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Wrap Finance  

 

 

 

 

 

 

Wrap Finance

 

What is a Wrap?

 

A wrap, or wrapping, has become a populist term for selling property using Vendor Financing. The concept has been around for a long time, but has recently received increased exposure as it was the vehicle used by Robert Kiyosaki associate, US investor John Burley, on his journey to financial freedom. Many Australian real estate investors have now adopted the technique and are practising it here.

 

Investors using Property Lease Options to sell properties may often be helping home buyers with little or no deposit monies, but those buyers will eventually still require conventional finance to exercise their option to purchase. Investors selling via vendor financing aim to help home buyers who not only may not have a sufficient deposit, but also those who may have difficulty qualifying for conventional finance (i.e. as is the case with many self employed people).

 

Typically, the investor will obtain the necessary finance and negotiate to purchase a property below its market value. He will then on sell this to a home buyer for market price on vendor finance terms, but with his own mortgage still existing. The interest rate paid by the home buyer to the investor will typically be slightly higher than that paid by the investor on his mortgage, so the home buyerís interest effectively "wraps" that of the investor. The investor makes a margin on the sale price as well as a margin on the interest rate.

 

 

How can they be used?

 

Vendor finance can be used by investors both to purchase property as well as sell it.

 

The advantage to an investor of using a vendor's finance when purchasing property is to avoid having to qualify for and obtain conventional bank finance, and/or to minimise or avoid having to pay a 5%-20% deposit.

 

Investors using vendor finance to sell property do so for the long-term cashflow it can provide - in effect the investor becomes a bank and can collect residual income year on year. His/her target market would generally be in lower socio-economic areas, be they regional or outer-suburban. The reason for this is because more potential buyers can be found in that socio-economic group that are either experiencing difficulty saving for a normal 5-10% deposit, or in applying for finance.

 

Letís look at an example to best illustrate where the profit is made in a Wrap deal where an investor is selling a property.

 

Assumptions:

 

bullet

investor is purchasing at a 15% discount to market price and on selling at market price

bullet

investor is putting in a 10% deposit plus purchasing costs (in the alternative, an investor could obtain 100% finance by using their home equity for security)

bullet

investorís mortgage is at 6.5%

bullet

home buyer's contract interest rate is 8.5%

bullet

both loans are structured with P&I repayments over 20 years

 

 

Investor

Home Buyer

Profit

Property Price

$110,000

$130,000

 

Deposit

$11,000

$7,000

 

Closing Costs

$4000

$1,000

 

Loan

$99,000

$123,000

 

Interest Rate

6.5%

8.5%

 

Monthly Repayments

$739

$1068

$329 p/mth

 

In the above illustration, the investor will have only kicked in $8000 of his/her own money ($15K deposit & costs less $7K deposit received from the purchaser). The purchaser's deposit and legal costs could be largely covered by the govt's $7K first home buyer's grant, so the pool of potential purchasers is enormous (the banks presently knock back about 25% of all home loan applicants).

 

In return, the investor receives $329 p/m of positive cashflow, or $3948 pa. This equates to a 49% cash on cash return on investment. The investor's cash in will be entirely recouped after just over 2 yrs - beyond this they can look forward to $329 p/mth in positive cashflow for the next 18 years.

 

The purchaser, of course, may wish to payout his contract to the investor sooner than that. If so, at a minimum, the investor will make a $16K profit, the difference between his/her cost to purchase and the sale price to the purchaser.

 

$329 p/mth may not sound like much, but multiply it by 20 houses and weíre starting to talk business. As all these deals provide positive cashflow, thereís no limit to the number you can do (unlike negative gearing). Youíre only limited by the amount of finance that you might be able to source or by your cash reserves in the event that you need to kick in a deposit / stamp duty & legals at the outset of each transaction. As we can see, the initial cash that you put in can be recouped within a few years.

 

 

Advantages:

 

bullet

allows you to tap into a huge pool of potential purchasers

bullet

provides a win-win outcome for both the purchaser and the investor

bullet

provides a long-term passive cashflow

bullet

no need to pay for property maintenance - this is the purchaser's responsibility - it's their home!

bullet

the purchaser may qualify for the govt.'s $7,000 first home owners grant, providing them and you with an instant deposit up-front

bullet

provides an alternative to holding onto a vacant property whilst you wait for a conventional purchaser or tenant

Disadvantages:

 

bullet

your capital gain is set at the time of sale and is not unlimited

bullet

there may be a requirement to foreclose on your contract with the purchaser should they default - however, if structured properly, you will likely still make a healthy profit even if it came to this. This risk can be substantially reduced given the right education and implementation of the strategy.

bullet

you may be initially limited in the number of properties you can purchase by the amount of cash or equity you have, as well as by the amount you can borrow to finance the deals. This problem can be virtually eliminated given the right education and the use of vendor or private investor funds. See below...

 

 

Want to know more?

 

Rick Otton is a Sydney based investor who has been selling houses using the vendor finance method for over 10 years. He has sold over 300 homes on this basis and was featured on channel 7ís Today Tonight program on 16-Sep-2002 for a feature story called "The home loan for battlers".

 

Most people have a huge untapped asset under their own feet: their own home. By simply using a small portion of the equity in your home to cover the deposit on an initial second property purchase, you can be on track to generating substantial extra income through this system. You can even turn the equity you currently have in your home into millions of dollars. Itís an opportunity thatís available to everyone who either:

 

bullet

owns their own home or is paying it off; or

bullet

has some cash set aside for an initial property deposit

 

Even if you have neither of these, Rick can show you how to find private investor funds, or how to use vendor funds, to secure your initial properties. Many of Rick's students are successfully doing this by securing joint venture partners - you supply the time and expertise and your JV partner supplies the money.

 

Rick has developed an educational resource to teach other investors the A-Z of wrapping in Australia. See our page entitled Rick Otton's Wrap Pack in our Property Investing section.

 

For a limited time, Rick is also making a very special offer to the Financially Free.com.au community by offering a copy of his introductory Positive Cashflow CD-ROM for Free. This is a limited offer and may be withdrawn at any time. So act now if you think that this strategy may be for you. Rick's special offer can be found on our page entitled Free Wrap Pack Introductory Kit also in our Property Investing section.

 

 

 

The Elevation Group