An article I wrote last week entitled Newbie Alert – Don’t Buy Into the Wholesaling Hype started some meaningful discussion on the BiggerPockets Blog. I struck a nerve; can you believe it…?
New investors are understandably vulnerable to persuasion, and believe me when I tell you that there is no shortage of advice out there, one of the most prolific (and wrong) being that if you have no money, the thing to do is wholesale houses as a means of coming up with the down-payments. Indeed – it seems that many among the ranks of newbie real estate investors out there are convinced that to wholesale houses is a good and necessary stepping-stone on their way to being able buy rentals, which is what most say they ultimately want. Privately and on the forums one of the questions I hear most is exactly this: I don’t have rich parents, a high-paying job, or a rich boyfriend; should I wholesale houses to get down-payments for rentals – everyone says it’s a good way to go…
As far as I am concerned, to wholesale houses as a stepping stone to get to income-producing property is not only highly inefficient by the numbers, as I will show in a minute, but it can very well be destructive to your achievement of stated ultimate goal since it pulls your most valuable resources, time and energy, in the direction opposite to your stated objective.
TALKING ABOUT THE NUMBERS
Let us say that both you and your wife have full-time jobs – most people do. The incomes from these jobs cover your family’s bare necessities, but there certainly isn’t any money left over with which to make down-payments on any kind of rental property. So – you decide to wholesale houses part-time, and let’s say that because you are one in a million, after a couple of years of hustle you actually manage to build a wholesaling pipeline of 6 deals per year, which for a part-timer is fantastic indeed. Further, let’s assume a $5,000 wholesale fee per deal, thus grossing you $36,000 in a routine year.
Now – at this point you could choose to go full-time in your wholesaling business, but this would require you to let go of the employer-provided health insurance, and since your spouse’s job doesn’t come with health insurance you can not do that. So, you keep your job and keep making that $36,000 extra via wholesaling every year. And naturally, even though your cost of marketing and advertising goes down over time as you become better known, you still re-invest about $5,000/year, and thus we will call your annual net before taxes around $30,000 to keep it simple.
Now you get to pay income taxes on these earnings, and this comes with a bit of sticker shock. Since your job and your wife’s job together generate around $65,000/year, on a typical year you might find yourselves in the 15% tax bracket filing jointly. But, although we like to think of wholesaling as being a form of investing, it is not at al – it’s trading. Sure enough, the IRS thinks of this type of income as earned income – no different from your day job (this should set some bells off in your head btw). What this means is that your family’s gross earned income has now gone up from around $65,000 to $95,000, which more than likely pushes you out of the 15% income tax bracket and into the 25% – WOOPS!
And lest you forget that all earned income is subject to FICA taxes, which means that your wholesaling income will cost you about 40% in taxes including self employment tax. So, you’ve hustled, and when I say that I mean you’ve absolutely killed yourself to wholesale 6 houses per year part time, and what you have to show for it after-tax at the end of the year is perhaps $15,000…nice L
WHAT DID YOU SAY YOUR PLAN WAS?
Oh yeah, you are going to parlay this money into long-term investments. So, how does this 15k do for you – does it buy much? After 2 year of this hustle, if everything goes well, you would almost afford a 25% down-payment on an $120,000 4-plex in most places in the country. I say almost because the secondary market points for non-owner occupied investment property have become NUTS, and I bet in addition to the $30,000 down you would need at east 3.5 points up-front to close, which is another $4,000 or more. That’s if you could qualify for one of those mortgages in the first place…
I suppose you could do that; you could bust your rear for two years and trade in 30k for $600/month ($7,200/annally) of Cash Flow. Now – in my world that in and of itself is just stupid. You shouldn’t need money to buy real estate, and especially if you are going to work this hard to earn it. But, that’s not the point. What is the point, is that if you manage to wholesale houses for 8 fantastic years, you will be able to buy four 4-plexes totaling $2,400 of monthly cash flow. First – good luck having 8 fantastic years of wholesaling in the “stable” marketplace of ours. And secondly, wow – 8 years is a long time to wait for $2,400 of cash flow!
BUT IF I Do NOT WHOLESALE HO– USES, THEN WHAT?
Let me say this – there is plenty of money out there for all of us to do deals, without the needing to wholesale houses. The distinction is that while some of us can see this money, others can not – it’s a function of perspective! As the above quote by Helen Keller suggests, success in any endeavor is underpinned first and foremost on our ability to see that which other people can not see. Here are some basic realities to recognize:
3 TYPES OF PLAYERS
Out there in the business world there are 3 types of players:
- Those with Vision (Ideas)
- Those with Money (Means to Finance Ideas)
- Those with both the Ideas and the Capacity to Finance Them
The latter is very rare for sure. It almost never happens that a person develops an idea and independently has the financial capacity to implement it. Indeed, most of what’s going on out there is that some of us have the ideas, the tenacity, and the technical knowledge of how to implement those ideas, while others have the money to back this process, and what it takes to succeed is a “marriage”, a collaborative relationship between those with ideas and those with money – takes two to tango, so to speak.
What should jump out at you here is the reality that while you certainly need the money, the money needs you as well; each is dead in the water without the other! Yes indeed, a lot of people have money, but this doesn’t mean that they have the expertise, time, health, or talent to come up with and implement ideas. Money needs you as much as you need the money!
WHAT DOES ALL THIS MEAN?
Realizing the above should lead you to formulate several conclusions:
- You have leverage in this equation, and it’s time you stop thinking of yourself as a second-class citizen just because you are lucking funds. If you possess ideas and expertise relative to implementation of those ideas, you are a partner.
- Ideas and expertise is not enough. Why – because not every idea is attractive to the money. You must figure out exactly what type of ideas and skill-sets are attractive to the money, and when you get this right the money will follow.
- This means that the activities you undertake on a daily basis need to reflect pursuit of ideas, skills, and expertise which are attractive to the money. If owning 100 rental units is what you ultimately want to accomplish, the question you must ask yourself is whether wholesaling houses will get you there. And furthermore, whether wholesaling houses is causing you to gain the type of knowledge and expertise which will be attractive to the kind of money that can make 100 rental units probable for you…
- If you are not able to finance your deals, then one or all of the following must be true:
- The deals you find are not what the money is looking for, or
- The money doesn’t believe that you have the expertise to put together and manage the kind of deals you say you want, or
- You are not presenting yourself and your deals appropriately, which is a function of understanding principles of negotiation and falls outside of the scope of this article, or
- All of the above…
SO – WHERE’S THE MONEY?
And the answer is that it’s everywhere, but you can’t see it and it can’t see you because the activities you engage in on a daily basis are the wrong activities for someone who says he wants to attract money to finance rentals – surprised? Why – you are busy wholesaling houses… Not only is it true that by trying to wholesale your way to your ultimate goal of long-term holds what you are doing is trying to “go it alone” in terms of financing your ideas instead of focusing on the great advantage of the capitalist marketplace which is the synthesis of ideas and money, but the connections you make and expertise you acquire bare only marginally on that which you say you want. You are not where the money is, and money is not where you are!
Spending all your free time coming up with wholesale fees may in the end lead you to be an expert wholesaler, and if this is your ultimate objective than very good for you! But, in most parts of the country this is not going to provide you with enough money for the down-payments on as much income-producing property as you say you want. And furthermore, in the process of focusing on wholesaling you are not going to be making the kind of connections and learning the kind of thought process and skills that will make your attractive to financiers of those long-term holds that you say you want.
If you truly want to own rentals, then instead of focusing energy on wholesaling, perhaps it is time to focus on understanding who finances long-terms holds and how, and taking steps that will make you desirable to those people and entities.