ABOUT MY STRATEGIES
Secure Your Future with
Regular Cash Flow, Using Proven
‘Slow Trade’ Strategies
By Kim Willis
Why
Trading Strategies Are the Best Way
to
Produce Reliable Positive Cash Flow
If
you really are serious about creating a worthwhile income stream from
property,
sooner rather than later, trading is the only way to do it. Buy low; sell high, is the
way to go. But what
sort of trade? Read
on…..
Types
of Trading Strategies
Here
is my definitive list of income rich property strategies:
-
Flips
-
Trick and Flick
-
Build and Flick
-
Property Development
-
Rent Buy
-
Vendor Finance (Wraps)
-
Sandwich
Lease
Rent Buy
Advantages
The
reasons I like rent buy style strategies (and have been actively
employing them
since 2001) are as follows:
-
Positive monthly
cash flow
-
Contract
‘wash up’ profit when the deal matures (completes)
-
Tenant/buyers
usually look after the property better than traditional tenants.
-
Tenant/buyers may
even improve the property for you, at their cost
-
Tenant/buyers
usually will compensate you for rates and insurance
-
Certainty that
flows from having a tenant/buyer who has signed a contract to pay you
$X amount each week, and has agreed to your sale price.
-
Tenant buyer will
pay you an upfront sum (could be $10,000 and more), which could be used
to reduce your cash outlays
-
Taxation
advantages (if property held for more than 12 months)
-
Potential to
build a significant portfolio
-
Use it to finance
your buy and hold investments
-
Use it to quit
the rat race
Types
of Cash Flow Produced by Rent Buy
Look at it like this. The
regular monthly income produced can be
called DRIP Income, whilst the one off lump of income produced at the
end of
the arrangement, can be called BUCKET income.
Example:
$500 per month NOW (Drip Income), PLUS $25,000 wash
up profit (Bucket Income). Good
if you
can get it.
Who is Our
Target Market?
In
a nutshell you want good quality people who do not fit a traditional
lender’s
requirements. Approximately
20 per cent
of first home buyer loan applications get rejected by the banks. So the market is there. Examples could be:
-
Self
Employed who do not have a 20 per cent deposit
-
People
with credit problems (but now under control)
-
People
with non-traditional sources of income
Why
Would Tenants Choose a Rent Buy?
There are many advantages from the
tenant’s point of
view. Advantages
can include:
Rather
than take years to save a big deposit, tenants can acquire a house now
by way
of the rent buy style approach, and create equity which can then be
used as a
de facto deposit. For
many this is a
better way to go than the old fashioned approach of laboriously saving
money
month after month, year after year.
A
Real Life Scenario Using
the Buyer First Approach (Vendor Finance Example)
Here is an example of a
deal we did in 2006. The
house is
situated on the north side of Brisbane. We used the
‘buyer first’ approach.
Therefore we ran some rent buy style
ads,
until we found the right person.
Once we had our buyer we
trained
them on what to look for, and then sent them to work.
Within a month they had found a number
of
houses they liked. We
placed offers on
all of them, and one of the vendors approved our offer.
We call this plan a vendor finance plan
because it is structured just like a long term home loan with interest
levied
on the outstanding balance owing.
On the
other hand, if we had structured it more like a rent buy, with a lower
weekly
payment arrangement, we would only offer a fixed price to the tenant
buyer for
2 years maximum.
How
You Profit
You
make money in a number of ways. Firstly
there is your monthly cash flow surplus.
Then, when the deal ends or matures, you
will receive your back end
contract profit which is based on the difference between your buy price
and the
marked up tenant buyer price.
Purchase
Price:
$269,000
Buy
Costs:
$13,000
Investor’s
Total Price:
$282,000
Mark
Up:
$26,900
Client
Price:
$308,900
Monthly Cash Flow:
$880.38 per
month
Investor
Interest Rate:
7.15% pa
Buyer
Interest Rate:
9.4% PA
POSITION
AT 3 YEARS
1. Cash Flow:
Net
Cash
Flow:
$31,681 ($880 pm X
36 mths)
2.
Capital Profit:
Buyer’s
Price:
$308,900
Less Deposit:
$6,000
Net Buy Price:
$302,900
Buyer’s Amt Owing:
$295,007 (payout at 3
years)
Less Investor Price:
$282,000
Sub Total:
$13,007
Add Deposit:
$6,000 (already received)
Sub Total:
$19,007
Add Early Penalty:
$9,276 (payout penalty –
optional)
Total:
$28,283
3.
Profit Summary:
Net
Capital Profit:
$28,283
Net Cash Flow:
$31,680
Total
Deal Profit
$59,963
Since this deal was done, house prices have
increased. The
above house could not be
bought on the open market today for less than $340,000, so you can
readily see
that the tenant buyers have already created equity, based on their buy
price of
$308,900. In fact
their equity is now
greater than this because of the reduction in principal owing (part of
each
weekly payment they make goes to principal).
Since then interest rates
have also increased. But
this is not a problem, as any increase in
rates the investor has to pay, is passed onto the tenant buyer.
The above case history
does not make allowance for
rates and insurance. That’s
OK too, as
the tenant buyer is required to reimburse the investor for these items.
If you would like examples of more recent deals,
send me an email and I will send you some spreadsheet examples. But I decided to use this
older case history
to show you how quickly a tenant buyer can create equity. Frankly, this arrangement
can often be a better
way for people to go when compared with the oft used advice given to
tenants to
‘take a couple of years and save up your deposit’.
The reality is that few
people have the discipline
to save a worthwhile deposit and even if they were good savers, by the
time
they reached their savings goal, they may well find that prices had
once again
moved upwards.
Using
the Property First Approach to Create More Margin
Done
right, the ‘property first’ approach can be more
profitable than the ‘buyer
first’ approach. This
is because you
will be the one who finds the house and negotiates the price etc. Sometimes, when the tenant
buyer finds the
house, emotion is running hot. They
want
the house, no matter what.
This
can make it more difficult for you to buy the property at a good price,
simply
because you don’t want to upset the tenant buyer by putting
in ‘low ball’
offers that have little chance of success.
Example
of Property First Deal in a Rent Buy Context
The main purpose of this example is to show
you how more margin can be established initially, and how you can use
that
margin to fund other deals. But
where it
gets really interesting, from a financial point of view, is when we
market the
property as a rent buy.
Purchase
Price:
$300,000
Closing
Costs:
$16,000
Makeover
Costs: $36,000
TOTAL
COST:
$352,000
New
Valuation:
$430,000
Refinance
(90% LVR):
$387,000
Original
Mortgage:
$270,000 (90% of
$300,000)
Gross Amount Available For the Next Deal: $117,000
($387,000
- $270,000):
The
above example assumes there is a mortgage on the property in question,
of
$270,000. It is
also assumed that the
balance of the purchase costs, including the deposit, were borrowed
from your
line of credit.
Traditional
Rent:
$400 per week
From
the Tenant Buyer’s Point of View
Price:
$450,000
Weekly
Pmt:
$600
(plus rates and insurance)
Weekly Rent
Credit:
$250
Initial
Option Fee:
$8,000
Rent Credits at End of Term:
$26,000
Total
Credited to Deposit:
$34,000
Contract
Term:
24 months
If market value has
increased to say $480,000 in 2
years, the excess will accrue to the tenant buyer, namely $30,000. This sum can also form
part of the equity
that has been created using this method, which would bring the total up
to
$64,000. Pretty
neat, eh?
At the end of 2 years,
your buyer can buy the property at the pre-agreed price, and all the
option
fees/rent credits are returned. Use
of
this tactic makes it much easier to sell the concept.
Anyway, the upshot of this is that it
has the
effect of giving your buyer at least a 5 per cent deposit. Any additional monies
created, from the
$7,000 FHOG scheme or other sources, can be regarded as cream and used
as
additional equity, or to pay for mortgage insurance and other costs.
Do
Buyers Find This Arrangement Attractive?
Absolutely. But note this: these arrangements work
best in areas that
are likely to produce a good capital gain.
They work best for people who want to
buy a property for $X, yet can’t
get approval for finance now.
This
method allows them to live in the house they want to live in NOW (and
why
not?), whilst they get their financial ‘house in
order’. Benefits
to them over renting are that they
now have a disciplined way of creating the deposit, plus they have
security of
tenure (a big, big issue for this market), and the ability to have the
decor
etc custom tailored to their own taste.
At
End of the Term:
1. Buyer Exercises
Option to
Buy. Buyer
receives Rent Credits
(option fees) AND Bonus Credits (if
applicable).
OR
2. Buyer Decides Not
to Buy. Buyer
vacates the property (you may elect to
give them back a portion of their rent credits).
OR
3. Buyer Can’t Qualify for Bank
Finance. Buyer
vacates the property
or you may negotiate a new option contract (probably at a higher
price!)
YOUR
COSTS
Interest
Pmt *($344,000 at 8.0% pa):
$529 pw ($352,000 less $8,000 option
fee)
Property
Costs (rates and insurance):
$45 pw
TOTAL
WEEKLY COST:
$574 pw
Income
(rent):
$645
pw
CASH
FLOW SURPLUS:
$71
pw
*
Assumes all costs were borrowed inc deposit and reno
costs, making a total of $352,000, less $8,000 being
monies received from the tenant buyer for the Option Fee.
How
You Profit
Profit
is comprised of just two elements: your monthly positive cash flow and
your
capital profit. Because
a rent buy has
no relationship with a finance style arrangement (such as vendor
finance), a
payout penalty is not charged.
1.
Cash Flow*
Net Cash Flow:
$9,880
(Assumes $71 pw net of loan
costs in year 1, and $119 pw net in year 2, because of a mandated
increase in
year 2 rent)
*Excludes rates and
insurance. Assumes
mortgage interest expense remains constant.
2.
Capital Gain:
Total
Property Cost:
$352,000
Sale
Price:
$450,000
Gain:
$98,000
Less Rent Credit (Buyers Deposit):
$26,000
Balance:
$72,000
Less (Optional) Bonus Rent Credits:
$6,000
Net
Gain:
$66,000
3. Total
Gain:
Net Cash Flow:
$9,880
Net Capital Gain:
$66,000
Total
Profit:
$75,880
The above example
represents an excellent return considering the short 24 month time frame.
If
Bonus Rent Credits were not
offered, profitability would be further enhanced by $6,000.
How
Much Money Do
You Need to Get Started?
You
need as much as $80,000 (sometimes more) and as little as $0. This will depend on how
much money your buyer
gives you, the amount of vendor rebate (if any), whether you renovate
(and
refinance afterwards to extract more cash), what percentage of the
purchase
price a lender will advance to you, and if the $7,000 First Home Owners
Grant
is payable (and when).
You
will also need to have the ability to borrow at prime interest rates. Let’s have a
look at some scenarios (based on
the example already shown above):
SCENARIO # 1
Cash Invested:
Deposit:
$30,000
(based on 90% LVR)
Buy
Costs:
$16,000
Renovation:
$36,000
TOTAL:
$82,000
LESS:
Buyers
Deposit:
$8,000
NET
CASH IN THE DEAL:
$74,000
SCENARIO # 2
Cash Invested:
Deposit:
$30,000
Buy
Costs:
$16,000
Renovation:
$36,000
TOTAL:
$82,000
LESS
Buyers
Higher Deposit:
$15,000
$7,000
FHOG:
$7,000 (if
instalment contract)
Vendor
Rebate: $20,000
NET
CASH IN THE DEAL:
$40,000
Of
course the above example assumes a renovation cost of $36,000. If a renovation is not
carried out (which is
common), the above example would show a Net Cash in Deal figure of just
$4,000!
How to
Create Even More Monthly Cash Flow –
Vendor Finance
The foregoing example shows monthly net cash flow
of $307 ($71 per week). This
is good, yet some of the deals we do
produce monthly net cash flow of up to $1,200 per month. How?
We achieve this by adopting the rent buy
sister strategy, vendor
finance. Vendor
finance is a longer term
arrangement with a fixed price contract.
It
works just like a real finance plan in that an interest rate (pitched
typically
2% above prime bank rates) is charged on the outstanding balance. The balance is reduced
progressively over
time by way of principal reductions.
This comes as a result of the tenant
buyer paying an extra amount each
week, over and above that which would be required if only an interest
only
program was in place.
All
of this has the effect of delivering to the investor a higher income
stream. The
downside from the tenant
buyer’s point of view is that their weekly payments will be
higher. Although
the longer term protections in
place for the tenant buyer (with a fixed price), together with the
payment of
the First Home Owner’s Grant (if an instalment contract is
used), make this a
worthwhile option for many people.
Common Questions Investors Ask
Aren't These
Arrangements High Risk?
Define risk. Our position is that if the practitioner has
sufficient
skill, the risks are very manageable. Low even. One of the keys is to buy
assets that are
priced below market value. Where is the risk in that? Even if you have a problem
with the rent buy
deal such as a default, you can either sell the property, remarket it
as
another rent buy, or convert it to a long term buy and hold and install
a
tenant.
Are
Defaults a
Problem?
Sometimes, although in our experience, total defaults are
low. If a
problem occurs, we also try and work through the problem with the
client.
Usually, the problem is resolved and a total default is avoided.
How
Can You
Justify Interest Rate Mark Ups? If
it's good enough for sub-prime lenders to charge a
premium for risk then why not for us? Mark ups should be
reasonable, in
the range of 2 - 3 per cent above normal bank rates.
How
Do You Find
Buyers?
We use
ads, signage, flyers, word of mouth, shopping centre promotions.
How
Do You Buy Below Market Value? We
do it by finding motivated sellers. We find them
via agents and through private sources. That's
simple. We nuance
this approach in a variety of ways. We have developed a very
tough
approach, simply out of necessity - our clients need affordable
housing.
If we were to pay too much, their situation will be jeorpardised.
Recent
Negative
Publicity Suggests That These Arrangements Are Dodgy. What Is
Your
Response?
The basic
strategy is sound. But like all things - execution is
all. We pride
ourselves on taking an ethical, caring approach. Keep in mind
that the
media are big money making organisations that make their money from
high
ratings.
High
TV ratings
flow from presenting unusual stories with news appeal. They
tend to have
a black and white view of the world, and often do not present a
balanced
view. This is not to defend unethical practices, but simply
to say that
hard luck stories that are presented, usually represent the exception -
not the
rule. Check out our subsidiary www.homebuyexpress.com.au and see for
yourself.
What
About the
Legalities? The
use of option contracts is legal in every state of Australia.
The use of instalment purchase contracts
is
illegal in South Australia. Please check with your
lawyer for further
clarification.
How We Find Tenant Buyers
We
mainly use ads in local papers. Here
are
some examples of headlines:
Where to From Here?
My
Creative Cash Flow Home Study Course is a fabulous resource. It includes manuals,
CD’s, contract templates
– just about everything you need to get started. And, it also includes
generous LIVE SUPPORT so
you can connect with professional deal makers in my team (maybe even
me), who
can answer your questions and give you great ideas.
It’s a significant program for
significant
people. If you want
more info go to our
website at www.cashflowprograms.com/creative,
or drop me a line.
Blog. Visit my Blog at www.propertyprofitsblog.com.au
Finance. Talk to www.ZapHomeLoans.com.au
Joint Venture. Visit www.CashFlowProperties.com.au
