wrap in country town

[stirling]

I am assessing a wrap of a country property.

My purchase price is $40,000 wrapee purchase price is $50,000
My interest rate is 6.5% wrapee interest rate is 8.5%.

(I am assuming if wraps for $120,000 properties make $30,000 then wraps for $40,000 properties should make $10,000)

My Initial deposit = 30% (country town) = $12,000
Their deposit = FHOG = $7,000
Assume costs of $5,000 for paper work
My initial cash outlay = $12,000 -$7,000 +$5,000 = $10,000

Usual rents = $100. Their weekly payment = $90 + council + water etc
My weekly interest payment = $48 (6.5% IO on $38,000)
Their council + water etc = $40 per week.

If they buy after 1 day I make $5,000
If they buy after 5 years I make $10,000

Compared to renting out.
I need to put up $10,000 instead of $12,000
Cashflow I get $2200 per year instead of ($1000 and zero if hot water service goes).
From bank position I am getting $90 per week instead of $100 per week (worse off)
Unless I pay Council + water etc then I get $130 per week (bank will assess this as better)
After say 5 years I get $10,000 if wrapee purchases. Need to only get 1.05% pa growth to match.

Can anyone comment on this?
Also what happens if interest rates go up. I am assuming I can not fix interest rates for 5 years as the property may get purchased after 1 year?

Stirling

 

[Bear924]

I have also investigate wrapping in smaller country towns however a few points caused me to pause.

- How much deposit is enough deposit when the house is only worth 60K.... Steve Otton suggest a minimum 6K deposit .... can any of your targeted wrappees afford this?

If the price of houses in the country town drop lower (remembering real estate is currently a hot word) and your wrappees decide to walk away do you have an exit strategy...

Does having your money tied up in this deal (20K or so I guess), would you be better to purchase something that will provide capital growth.

Eg
200K house growing at 5% p.a. will increase by 10k every year. This improvement in capital is tax free until you sell, which means that the wrap property will need to earn 10K plus tax to return the same rate.... this is particularly important if your wrappee cannot afford to pay you out and it takes them 20 years to pay back your loan.... it is possible that bank lending will get tighter again shortly.

 

[Carmel]

Also what happens if interest rates go up. I am assuming I can not fix interest rates for 5 years as the property may get purchased after 1 year?

Your deal, you get to decide, surely? Some wrappers refuse to allow payouts within, say, 2 or 3 years. You decide.

Options:

* write up contract so rate = %x, say 2.5% above an agreed benchmark (eg, NAB published variable rate). Then if NAB raises rates to say 6.75, their rate goes to 9.25%.

* fix rate for period of 5 years, write in break cost to contract as condition: it's a cost they pay. You could just refer to it (eg, break cost as charged by NAB), tie it to the interest/monthly payment, or set a figure. You can even have different figures/scales for different periods.

Some examples: Pepper Home Loans charges 3 months interest to borrowers paying out the loan in years 1-2, then 2 months interest in years 3-4 and 1 month's interest in year 5. Liberty Financial charges flat fee of $1975 if loan paid out within 10 years. GE Mortgage Solutions charges $2400 to payouts in yeara 1, $1600 in year 2, $800 in year 3.

Re. deposit: the *only* deposit you're getting is FHOG? So they have *NO* money of their own in the deal at all? No 'hurt' money at all that they actually saved? Feels a bit risky to me & would be advised against by Rick Otton... what commitment do they have? There's a lot of 'ifs' in your deal...

If you can't at least get your costs out of them upfront ($5000) as 'hurt' money, I'd be a bit wary.

 

[stirling]

Excellent point Carmel,

They do need some hurt money. Even if they are renting then they are at least up for 4 weeks bond = $400.
However if they have $5000 + $7000 FHOG deposit on a $40,000 house then they should not have any trouble getting a loan from a bank even if they are ex bankrupts, so why would they want to wrap.
Maybe $1000.
If they walk away after day 1, I make $7,000 (FHOG)- $5,000+ $1000 = $3000.

Bear924,
I wish I could buy some capital gain, negative cash flow property, but I have reached my cash flow limit. Also need to show the bank some cash flow.

In regard to income to show the bank, ideally I should add council, water, insurance onto the weekly payments. Then I can tell the bank "Look I am getting $130 p.w." rather than "Look I am getting $90 p.w."

Stirling

 

[Jacque]

Hey Hey
I think both Steve McKnight and Rick Otton have amalgated here into the one person (Steve Otton!) Not that they'd mind, as they're both very nice fellows. Happy wrapping guys!

 

[Carmel]

If they walk away after day 1, I make $7,000 (FHOG)- $5,000+ $1000 = $3000.

Hmmm... are you definitely sure about that? I'd want to be reasonably certain that you'll actually get to keep the FHOG if they skip after 1 day...

The reason Rick insists on a minimum dep of $5K is to cover his costs in case they default. I do think I'd look closely at your exit strategy, to ensure it's sound. Cover all the 'what if it goes wrong?'