Wholesaling vs Novation Agreements In Real Estate
If you wholesale real estate and are not using novation agreements as part of your disposition strategy, then keep reading! This article will go over when to you use a novation agreement in real estate vs keeping it as a traditional wholesale deal.
Have you been struggling to find buyers for your wholesale deals? You are not alone. The end of 2022 was tough year for house flippers and wholesalers. In an effort to curb inflation, The Federal Reserve rapidly increased interest rates in the second half of 2022. By December, rates were the highest they have been in 15 years. What did this mean for the housing market? It very quickly turned from a seller’s market to a buyer’s market.
The Market Shift in 2022
The real estate market can be a roller coaster at times. If you are wholesaling, you are at the forefront. You feel a market shift immediately. Why is this?
Most cash buyers are tied in pretty close with the economy. This is because many investors who call themselves, “cash buyers” are actually using other people’s money to acquire real estate. The people that lend the money are private lenders, hard money lenders and even institutions that lend money for fix and flip deals.
Even when there is the slightest shift in the market, your buyers will react. Just like a bank, private & hard money lenders charge points, fees and interest when lending to investors. When there is a market shift and especially a change in interest rates, that directly impacts your cash buying investor. Not only does it impact your buyer, it impacts the buyer who will buy the house from them if they flip it.
What did this mean for wholesalers? If you were wholesaling at the end of 2022, I guarantee you had to work A LOT harder to move your deals. It seemed like all of the cash buyers disappeared overnight. Even the larger house flippers were being extra cautious during this market shift. This is where a novation agreement in real estate becomes handy.
The Traditional Wholesale Process
In the traditional wholesale process, you put a deal under contract with a seller. Then you mark up the price, market your contract to cash buyers and earn an assignment fee when you close with title.
The reality is, not all wholesale deals are great deals. When you have a deal with a smaller margin, it can be a big challenge finding a buyer. We have all been there… dreading the thought of calling the seller and asking for a price reduction. Or worse, telling the seller you need to back out of the deal. If you followed my advice on the inspection period, you should be in the clear. But that still doesn’t make it easy.
What if… instead of calling the seller and asking for a price reduction you had another solution. What if… instead of backing out of a deal and making nothing, you could bring in a buyer that is willing to pay 20 or 30% more than your cash buyers?
Guess what. With a novation wholesale deal, you can!
What’s even more exciting about the novation strategy? Less than 5% of wholesalers are using novation. Guys, there is a HUGE untapped market for this!
Novation Wholesale Agreement – How it Works
So, who are these buyers that pay 20-30% more for houses? Retail buyers. People that want to live in the house. Houses are being sold on the MLS everyday for 20-30% higher than what a wholesaler would generally put it under contract for. Generally these houses are in good condition and don’t need much work, but not always. Retail buyers will buy projects too!
As a wholesaler, we are almost never doing any marketing to retail buyers. And rightfully so. If we want an all cash-offer, quick close, etc…. we want fix and flip investors buying our deals.
However, when you have a house that is in good condition and the seller has a higher asking price, you no longer have to turn your back on those deals anymore. Or, let’s say you already have a deal under contract but couldn’t find a cash buyer – don’t walk away from that deal without mentioning novation!
With a novation agreement in real estate, your original wholesale contract will be replaced by a new agreement with the retail buyer and seller. You also have the seller sign a ‘net proceeds agreement’ which locks in the proceeds they will receive from the sale.
Example of Novation Wholesale Deal
Let’s say you have property under contract for $150,000 and mark it up to $170,000 but can’t find a buyer. You reduce the price to $160,000…. still can’t find a buyer. You reduce to $155,000… still can’t find a buyer (we have all been there!). What next?
From here your options are:
1) Ask the seller for a price reduction. I usually have a 25-30% success rate getting a price reduction. It’s never fun asking. If it’s nice a house, they almost never go for it. Plus, now they are losing confidence in you.
2) Back out of the deal entirely. You make no money.
3) Pitch a novation real estate agreement and find a retail buyer that is willing to pay $185,000!
Pitching a Novation Real Estate Agreement – Script
Me: Mr. Seller, unfortunately after further inspection the property isn’t going to work for us. However, I can bring in a retail buyer and still get the deal done. How does that sound?
Seller: Sure, how does that work?
Me: I’ll just need a little more time to close, maybe 30-45 days. We may have to schedule another appraisal and inspection, but that’s it.
Seller: Ok, is there any other paperwork?
Me: I’m glad you brought that up. We may have you sign a new purchase agreement and a net proceeds agreement. The new purchase agreement will show a higher price than our agreement. This is so that we can cover the realtor fees, commissions, closing costs, etc.
Seller: So there’s a realtor involved now?
Me: You will be working directly with me but the new buyer may have a realtor representing them.
Seller: Ok, sounds good. What are next steps?
Me: I just need to have you sign some additional paperwork so I can advertise your property on the MLS. I will cover any cost associated with listing the property. Then, I will call you when we have interested buyers that want to see the house. We can schedule showings at your convenience.
Seller: Sounds good. I will look out for your paperwork. Thanks!
Listing the Property on the MLS
There are certainly other ways to find retail buyers aside from the MLS. Zillow FSBO, Craigslist, Facebook marketplace, realtor connections, etc. But if you want the most exposure, go ahead and hire a flat fee broker to list the property for you. Most of them charge between $200-500 for basic MLS listings with no service from the broker.
Depending on the MLS rules in your region, you may be able to sign the listing agreement as the principal if you already have a signed purchase agreement. This is because you have equitable interest in the property. You will also want to make sure your original purchase agreement contains a marketing clause that would give you permission to market the property on the MLS.
Some states may require you to have a real estate license if you intend on doing a novation real estate deal.
Disclaimer: I am not an attorney so please consult with your local attorney before drafting these documents and check MLS rules in your area.
Once the property is listed, you will have to manage the showings and any offers that come through. When you get an offer you are happy with, the seller will need to sign the new purchase agreement.
Make sure you are transparent with your seller throughout the process. If the buyer is getting financing there will be an appraisal and possibly an inspection.
The seller will also see the higher purchase price on the new agreement. As long as you explained this to them ahead of time, they are usually fine with it. It’s all about honesty and transparency!
Potential Earnings from Novation Real Estate Deals
In the previous example, if you had a property under contract for $150,000 and found a retail buyer at $185,000, this is what the breakdown would look like.
Purchase Price: $185,000
Buyer’s Agent Commission at 3%: $5,550
Flat Fee Listing Cost: $500
Seller Closing Costs: $3,500
Total Commissions, Fees and Closing Costs: $9,550
$185,000 – $9,550 – $150,000 (net proceeds agreement) = $25,450 Assignment Fee to the Wholesaler
Crazy, right? Now, not every deal ends up this way, but we have never lost money on wholesale novation deal.
In summary, novation agreements in real estate are an excellent tool to have in your dispostion arsenal. While I probably wouldn’t recommend trying to use novation on every wholesale deal (you need to keep your cash buyers happy too), there are many opportunities to use novation and monetize your leads more effectively.