What are Novations in Real estate – Should you do them?

Novations are a buzzword among investors and wholesalers.

It’s a “new” strategy that enables wholesalers to tie up more contracts and make a little more on a deal — especially on a house that doesn’t need repairs, doesn’t need to sell fast, and doesn’t call for a deep discount wholesale price.

In this article we’ll cover a few things:

  • What is a “novation”.
  • How to perform a novation deal.
  • How to find these deals.
  • And some “dark” consequences of doing them.

Let’s dive in….

What are Novations in Real Estate

In real estate, a novation is a legal process where an original contract is replaced with a new contract, involving a change in parties or terms, while maintaining the essence of the original agreement. This process allows for the transfer of rights and obligations from one party to another, effectively creating a new contractual relationship.

In Simple terms:

Simply… a novation contract enables you (the wholesaler) to take a house, list it on the MLS for a certain price (typically lower than the retail value), and then if it sells HIGHER than that price, then the wholesaler collects the difference.

An Example of a Novation Deal in Real Estate Wholesaling

Let’s break down how a novation deal works with a real-life scenario:

Step 1: Finding the Property
Imagine you, as a wholesaler, come across a well-maintained property. The owner is looking to sell but isn’t in a rush and the house doesn’t require significant repairs. It’s the perfect candidate for a novation deal because it can attract buyers on the MLS (Multiple Listing Service) due to its good condition.

Step 2: Negotiating the Novation Contract
You approach the seller and propose a novation agreement. Here’s where you explain the benefits: the property gets listed on the MLS, potentially fetching a higher price than a quick, off-market deal. After some negotiation, you agree that the property will be listed for $300,000, a competitive price considering its condition and market value.

Step 3: Listing the Property
You list the property on the MLS at the agreed price. Since the house is in good shape and well-priced, it attracts interest. Your role here is to leverage the MLS to get the best possible offer, something the seller might struggle to do on their own.

Step 4: Closing the Sale
After a few weeks, you receive an offer for $320,000, which is $20,000 above the listing price. The seller is happy because they get the full $300,000, which was their target. The buyer is satisfied because they’ve found a well-maintained home.

Step 5: Earning Your Profit
Here’s where the novation deal shines for you as a wholesaler. The difference between the selling price ($320,000) and the agreed-upon listing price ($300,000) is your profit. In this case, you earn $20,000. This is the essence of a “net listing” in novation deals – you collect the excess over the agreed listing price.

In this example, the novation deal worked smoothly. The seller got their desired price without the hassle of marketing and negotiations, the buyer acquired a great property, and you, the wholesaler, earned a profit without investing in repairs or having to find distressed properties. This scenario highlights the efficiency of novation deals in the right market conditions – particularly with properties that are in good condition and can be listed directly on the MLS.

What’s the difference between a net listing and a novation?

Understanding the nuances between a net listing and a novation is key for wholesalers, agents, and investors navigating the real estate landscape. While they share similarities in outcome, their processes and legal standings differ significantly.

1. Who Performs Them:

Net Listing: This is typically performed by a licensed real estate agent. In a net listing, the agent agrees with the homeowner to sell the property for a minimum price, and anything above this price becomes the agent’s commission. However, it’s crucial to note that net listings are not legal in all states due to potential conflicts of interest.

– Novation: This is often the domain of unlicensed wholesalers. A novation allows wholesalers to effectively engage in what resembles a net listing, but without the need for a real estate license. The wholesaler agrees to sell the property for a certain price and, if able to sell it for more, keeps the difference.

2. The Contractual Differences:

– Net Listing Agreement: This is a formal agreement between a homeowner and a licensed agent. The contract outlines the terms of the sale, including the minimum sale price and the agent’s commission, which is the excess over this base price.

– Novation Contract: The novation contract is fundamentally different. It involves the wholesaler entering into an agreement with the homeowner to sell the property, and then finding a buyer to whom they transfer their contractual rights. The original contract is ‘novated’ or replaced by a new one, where the end buyer directly deals with the original seller. The wholesaler’s profit comes from the difference between the original and final sale prices.

In summary, while both net listings and novations can result in a similar financial outcome, they are distinct in their execution. Net listings are more regulated, requiring licensed agents and legal in only certain states, focusing on the agent-homeowner relationship. Novations, on the other hand, allow wholesalers to step into a similar role without needing a license, using a different contractual approach to achieve a comparable result. Understanding these differences is crucial for anyone looking to leverage these strategies in the real estate market.

Are Novations Legal in Real Estate?

Navigating the legality of novation deals in real estate can be a bit of a gray area, varying significantly from state to state. Generally, due to the specific nature of the novation contract, many states do recognize and allow these types of transactions.

However, it’s crucial for wholesalers and investors to understand that the legalities hinge on the precise wording and structure of the contract.

Given this variability, it’s highly recommended to consult with a real estate attorney in your specific state to ensure that your novation deal aligns with local laws and regulations. This due diligence is key to conducting novations both successfully and legally.

How to Find Novation Deals in Real Estate

Finding novation deals requires a strategic approach, focusing on off-market strategies and direct-to-seller tactics. The ideal properties for novation are those with significant equity, generally 30% or more, and don’t necessitate quick sales or extensive repairs. Here’s a step-by-step guide to uncover these opportunities:

1. Direct Mail:
– This is a powerful tool to reach potential sellers directly. Utilize services like us, Ballpoint Marketing. We specialize in handwritten mail! Which is the top way to reach owners. This personalized touch can significantly increase your response rate. Tailor your message to target homeowners who have considerable equity in their properties and might not be in a hurry to sell. Highlight how a novation deal can be beneficial for them.

2. Cold Calling:
– A proactive approach involves cold calling homeowners. This method allows you to directly engage with potential sellers, explain the benefits of a novation deal, and assess their interest and situation. Focus on areas with high equity properties and refine your pitch to address the specific advantages for homeowners in a novation deal.

3. For Sale By Owner (FSBO) Listings:
– FSBO listings can be goldmines for novation deals. These sellers are already motivated to sell without an agent, which aligns well with the novation approach. When contacting FSBO sellers, present the novation deal as a solution that could potentially yield a better return for their property.

4. Referrals:
– Networking with other real estate professionals, investors, and even past clients can lead to referrals. Inform your network about your interest in novation deals and the specific criteria you’re looking for in properties. A strong referral network can be one of the most effective ways to find hidden gems in the market.

Remember, the key to successful novation deal hunting is a combination of direct, personalized outreach and a clear understanding of the property criteria that align with novation deals. By targeting properties with ample equity and homeowners who are not under pressure to sell quickly, you position yourself well to uncover and secure profitable novation opportunities.

How to pitch sellers a novation

Pitching novation deals to sellers is an art that involves clear communication and negotiation skills. Your goal is to present options that cater to the seller’s needs while also outlining the benefits of a novation deal. Here’s a step-by-step approach:

1. Understand the Seller’s Situation:
Before presenting any options, understand the seller’s motivations and needs. Are they looking for a quick sale, or are they more interested in getting a higher price for their property? This initial assessment will guide your pitch.

2. Present Two Distinct Options:

– Option A – Wholesale Price: This is the quick cash offer. It’s lower than market value, but it provides the seller with a fast, hassle-free sale. This option is best for sellers who are in a hurry or have a property that might need repairs.

– Option B – Novation Deal: Here, you offer a potentially higher price through a novation contract. Explain that the property will be listed on the MLS, aiming to sell it for a higher price than the wholesale offer. The seller gets more money, but it requires time and access to the property for showings.

3. Highlight the Benefits of Each Option:
Clearly outline the pros and cons of each option. For the wholesale price, emphasize speed and convenience. For the novation deal, focus on the potential for a higher sale price and exposure to a broader market through the MLS.

4. Negotiation and Agreement:
– Once the seller shows interest in one of the options, start negotiating the terms. Be transparent about how you will proceed with the novation deal, including listing price, expected timeframe, and your role in the process.

5. Finalize the Contract:
After reaching an agreement, ensure all terms are clearly laid out in a contract. This contract should detail the agreed-upon price, your commission as a wholesaler in case of a novation deal, and other relevant terms.

Remember, the key to a successful pitch is building trust with the seller. Be honest about what you can deliver and ensure that the seller understands each option’s implications. This approach not only helps in closing the deal but also establishes a reputation for fair and transparent dealings in the real estate market.

Here’s a video on how to pitch novations, from an investor who specialises in Novations:

The Disadvantages of Novation in Real Estate – The Dark Side

While novations can be an innovative strategy in real estate wholesaling, they come with their share of potential drawbacks. It’s crucial to be aware of these pitfalls before diving into this practice.

1. The Fine Line Between Agent and Unlicensed Agent:
Novations operate in a legal gray area. As a wholesaler, you’re essentially performing tasks similar to a licensed real estate agent but without the license. This can raise legal questions. While the contract in a novation deal might offer some protection, it’s a thin line that could potentially attract scrutiny from legal authorities. Always consult with a real estate attorney to navigate these complexities. Remember, laws vary by state, and what might be permissible in one area could be illegal in another.

2. Potential Seller Anger and Reputation Risk:
Post-deal seller remorse is a significant risk in novation deals. There have been instances where sellers feel misled after the fact. They may perceive that the wholesaler misrepresented the property’s value, enabling the wholesaler to make a substantial profit by listing it on the MLS. This perception can lead to negative reviews and a tarnished reputation. Many wholesalers who frequently engage in novation deals face backlash in the form of bad Google reviews and community disapproval. This negative feedback often stems from sellers who believe they could have gotten a better deal without feeling that the wholesaler added any real value.

Conclusion:
Entering into novation deals requires a thorough understanding of not just the potential profits, but also the legal implications and ethical considerations. While these deals can be lucrative, they must be approached with caution, transparency, and legal advice. Keep in mind that the long-term success in real estate often hinges on your reputation and ethical practices. As such, weigh the immediate financial gains against potential future repercussions in the community and legal landscape.

Here’s a quick video, from Ryan Dossey, on reasons why he doesn’t do creative finance often or novation: 

Understanding Novations in Real Estate

Novations in real estate are a strategy for wholesalers to potentially earn more by listing properties on the MLS and profiting from the sale price exceeding the listed price. While they offer opportunities, particularly for properties not in urgent need of sale or repair, they come with legal complexities and require careful navigation of state laws. The key to success in novations lies in direct-to-seller strategies, clear communication with sellers, and an awareness of the ethical implications and potential for seller remorse. It’s a nuanced approach that demands transparency, legal understanding, and a strong grasp of market dynamics.

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