Executive Summary:
The Basic Residential Real Estate Investment Model demonstrates our ability to generate superior investment gains through the prudent use of leverage secured against hard assets. This involves acquisition, at or slightly below market value, of homes that are in generally good repair. These are essentially retail investments.
Wholesale investing involves purchasing homes, in need of more major repairs, at discounted prices and adding value through renovation. These opportunities are found through court-ordered sales or from otherwise motivated sellers. Acceptance of wholesale offers requires the ability to pay cash and to close quickly.
When renovations are complete and a qualified tenant is in place, new conventional first mortgage financing can be put in place. This means that an investor may then be able to extract up to 80% of the improved market value. Ultimately we are controlling the same asset, but with significantly less capital.
Adding value through renovation, and this more sophisticated use of leverage, translates into higher returns. Capital raised through refinance can then be redirected to the next project – thus recycling the down payment.
Why Use an Equity Partner?
This is by far the best question I have received. Real estate investors routinely target returns of 20-40%. They just don’t usually share them with you!
It is certainly possible to arrange short-term debt (bridge financing) through private or commercial lenders. Interest rates are naturally higher than conventional financing, but not unreasonable. The problem is that each deal requires at least some new capital, and additional credit when it comes time to refinance. Eventually I will run out of both.
An equity partner is in for the long haul and shares in gains through renovations, as well as cash flow, mortgage principal reduction, and appreciation. Ready access to capital and credit enables us to find and close better deals.
There is risk associated with all investment activity
Seasoned investors identify, mitigate, and manage risk. The lowest risk real estate investments are single-family homes. Townhouses have fewer variables when it comes to renovation – interior only – so there is reduced likelihood of error in estimates. We are minimizing down payment, but not equity, and we are fully secured on title.
These wholesale purchases do however require cash up front, and the luxury of conditions, inspections, and written estimates may be significantly lessened.
Case Study:
This is the same property profiled in the Basic Model. After Repaired Value and rental assumptions are the same. The reason returns are so much better is because of the wholesale purchase price, value added through renovations, refinancing, and most importantly, because the same asset is controlled with less capital.
| Wholesale-Hybrid Model (recycling down payment) | |
| After Repaired Value (retail) | $204,000 |
| Unconditional Cash Purchase Price (90% of ARV less Renovations) | $163,600 |
| Seller Financing | $0 |
| Closing, Carrying Costs & Contingency (3 months) | $4,400 |
| Full Interior Renovations | $20,000 |
| Initial Financial Contribution (Purchase + Renovations + Carrying) | $188,000 |
| Refinance with new first mortgage (80% loan-to-value) | $163,200 |
| Acquisition & Project Management Fee (2% of ARV) | $4,080 |
| Capital Investment Remaining after Refinance (initial + fee - mortgage) | $28,880 |
| Year 1 cash-flow (rent - PITCM) | $4,219 |
| Year 1 cash-on-cash return | 14.61% |
| Year 1 principal reduction (35 year amortization; 2.5% variable interest) | $2,868 |
| Year 1 gain (cash flow + principal reduction) | $7,087 |
| Year 1 return on investment assuming 0% appreciation (gain / investment) | 24.54% |
| Estimated 5-year value (assuming 3.5% annual appreciation) | $242,288 |
| Estimated 5-year mortgage balance | $143,315 |
| Estimated 5-year gain (Value + cash-flow – mortgage balance – investment) | $91,188 |
| Estimated 5-year return on investment (5 year gain / investment) | 316% |
Capital Partner:
The Capital Partner’s projected net gain is calculated as follows:
| Calculation of Capital Partner 5-Year ROI | |
| Estimated 5-year gain | $91,188 |
| 50% of 5-year gain | $45,594 |
| Divide by Capital Investment | $28,880 |
| Capital Partner return on investment (5-years simple interest) | 158% |
A Final Note:
This post is provided for information purposes only. It is not intended to solicit investors.
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