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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 buyer’s 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.
Let’s look at an example to best illustrate where the profit is made in a Wrap deal where an investor is selling a property.
Assumptions:
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 we’re starting to talk business. As all these deals provide positive cashflow, there’s no limit to the number you can do (unlike negative gearing). You’re 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:
Disadvantages:
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 7’s 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. It’s an opportunity that’s available to everyone who either:
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.
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