© 1999 Jon Richards, Publisher, NoteWorthy newsletter
We will discuss a method of making a profit buying and selling VA, FHA foreclosed homes and other homes bought with assumable financing. The method is called “Buy-Wrap-Sell.” It is a relatively safe, relatively risk-free method of buying and reselling single family homes.
The amount of profit in these houses depends on the resale arrangements almost as much as on the purchase terms. If you buy a home with less than a 3% cash down payment, buy it at 10% below its market value, and fix it up for resale (as most investors do), you have built in a strong potential for profit. Structuring the resale to appeal effectively to retail buyers can clinch that potential. Most retail buyers will pay a premium if you can sell to them on good terms, with a low down, and with low closing costs.
One way to sell at this premium price is to “Wrap” your original loan. Let’s look at an example of this sales method, and then examine how you can “wrap” your loan when you sell your investment house.
Our Kind of Place
This is an actual case, and is typical of how investors are making a profit ugly houses with assumable financing. All the prices and figures in this discussion are rounded to the nearest dollar for the sake of clarity. Get your calculator out and follow along.
Ms. Smith a note broker and real estate investor purchased a home in Antioch, CA. It was a large, 3 bedroom, 2 bath, VA foreclosed home. It was ugly! The doors and windows were boarded up, the carpets were dirty, and the walls had grease spots everywhere. The bathroom smelled like a downtown bus terminal. In other words, it was just the kind of house we love to buy. She bought the house at $94,500. The investor felt that $1,500 in cleanup and repairs would make the house attractive to the retail buyer. She also felt that with the help of a broker, and conventional financing, the home would sell for $115,000. We’ll discuss this in a moment, but you should not sell these “fixer” homes conventionally. Here are the steps the investor took in buying and reselling this house.
Structuring the bid
First, she bid a price 3% and $50 higher than the VA asking price, a total bid of $97,385. Her down payment (stipulated by the VA) was $2,000. In ten days she was notified she had the winning bid.
Ms. Smith’s cash outlay to close was $3,150: $2,000 cash down payment and $1,150 in closing costs.
Ms. Smith now owned a house with down payment and closing costs less than 2% of the purchase price. This is virtually impossible in a conventional purchase, even if it is “No Down Payment” deal, because closing costs are usually so high. With VA purchases you only pay wholesale closing costs.
Paint-up, Clean-up, Fix-up
After taking title to the house, Ms. Smith put $1,500 fix-up and clean-up money into the house. She repaired the doors, cleaned the house from top to bottom, and took the boards from the windows and entry doors. Each investor must carefully examine each house for its own problems, then plan the most effective repairs.
Time to Sell: The Wrap
When the work was completed and the house ready for re-sale, Ms. Smith placed an ad in the paper. It read:
♦ Large 3 Bedroom House, $125,000.00, $4995 Down No Points,
♦ No Bank Qualifying, Low Monthly Payments (408) 555-1234
She selected a young couple from the respondents to the ad and sold the house to them for $123,500.
Let’s look now at the terms of the sale Ms. Smith and the buyers agreed upon.
After the $4,995 cash down payment—equal too less than 5% of the purchase price! The buyers owed a balance of $118,505. The investor’s VA note still exists at $95,385. She created a Wrap-Around Loan of $118,505, payable at 11½% Interest Only, all due and payable in five years. At that time, the couple would refinance and pay off our client. This payment period helps the buyers build up a payment record and builds in time for the house’s value to appreciate. Meanwhile, the couple owes our client $118,505 and will pay her 11 ½% annual interest or $1,136 per month. She must, of course, pay the VA the $802 per month she owes on her loan, leaving her a cash flow of $334.
That’s how a Wrap-Around Note works. Columnist Robert Bruss describes it as: “The face amount of the Wrap’s Promissory Note is the total of the existing first (and second, and third, fourth, etc.) mortgage plus the cash or equity loaned by the Lender to the Borrower. The interest rate of the Wrap must equal or surpass the interest rate on the underlying old mortgage, which remains undisturbed when the Wrap is placed on property. In other words, the Wrap wraps around the old mortgage already secured by the property.”
It is truly a win-win situation for both parties. The couple bought a house for very little cash down, did not have to qualify for bank financing or pay lender’s point fees or other costs usually associated with a home purchase, and can build a strong credit record. Our client made a profit in three ways.
First, she had only $2,702 invested ($1,500 in fix-up costs, $1,150 in closing costs and $2,000 down payment, less our $1,948 rebate). But she received $4,995 in the down payment from the new buyers. She received her money back plus a profit of $2,293. This is a profit of 117% for a few weeks work!
Second, she receives $1,136 from her new owners, and pays the VA only $802, leaving a monthly cash flow of $334. She can do two things with the cash flow. She can save it and buy several of these houses, to build a significant cash flow. Or, using that monthly income, she could borrow a large sum of money, and use it to buy more houses, sooner. In fact, she chose the latter course and that is how this investor has accumulated 7 of these houses in 9 months!
The third profit comes in five years. At that time, the couple will pay her the $118,505 they owe her. However, she will only have to pay the VA $91,800 and will have a profit of $26,701. This is because the VA loan will have been paying down (amortizing), while the new purchasers are paying only the interest on their $118,505 loan.
To recap this typical transaction, our VA buyer made a $2,293 profit immediately on the resale of this house, a cash flow of $334 for 5 years (which can be used to borrow more money), and a capital gains profit of $26,701 in 5 years.
The power of this method is twofold. First, this house was a fixer-upper. Ms. Smith could see through the cosmetic damage, and could fix it up to attract a retail buyer. She knows how to make a house look good from the street, how to make the interior interesting at the most effective cost, and how to market the house aggressively. This is not a difficult skill and develops more and more as you invest.
Second, she used a Wrap-Around Loan, in which the new buyer’s $118,505 note included the VA note of $95,385. She benefited from the rate difference between her 9½% loan and the new buyers’ 11 ½%.
Understand and work with the thinking behind the above example, since it is the basis of making money in Real Estate.