Purchase Price is $400,000
It will cost $50,000 to fix up and make it ready for re-sale.
She could pay all cash or finance. She talked to a Hard Money Lender who has provided a “future value appraisal” of $675,000. If financed, she can get 100% loan to value and the rate will be at 10% interest only and will cost 4% in points (the Buyer will pay the points out of pocket).
The holding term is 3 years. What will give her a better rate of return?
Step 1 – Solve for the all cash scenario rate of appreciation. $450,000 is the Present Value, 3 year term and $675,000 is the Future Value = 14.47% rate of return for all cash purchase.
Step 2 – Solve for the Future Value loan payoff – the loan payoff is $450,000 because it was an interest only loan.
Step 3 – Future Value minus Loan Pay off = $225,000. To solve for the rate of the financed purchase, you’ll take the $225,000 and enter as future value in your calculator and then you’ll take your amount of points you paid of $18,000 and enter that as the loan amount and then add the 3 years as the term and you’ll solve for the interest rate which = 132.08%.
What This All Means:
If she pays all cash, she will make a 14.47% return on investment (provided it’s able to sell for $675,000).
If she finances with the Hard Money Lender, even though she is paying 4% in points and 10% interest, her return on investment will be 132.08%.
What would you do? Pay all cash and tie up your funds for 3 years for a 14.47% return on your cash or finance the property and get a 132.08% return in 3 years?