Gearing and Cashflow

November 20, 2012

One thing to look out for when buying real estate as a foreigner in USA is vendor finance. This usually means that

a. The seller is motivated and is willing to cut a deal and

b. Your return will improve dramatically if you agree a good rate.

Often the price is a little higher than market, but this, as the example below shows, often is more than compensated by attractive vendor finance conditions.

Lets look at an example first –

An investor has $100,000.

Scenario 1 – He buys 2 houses at $50,000 each, with gross rent of $1,300 per house, and net of $900 per house after taxes, management fee, water, and a small set-aside for repairs and void periods.

His net return will therefor be $900 x 2 houses = $1,800 x 12 months/$100,000 = 21.6% annual return on his investment.

Scenario 2 – He buys 2 houses at $65,000 each, and one at $70,000 and is able to negotiate good vendor finance terms of 50% loan to value, with a 15-year loan at 8% interest.  His repayment on this is $996 per month.  The rent is $1,300 per house, the same as the cheaper houses in scenario 1.

His net return will therefor be $900 x 3 houses x 12 months + $555 average monthly amortization – the mortgage payment of $996 per month =  $2,259 per month = 27.1% annual return on investment.

In other words, even though the investor is paying an inflated rate for his houses, the vendor financing gives him a higher return on his money – 27.1% as opposed to ungeared 21.6% net.

The result is a win/win scenario for both buyer and seller – the seller gets a higher price for his house, and the buyer gets a higher return on his money.

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