The Pros and Cons of Wholesaling to Hedge Funds

In my conversation with Saj Babu, who began wholesaling in 2012, he explained the step-by-step process of wholesaling deals to hedge funds, as well as the pros and cons of this particular real estate investing strategy.

Saj’s real estate strategy is to find deals in markets that have already been selected by large hedge funds, conduct the financial due diligence, and wholesale qualified deals to these hedge funds. The following is the detailed process that Saj follows after finding a deal:

1. Due Diligence

Before bringing the deal to the hedge fund wholesaler, Saj qualifies the deal by determining how much work needs to be done and what the properties after-repair value will be.

2. Get Qualified Deal Under Contract

If the property passes Saj’s initial due diligence period, he makes an offer and puts the property under contract.

3. Property Inspection

After Saj puts the property under contract, the hedge fund analysts and contractors go out to the property for an inspection. Saj isn’t required to be present during the inspection. However, he usually elects to attend in order to gain more knowledge on the inspection process and to hang out with the contractors to see what they are going to do and how they are going to do it. The knowledge gained and relationships built with the contractors sets Saj up for future real estate endeavors.

4. Determine Repairs

During and immediately after the analysts and contractors inspect the property, they determine the exact rehab checklist. Hedge funds will rehab the property in such a way that they will receive the highest dollar value in that subdivision or quarter mile radius hedge fund wholesaler. They will not go into a property and slap on a coat of paint and throw on some flooring to simply make the property habitable. Hedge funds want to get the highest sales price or rent as possible, so this goal reflects the level of rehab. They will put in a little bit more work than usual, knowing that the asset is going to bring them more value down the road.

5. Verify Saj’s Information

Once the exact repair checklist is determined, the analysts will verify that the information that Saj provided, i.e. the rehab numbers from his initial due diligence, matches their projected budget. When Saj first started working with hedge funds, his numbers weren’t accurate at all. He came in at an amateur level, so there was a learning curve. Since he didn’t know how much repairs like flooring, painting, etc. actually cost, he was using a simple $10-$15 per square foot calculation for rehab costs. However, after working with the hedge fund analysts and absorbing all the information he could during the inspections, he was able to understand exactly what the hedge funds were looking for and how they calculated the repairs costs. As a result, his initial due diligence numbers became more and more accurate over time.

6. Back and Forth Negotiation

If needed, and especially in the beginning, since Saj’s rehab numbers were inaccurate, he goes back and forth with the analysts to agree upon the wholesale price. Once everyone is on the same page, they move on to the next phases of the process, which are no different than any standard real estate transaction.

After gaining some experience wholesaling to hedge funds, Saj is able to provide an honest list of the pros and cons:

Pros

• Extremely Quick
  • They have their purchasing process down to a science, so you know exactly what you are going to get
• Higher Purchase Price
  • They pay a lot more for properties than a typical cash buyer

Cons

• Unstable
  • When hedge funds are looking to buy, they are purchasing in mass quantities. Therefore, they expect a consistent pipeline of deals coming in.
  • When hedge funds stop buying, they still expect you to continue to bring them deals. However, they won’t be able to close on them until they have replenished their funds.
    • They may be “frozen” for a few weeks or a few months

All in all, hedge funds never want to turn off their “deal-receiving switch,” but when their engine turns back on, it is churning! They close extremely quickly and will pay a premium for the properties, but you may bring them a deal a week after closing on an amazing deal, and they won’t be open for business.