Enhancing Profit Made On Real Property

Posted by Ric Thom on October 18th, 2010

Wrap around real estate contracts (RECs) can enhance the profit made on real property. There are literally dozens of different ways to use a wrap around REC. Here’s just one example.

Carmen purchased a piece of vacant land a couple of years ago. She bought it from Robert on an assumable REC. Today she owes Robert $100,000 at $1,000 per month at 8% for the next 166 months. Jim shows up and just has to have her property. He offers Carmen $130,000 for the property. Jim wants to give Carmen $30,000 down and assume the $100,000 REC that she is paying Robert on. Carmen doesn’t want the $30,000 cash for two reasons. First, she would have to pay capital gains tax on her profit now. By using seller financing she can spread her capital gains tax out over the life of the contract. Secondly, she doesn’t have a better place to invest her money. So, Carmen and Jim agree that they will enter into a REC where Jim puts down $10,000 and will pay the remaining balance of $120,000 to her under the following terms: $1,337.23 per month at 10% interest for the next 166 months. Carmen is leaving $20,000 of her equity in the transaction. Carmen promises, under this contract, that she will have Robert paid off before or at the same time that Jim pays her off.

Here’s the mechanics: Every month Jim sends $1,337.23 to the escrow company, as per his and Carmen’s contract. Carmen has instructed the escrow company to send the entire $1,337.23 she receives from Jim to Robert on her behalf. By doing this Carmen will have Robert paid off in 104 months instead of 166 months. Then, Carmen no longer owes Robert, but Jim will still owe Carmen $64,500 at the end of the 104 months or $1,337.23 for another 62 months. The most important thing to remember when structuring a wrap around real estate contract is to make sure the wrap around contract does not amortize faster than the underlying obligation which it pays.

Carmen turned $20,000 into $64,500 in just 8.6 years. If Jim makes a lump sum payoff of $64,500 on the 104th month, Carmen’s return on her $20,000 is about 13%. Now, that’s a wrap.