Since starting my own career flipping houses in 1998, I've seen a disturbing trend develop and continue to gain momentum with regard to ethics in real estate investing.
In my view operating your real estate investing business with integrity is a non-negotiable item. I've written entire chapters about it in my own flipping homes continuing education materials, so my students know exactly how I feel about this. But I believe it's high time to write a series of articles on the topic and address some of the ethical issues I see my fellow real estate investors allowing themselves to give in to. And the first issue I'd like to address is the value of your word. Here's a common scenario I hear:
“Joe” is a wholesale real estate investor – that is, his business is to find houses at a wholesale (below market) price, get them under contract to purchase, and then assign his interest as buyer to another real estate investor who will close in his place. Joe will collect a fee in exchange for selling his equitable interest in the contract, and the investor who closes on the purchase will have a great deal to keep or fix and flip.
Joe is flipping houses on the wholesale market, which is not unethical. This is the same way most industries work – wholesale and retail. And Joe is not actually selling a house, but is selling his interest in the contract – but that's a discussion for another time. So investor Joe finds a motivated seller with a property he thinks might be a sweet wholesale deal but he's not really sure. So he makes an offer. Seller counter-offers. Bingo, Joe may have something here.
Now as I've written in previous articles, this is the point where Joe should stop and really do his due diligence on this property. Moving beyond merely smelling a deal, Joe should stop and really analyze the numbers, the market and even his prospective investor-buyers to see if he really feels confident about this before moving to finalize things with the seller. But this seems like a little too much work right now for investor Joe – and this is where things start to go downhill. Joe decides to go ahead and ink the deal, thinking to himself, “Hey, no problem. If this deal turns out to be a stinker, I'll just use my weasel clause to back out – no harm, no foul.” No harm, Joe? Really?
The Unethical Safety Net
You see, Joe has a line in his contract that says, “This contract is contingent upon approval of Buyer's partner.” Who is Joe's partner? It's probably his cat, Fluffy. Or maybe his wife, who isn't all that happy about Joe's crazy house flipping business anyway and would probably dispute all of Joe's contracts if he'd let her.
Here's what's really going on. Joe understands that later on if he realizes things aren't nearly as rosy as he first suspected, he can just say, “Hey, my partner (i.e. Fluffy) decided this deal isn't a good fit for us after all. Sorry about that, but I'm outta here.” I ask you – does this seem fair to the seller? Does it seem ethical? The seller, who had doubtless already made definite plans surrounding the sale of his property, is left with shattered hopes at the very least – and sometimes a lot worse.
But this is exactly the type of approach I hear time and time again proposed as a “safe way” of flipping houses by many real estate investors nationwide. In fact many of my own colleagues who are teaching house flipping and real estate investing are also teaching people it's OK to do business this way. Let me stand apart from the crowd and state in no uncertain terms that I do not approve of this – nor do I teach my students to – and nor should you.
Are All Contingencies “Weasel Clauses”?
Almost all contracts have contingency clauses – valid conditions that must be met in order for the agreement to proceed. And the legitimate, appropriate use of contract contingencies I take no issue with. It's the frequent and free use of these contingencies as a replacement for doing your homework that I find disturbing. As a professional real estate investor, you should always be 100% honest with all parties in a transaction. When you sign your name to a contract, do it with honor.
You should make every offer with the full intent of settling the deal one way or another. If not, don't ink the deal. If certain circumstances need to fall into place before you can settle on a deal, present the offer, but clearly disclose those circumstances upfront. Above all, be honest with the seller about your position and your means. Doing business this way has never caused me to lose a deal. And even if it had, there are been plenty of other profitable opportunities for me.
Even if you set the ethics of it aside and look at it from a purely selfish perspective, people tend to remember someone backs out of a deal – and word gets around. A bad reputation will inevitably catch up with you (yes, even in a large city). On the other hand, if you sign your name with honor, experience has taught me time and time again that you will be much more successful. In fact, as a result of honoring my contracts, I've actually had my offers accepted over other, higher offers simply because my name has reputable value. Sellers know that I will do what I say I will do.
Building A Good Name Hasn't Always Been Easy
There have been times when settling on a deal seemed like it was going to blow up in my face. But every time I was able to find a way to honor my word and put the deals together, even though they weren't great deals for me. I broke even on one, and made about $500 on the other. But the bottom line is that I settled them. I didn't wait for something to happen. I got out and hit the streets. I was aggressive in finding a way to make things happen the way they should.
Yes, I've encountered several situations where I couldn't find a wholesale buyer for a particular deal. Though my intention when I first started flipping houses was to exclusively do wholesale deals, I was forced by my word to honor these contracts and settle on the homes myself. In fact, this is how I started rehabbing houses in the first place. Believe me, anyone and everyone who focuses on wholesale real estate flipping will find him/herself in the same position. When you come to that point, if you're signing your name with honor, you will find a way to settle the deal with integrity, and either fix and flip the house or hold it until you can find a wholesale buyer (yes, possibly even at a loss).
The Bottom Line
As an ethical real estate investor, you should sign your name to each and every contract with honor. Anybody can go make an offer, but your name is your name and it has value. If you sign contracts without producing, then in time your name will have little worth. Contingency clauses have their place, but you shouldn't be using them as a safety net to sign up deals you feel unsure of. You should sign your name with integrity and always do everything within your power to keep your worth. In the long run your reputation as a person of integrity will bring you much more profit and prosperity than any short term gain you may experience by being a weasel.