Have been reading up quite a bit on Vendor Finance lately as a positive cashflow strategy. I am referring to Installment contracts in particular, or a 'wrap' as it's called on 'investor HQ' here. Not to be confused with 'rent to own' or 'deposit finance' types.
From what I have found, if intending to set this up as your dominant investing strategy it appears that most benefit would be gained from this method when the goal is to initiate several contracts and carry it on as a business in its own right. Rather than just one or two here and there (such as trying to offload a single negative geared property from your portfolio), which could be more beneficial if run through a JV with someone who has done it many times before; thus reducing your risk, costs, and learning curve.
That all sounds well and good. But I am curious to learn a bit more about some specific things, and I am sure there are others with similar questions on their minds.
1. What kind of finance is available for someone wanting to start a VF business.
I.e what lenders will provide finance on a property where the intention is to on-sell through an installment contract? Are you limited to Commercial loans? and aren't these typically more expensive?
2. If you already have a residential mortgage on a property, i.e your PPOR or an existing IP, can you (typically) continue to use that? Or would you likely need to re-finance?
3. Do you need a credit license to operate? … Looking at the requirements to obtain a license on ASIC, it seems difficult to break into this market if you don't currently work in that capacity. Anyone from outside the credit industry obtained one of these before? And what hoops did you jump to make it?
4. On the issue of CGT. How does that work for a PPOR turned VF property where it would normally be CGT free if sold and settled on a normal (e.g. 30 day contract)? I understand that on an IP turned VF the capital gains are paid on an emerging profits basis (i.e. as they are paid).
5. On deposits for property, what is the minimum recommended (or minimum required per above lending options) to obtain finance for the initial purpose? It appears the smaller – the better.
6. Instalment contracts. Which states are they legal in?
7. What would be a good structure for carrying out such a business, and protect personal assets/ minimise liability?
All go straight to your questions:
1. Most people starting a real estate vendor finance business start off using regular residential investment loans. There has been on-going discussion here for many years on the need for 'full disclosure'. An earlier posting regarding this issue is at; https://www.propertyinvesting.com/forums/property-investing/creative-investing/4344196?#comment-260266
2. All the JV partners we work with keep their existing loans in place. This seems to be the norm.
3. To answer this question you need to know what sort of vendor finance business you will be operating, i.e. will you be selling properties you own or will you be assisting people to sell their properties with VF? More information on this point is available at: https://vendorfinanceinstitute.com.au/home/acl-pack/
4. Have a chat to you accountant about how CGT is handled when selling your PPOR with VF. Do date we haven't run across anyone that's done it. However, regarding the sale of an IP with VF, I believe you're on the right track, i.e. it's treated on an emerging profits basis. There are some ATO rulings to back this up, so check with your accountant.
5. As with the purchase of most IP's, most investors seem to opt for as little money in the transaction as possible. We have some JV partners with 90% LVR loans on their properties and it has certainly increased their cash on cash return.
6. All States except S.A.
7. We use a Family Trust Structure for properties we've sold with VF. As they are positive cash flow, this precludes locking up negative gearing benefits in a Trust. Have a chat with Richard and/or Terry who are regulars on this forum and really know their stuff.
Thanks for the quick response Paul!
For question 3 the idea would be to sell houses that the business/trust/individual owns, as opposed to assisting others sell through VF (at least initially).
Would a credit license be required for this?
Again, thanks for your help.
If you were helping other people sell their properties with vendor finance, you would be able to operate as a an authorised Credit Representative.
You mention business/trust/individual. This could be three separate legal entities. The question is, when each of these entities is selling it's assets with vendor finance, how many can it sell before ASIC judges these transactions as being done, 'in the course of a business". It is likely that each entity could sell one property with VF and not run foul of the National Credit Code. Some lawyers say you can do three or four before an entity would run up against this problem. Obviously, I suggest you get advice from a lawyer that specialises in vendor finance and the National Credit Code.
Most new vendor finance businesses seem to sell one or two of their own properties and them move onto helping others do the same. This model suits authorised Credit Representative status.
Yes, a bit vague on the structure at this point. More looking from a holistic point of view at 'what could be done' if operating as any of those entities. The specifics of which would need to be thrashed out in consultation with quality professionals I absolutely agree.
At the moment this is really information gathering on a subject I find interesting… But I am also trying to put together a strategy for the coming 5-10 years, of which a business operating VF would be the focus. It seems some of the things I thought were roadblocks may be overcome with the right strategy, advice, and a fair bit of patience.
Thanks for your time Paul. As always you are most helpful! You have some interesting services and products available on your site that I will be sure to look into also.
ScottTerrywParticipant@terrywJoin Date: 2001Post Count: 16,213
Keep in mind if you sell a property with an existing mortgage you will probably be breaching the standard loan agreement you have with the lender.
As far as I know, no traditional lender, i.e. bank, building society, etc, will allow you to 'compromise their security', i.e. breach their loan agreement. If you look at most standard mortgage documentation, you need to get their approval to renovate the property, sell the property and rent the property, among other things. Obviously both they and everybody else ignores these requirements but the 'banks' put these conditions in the paperwork so they remain in complete control, i.e they like to remain in a position where their mortgage documentation allows them to 'call in' the loan when they feel they need to.
On the other side of the coin, a delinquent loan is bad for a traditional lender's balance sheet. The reality is, if the traditional lender gets paid each month, they remain happy and everybody goes about their business. For example, it's is estimated that 25 to 50 homes per week are sold with vendor finance and this has been happening for years
One of the strange things about traditional lenders' attitude towards vendor finance is the fact that, if you go to any 'branch' you will be told they will not approve what you are proposing. Yet, I have two business associates that got $7 million and $5 million lines of credit from two of the big 4 banks, to purchase residential properties and then on-sell them with Instalment Contracts, while the bank's underlying loan remains in place.
I guess that's the difference between consumer and commercial banking, i.e. one section says no, the other yes. We have built our vendor finance business since 2003 and have never had a challenge with an underlying loan lender. Why? Because we make sure they get paid each month
Also, when asked the following question by an PI insurance underwriter, i.e. '"How does the lender (vendor financier) overcome or address the issue of assignment of property under a mortgage with the financial institution?" the following legal opinion was provided by arguably the most experienced vendor finance solicitor in Australia, Tony Cordato:
'The answer to your question is a technical one – there is no assignment of property in an instalment contract. What happens is that the vendor is entering into a Contract for Sale. It is only on completion that an assignment (known as a Transfer) takes place.
An Instalment Contract is a Contract for Sale with a delayed completion.
The Bank / Lender’s consent is required for all Contracts for Sale, so there is nothing different here from standard procedure.
In terms of timing, a vendor notifies their Bank / Lender that they require a Discharge of Mortgage (by providing a Discharge Authority) shortly before completion is due. I find that Banks will hold open their discharge arrangements for a limited time, each Bank being different. The point is that the Banks do not like being notified a long time beforehand – some like the NAB require completion to take place within about 4 weeks after notification
Therefore, it does not accord with Bank practice to notify a Bank that a discharge is required under a Contract for Sale with a delayed completion until completion is imminent.
I trust that this answers the enquiry.'
Cheers, PaulTerrywParticipant@terrywJoin Date: 2001Post Count: 16,213
Excellent answer from Tony Cordato.
I suppose you could also fax is a discharge request with a settlement date of 14 June 2042.
Great information gents. This forum is a brilliant resource that benefits greatly from your participation.
In your experiene, who would be the most common client for a VF home? i.e. Self employed, seasonal worker, poor credit history, first home buyer, etc.
I presume this question may be dependent in some way on the location of the property. Brisbane city for example may be one thing, but Armidale may be another.
*edit* and another question:
Would it be viewed beneficial to some buyers to pay interest only on the VF loan until refinanced?
I guess where my head is at with this question is: What is the goal that you are helping the client to achieve?
Interest only repayments would be lower, and closer to a P&I loan from a traditional lender. I can see where this could bring some higher price/quality properties within reach for some clients, but the downside being that the buyer is reliant on capital growth or manufactured growth in the properties value to gain any equity above their deposit.
Generally speaking, how reliant is the buyer on growth in value to refinance?
We find that the primary goal of our buyers is home ownership and, once they're on their way towards that goal via a purchase with vendor finance, their secondary goal is getting the Title in their name and refinancing into a traditional loan, with a lower interest rate.
NSW has had a pretty abysmal capital gain environment since 2004 (sure, not everywhere), so our clients move towards their secondary goals via the deposit they paid and the gradual equity increase they achieve via their P&I loan with us. We usually find our clients are able to apply for a 90% LVR loan, from a traditional lender, at around the end of year 3 to the end of year 5.
If our buyers had Interest Only loans with us, they would have to rely on capital gain to help them refinance in the future. As capital gain has gone 'missing in action' in a lot of areas we stick to only offering P&I loans to our buyers.
Cheers, PaulNikMMember@nikmJoin Date: 2013Post Count: 1
I'm currently doing research to see whether vendor finance is the right thing for me.
One thing that I can't find a distinct answer to is whether you need to be a registered company with an approved credit license to be able to sell a property as a vendor financier after you have just bought the property via a vendor finance deal, ie, being a on-seller. Could you please verify whether this is the case? Is it possible to do the above mentioned as a private individual?
Thanks in advance!
It's always frustrating when someone answers 'that depends' but that's very much the case here. It depends on two major factors, i.e. what vendor finance strategy you have used to buy/control the property and what state the property is in (as the on-selling rules vary between States).
If you let us know which vendor finance strategy you're planning to buy/control with and the State you're planning to operate in, we'll be able to get back to you with a better answer.