Real estate wholesaling is the process through which an individual, the “wholesaler,” enters into a purchase contract with the seller of real property and assigns, for profit, that same contract to an end buyer. Notably, the process of wholesaling differs from “fixing and flipping” real property in that the wholesaler does not close escrow, performs no renovations, and incurs no carrying costs. Rather, the wholesaler assigns their contract rights to a third-party buyer who ultimately purchases the property directly from the seller.
Upon entering into a purchase contract, a wholesaler obtains equitable title, which is the interest retained by a person who has contracted to purchase a property but has not yet closed the transaction. This is different than legal title, which is actual ownership of the real property. Wholesalers must therefore remember that they cannot sell the property itself and must market and sell only their equitable interest. Stated differently, the wholesaler is selling their contractual rights, which is their sole interest in the property.
The process of wholesaling exposes real estate licensees to a great deal of potential liability. Disclosure and transparency are absolutely critical, yet even with full disclosure, sellers are often dismayed to learn that the wholesaler was able to assign the purchase contract to an end buyer who is ultimately paying more money than the contract price between the seller and wholesaler. To mitigate the risk, fully understanding the process is critical and real estate licensees are therefore encouraged to consider the below frequently asked questions and corresponding answers.
Q1. If an agent is contacted by a wholesaler seeking to retain the agent to represent their interests in the acquisition of equitable title to real property, what is the first step the real estate licensee should take?
It is critical that agents talk to their broker before agreeing to represent a wholesaler! This cannot be stressed enough. First, some brokerages do not permit their agents to represent wholesalers so the agent must determine whether their proposed representation is even permitted. Second, by seeing so many transactions, brokers understand the perils associated with wholesaling and can guide agents through the transaction, steering clear of pitfalls that often result in litigation.
Q2. Is the purchase contract assignable, or must the wholesaler write into the contract terms like “and assignee” when identifying the buyer?
Generally speaking, in Arizona rights and duties under a contract are freely assignable. More specifically, a party can assign its contractual rights to a third party unless:
(a) the substitution of a right of the assignee for the right of the assignor would materially change the duty of the obligor, or materially increase the burden or risk imposed on him by his contract, or materially impair his chance of obtaining return performance, or materially reduce its value to him, or
(b) the assignment is forbidden by statute or is otherwise inoperative on grounds of public policy, or
(c) the assignment is validly precluded by contract.
See Restatement (Second) of Contracts § 317(2). Consequently, terms like “and assignee” are not legally required for a contract to be assignable.
Q3. Must wholesalers and their agent disclose in their marketing materials the wholesaler’s lack of legal title?
Yes. Because wholesalers lack legal title, they must disclose in all marketing material that they solely hold an equitable interest in the property and are therefore not the owner on title. This disclosure should not leave any questions as to the wholesaler’s role in the transaction. Furthermore, if the wholesaler holds a real estate license, that too must be disclosed under Arizona law.
Q4. Following the wholesaler’s assignment of the Purchase Contract to an end buyer, does the wholesaler remain liable if the end buyer fails to perform?
Yes. The wholesaler’s assignment of the Purchase Contract does not change the terms of the underlying purchase contract, nor does it negate the wholesaler’s contractual obligations owed to the seller.
Q5. Must the wholesaler notify the seller of their intent to assign their equitable title to an end buyer?
Arizona case law holds that a buyer must disclose to the seller all facts materially affecting the buyer’s ability to perform and pay the agreed upon purchase price. See Lombardo v. Albu, 199 Ariz. 97, 14 P.3d 288 (2000). In other words, a buyer cannot present themselves as “ready, willing, and able” if they know that there is a significant risk that they will be unable to perform their contractual obligations. Many wholesalers have no intention of ever purchasing the property, which means they are not “ready, willing, and able” purchasers. If the wholesaler does not intend to perform if they are unable to assign their equitable rights, their intentions must be disclosed upfront to the seller.
Q6. If accepting a purchase offer from a wholesaler, can the seller request a substantial earnest money deposit in an effort to better protect their own financial interests?
Yes. As mentioned above, many wholesalers do not intend to purchase the property if they are unable to assign their contractual rights, even if that means forfeiting their earnest money deposit. Requesting a substantial earnest money deposit is one way sellers can better protect themselves in the event the wholesaler breaches the contract by failing to close escrow.
Q7. Does the Arizona REALTORS® Residential Resale Real Estate Purchase Contract contain a contingency by which a wholesaler can cancel the contract without penalty if they are unable to assign their equitable interest prior to close of escrow?
No. If the wholesaler desires to insert an assignment contingency into the contract, that must be negotiated via an Addendum or in Section 8a of the contract under Additional Terms and Conditions. Otherwise, no such contingency exists.
Q8. Upon assigning their equitable interest to a third-party end buyer, what steps should the wholesaler take?
If and when the wholesaler has assigned their contractual interest, they should immediately notify both the seller and title company.
Q9. If representing a seller who receives a purchase offer from a wholesaler, what information should the agent convey to their seller?
The majority of sellers have little knowledge of the process of wholesaling real estate and rely on their agent to help them understand what can be a complicated transaction. However, real estate licensees are prohibited from offering legal advice and should therefore advise their seller, in writing, to seek independent legal counsel to fully understand their rights and obligations should they accept the offer. With that said, there is information that the agent can and should convey. First and foremost, the agent should explain to their seller that if the wholesaler is able to assign their contractual rights, they will do so at a profit. In other words, the wholesaler intends to find a buyer who will ultimately pay more money than the contract price between the seller and wholesaler. If the seller is uncomfortable with this, they should decline the offer and seek a buyer willing to purchase the property for a greater sum. Second, if there is a risk that the wholesaler will fail to close escrow if they are unable to assign their equitable interest, that too should be explained to the seller so that they understand the risks associated with accepting the wholesaler’s purchase offer.
Q10. If the listing agent learns that the buyer is a wholesaler who intends to assign their contractual rights prior to close of escrow, must the listing agent disclose this information to the seller?
Yes. An agent’s disclosure obligation to the client arises from their fiduciary duty. Part of that fiduciary duty is the obligation to make a complete and full disclosure of all known material facts that might affect the client’s decision to sell the property.
This article is of a general nature and reflects only the opinion of the author at the time it was drafted. It is not intended as definitive legal advice, and you should not act upon it without seeking independent legal counsel
A licensed Arizona attorney, Scott is General Counsel & Assistant CEO for the Arizona REALTORS® serving as the primary legal advisor to the association.