Exploring the world of wraps – a special property investment report
A ‘wrap’ is another term for buying property using what is referred to as vendor financing. Common in the US and other countries, vendor financing is not as widely practised in Australia, but has caught on a bit more in recent times.
Investors can use vendor finance to both buy and sell property. With regard to the latter, the wrap strategy generally involves the investor obtaining normal finance from a lender, buying a property below market value and then selling to a buyer who may have difficult qualifying for traditional finance for whatever reason (i.e. insufficient deposit, self employed, etc.).
The profit margin is made upon sale, when the property is purchased at market price and the interest rate charged by the investor (vendor) is usually slightly higher than the investor is paying on their standard mortgage (this can be as much as 1.5% to 2% more).
Hence the term ‘wrap’, as the homebuyer’s interest charge essentially ‘wraps’ the interest incurred by the investor.
When using vendor finance to buy an investment property, you obviously have the opportunity to pay a lower deposit and don’t have to go though the process of qualifying for a conventional mortgage from a lender or bank.
In adopting the wrap strategy as a seller, investors effectively become bankers, not only making a profit margin when they shift the property, but also collecting residual income in the form of continuing loan repayments.
This arrangement may be indefinite as contractually agreed, or until the buyer can arrange alternate finance from a traditional lender. In other words, the investor has the potential to create long-term cash flow from the deal.
For obvious reasons, wraps are most commonly used in lower socio-economic and regional areas where homebuyers might have difficulty saving the necessary deposit to qualify for a standard loan product.
- Can be a win-win situation for both the investor and home buyer
- Can provide the investor with a greater pool of potential buyers
- When done properly, can generate significant long-term income from the investment – particularly with multiple wraps.
- Can minimise the risk of vacancies, as can occur when holding property for the long term and renting.
- Should the buyer default you will be forced to foreclose on the property and if selling in a tight market, may lose money on the deal.
- You may become limited in your borrowing capacity down the track if you have multiple loans to service.
- Your capital growth is set at the time of sale and therefore restricted, so even if the property’s value increases significantly, you will only receive whatever growth is built in to the initial sale price.
- It can be difficult, costly and complex to set up wraps because of the necessary intricacies of finance contracts.
- The investor has to enforce the vendor finance terms and ensure that repayments are made as agreed and scheduled, which can create a lot of additional work and stress.
- Finance for wrap transactions can be hard to get.
Ultimately, as with any to do with your property investment journey, the approach you take must align with your identified investment objectives and strategy. This should always be fundamental to any decisions you make around your portfolio.
If you would like more information on how you can profit from investing in Australia’s residential real estate sector by establishing clear investment strategies and structures, contact us or subscribe to receive regular post updates and industry insights.
Stuart Wemyss is a chartered accountant and founder of Property Tycoon Finance. Email: email@example.com
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