you get!

So, what is a “wholesale” deal? Well, wholesale means WELL below retail. Before you can figure out whether a deal is wholesale, you need to know what retail is. An appraisal is not retail. A tax assessment is not retail. Asking or listing price is not retail, and neither is a computerized “guestimate” from a free online comp website, like ZILLOW. Retail is what someone is willing to pay for a property based on average time on the market for similar houses. So, you need to get access to the MLS or a paid listing service to research similar houses in the neighborhood that have sold by ordinary means within the average time period for the market. Seller concessions, owner financing, builder concessions, financing concessions, real estate broker kickbacks and the like will skew the numbers, so look carefully.

Once you determine retail, then you can figure out wholesale. A house worth $200,000 retail is not a bargain at $192,000 in today’s market. In fact, it’s not a deal at $188,000 or even $185,000. In my market (Denver), a true wholesale deal means at least 25% off retail, closer to 30%.  In your market, that might translate to 30% under market, or maybe 10% under market. The price range of houses you are dealing with also skews the figure, since higher-end homes tend to take longer to sell and you may need a larger discount. If the property needs repairs, then you need to get it EVEN CHEAPER. So, the formula should be X% under retail, LESS repairs, using a very conservative (high) repair figure. Having a local real estate agent, investor or mentor to give you a reality check is often helpful. And, make sure that person giving you advice does not have a stake in the deal.

Use your head, and don’t trust the values given to you by the person SELLING you the property! Do your own research and your own comps. If a person is telling you they have access to an unlimited number of “wholesale” deals, ask yourself, “How is this possible?” There’s no shortcut to success — as, Harvey Mackay says, “Beware of the Naked Man Who Offers You His Shirt”. I say, “Beware of the Homeless Man Who Offers You His House… for WHOLESALE”.

Learn the RIGHT Way to Do Wholesale Deals