The Wholesaling Trap: 5 Red Flags To Look For When Selling a Home in Texas

Wholesale Contract: Red Flags

Receiving a purchase offer after putting a home on the market can be an immense relief for a Texas homeowner, especially if said homeowner is under pressure to sell due to personal circumstances. Unfortunately, as some homeowners learn too late, not all parties who submit purchase offers are genuine buyers.  

The practice of real estate wholesaling involves entering a contract to purchase a piece of real property and then, during the period between contract signing and closing, marketing that property to other potential buyers at a higher price. If they find one, they then assign their rights under the original contract to the new buyer in exchange for payment. The seller and the new buyer close, and the wholesaler walks away with their finder’s fee. 

Wholesaling is not inherently exploitative, and there are legitimate wholesalers who make good on their promise to close on the property if they do not find another buyer prior to the scheduled closing date.  Too often, however, unscrupulous wholesalers will enter purchase contracts that they have no intention of completing if an interested third-party buyer cannot be found. Some, in fact, enter home purchase contracts knowing that they do not have the cash or financing to complete the purchase themselves. Such wholesalers can be thought of as playing amateur real estate brokers, making their money by advertising the property on the buyer’s behalf and taking a cut if the deal closes.

The problem with this practice is that real estate agents are licensed, regulated, and bound to an ethical code of conduct; wholesalers are not. While there are statutes requiring wholesalers to make certain disclosures under penalty of fines or civil liability, they are not subject to the same restrictions on their behavior as brokers or agents. Some can, and do, use exploitative practices to take advantage of desperate sellers. Texas homeowners looking to sell their homes should be on the lookout for the following signs that an offer may not be made with the genuine intent to purchase.

1. Long delay between contract execution and closing

No two sales are identical, but with enough practice in the field of real estate law, certain patterns and norms do emerge. In the case of legitimate home purchases, all else being equal, the period between execution of a contract and the agreed closing date tends to be around thirty to sixty days. During this time, the buyer typically does their due diligence by hiring a home inspector, conducting walkthroughs, and so forth. Two months is generally sufficient for this purpose. 

There are, of course, legitimate reasons for longer delays – for example, if substantial repairs are required before the house is ready to occupy, or if the seller needs to wrap up a legal matter (e.g. probating an estate) before they can close. However, if a buyer presents a seller with a contract that has a 75-day, 90-day, or even longer pre-closing period, with no stated reason or explanation for the long delay, this may be a sign that the buyer intends to use that period not to do their due diligence for the purchase, but to market the property to third party buyers.  

2. Little or no earnest money

Earnest money is a down payment that the buyer places in escrow shortly after the contract is signed. Its purpose is to deter the buyer from terminating the contract without justification after signing; the seller typically keeps some or all of the earnest money as their compensation for wasted time, effort, and expenses if the buyer backs out before closing. Typical earnest money deposits are between one and three percent of the total purchase price, though the amount is an object of negotiation between buyer and seller. 

A proposed contract with a very low earnest money payment (e.g. $100) may signal that the buyer wants to be able to cut and run with minimal cost to themselves if they don’t find someone to “sell” the contract to before closing. This leaves the seller with next to no compensation for their expenses or for the time that the property was off the market, which is especially unfair if the contract also features an extended delay between signing and closing as discussed above.

3. Long option period and little or no option payment

Similar to the above, if the proposed contract features a months-long period for exercising a termination option and little or no cost for exercising it, this could be a sign that the purchaser wants an easy out if they change their mind about closing.

4. Special or added language regarding assignability

The wholesaler’s ultimate goal is to assign the contract to a third-party buyer in exchange for payment. As such, they need the contract to be freely or easily assignable. The general rule in Texas is that, absent an agreement in the contract to the contrary, the buyer’s and the seller’s interests in the contract are freely assignable. However, if the contract is silent on the issue of assignability and the buyer does not make their plans known to the seller in advance, then even though the law would permit the wholesaler to assign the contract, the surprised seller may become hostile and refuse to close with the party that “bought” the contract. Sellers should be on the lookout for custom-drafted language in the contract or in an addendum giving the purchaser the right to assign the contract to another party without the advance notice or consent of the seller. If such language is present, yet the purchaser’s intent to assign the contract was never made known to the seller during negotiations, the seller may wish to ask for an explanation for the language’s inclusion or even request its removal prior to signing. 

5.  Prior “Memorandum of Contract” filings by purchaser

A memorandum of contract or memorandum of agreement is a sworn written statement, usually attested to by the purchaser in a real estate purchase, reciting that a contract for purchase of a certain property exists between the buyer and the seller and giving the agreed closing date. The memorandum is recorded in the real property records of the county where the subject property is located, putting the public on notice of the purchase agreement.  On its face, such a memorandum is harmless; the facts stated therein are all true at the time of recording, and unless the contract contains a confidentiality provision, the buyer is within their rights to make a public statement respecting the contract’s existence.

In practice, however, memoranda of contract are abused by unscrupulous wholesalers and others as a means to cloud title to a property, making it more difficult for the seller to sell to any other party. Most qualified home buyers will seek to obtain title insurance for their purchase. If a seller’s contract with a wholesaler does not close and the seller puts the property back on the market, interested buyers’ title companies will search the real property records pertaining to the property, find the memorandum, and realize that there was a recent contract for sale of the property to another party that did not close. If the title insurance company’s underwriters see this as a possible indication of an undisclosed title dispute – which could result in the insurance company having to pay out a claim on the insurance policy – they may refuse to cover the sale. The property’s title may thus become effectively unmarketable to anyone but the wholesaler, forcing the seller to capitulate and agree to un-cancel the contract.

If a home seller suspects that the offer they’ve received may be from an untrustworthy wholesaler rather than a bona fide purchaser, they should search for the prospective buyer’s name in the real property records of their county (and perhaps even surrounding counties), looking for any memoranda of contract filed by the prospective buyer in the past.  A pattern of such filings may indicate that the buyer has a history of using them as a tool to coerce sellers into staying in contracts that they wished to terminate.

Unfortunately, once a memorandum of contract is filed, there is currently no way for the homeowner to remove the cloud on their title without going to court, other than convincing the party that filed it to remove it voluntarily. Hence, it is imperative to avoid entering a contract with a buyer that would be willing to use this tactic. Once a seller has fallen into this particular trap, it may be too expensive for them to fight their way out of it.

If you want professional help determining whether a buyer’s proposed contract contains exploitative terms, or if you would like assistance searching a county clerk’s records for signs of previous abusive filings by a prospective purchaser, a skilled real estate attorney can provide the support you need.

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