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Buying an appreciating house on terms
Note: You can use any financial calculator to do this problem, but if you want the BEST, you can
get our
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Financial Calculator for iOS, Android, Mac, and Windows!
THE SCENARIO
I've recently been thinking about how to help starting investors, who have a month-to-month cash flow surplus but not a suitcase full of cash, get into real estate investing. This post covers one idea I had to accomplish that goal.
Say I've got a house that's currently worth $90,000. The house is free and clear (i.e. there's no loan on the house; I own it outright). I want to sell that house to Billy for 120 monthly payments of $750, and Billy wants to buy it on those terms. We would structure the sale such that Billy only takes ownership of the house after the last payment is made (using an option or a tool called '
Contract for Deed'), so I retain the rental income and the obligation to insure it, pay property taxes, etc, for the interim. Billy doesn't need the rental income right now - he makes more than he spends each month.
The question is: Billy is hoping the house will increase in value so that it will be worth enough for him to have made a 9% yield on his investment. If Billy wants to make 9% on his money, what would the average annualized appreciation rate of the house need to be? Assume that Billy follows the schedule and doesn't make any extra payments.
THE SOLUTION
This problem has two parts.
First, we need to find how much Billy's investment would need to be at the end of the 10 years to meet his yield target of 9%.
Second, we need to figure out the what the house's appreciation rate over those 10 years would need to be in order to reach that value.
Step 1
First things first, make sure the calculator is using 12 Payments per Year.
N: 120 (Billy's buying the house over 10 years)
I/YR: 9 (Billy's target yield)
PV: 0
PMT: -750 (Billy's paying $750 per month)
FV: (this is what I'm trying to find)
The answer to Step 1 is that Billy's investment would need to be worth
$145,135.71 for him to meet his yield goal.
Step 2
To keep things simple, we'll leave the calculator using 12 Payments per Year.
N: 120 (The house is appreciating over the same 10 years)
I/YR: (this is what I'm trying to find)
PV: -90,000 (The house's current value is $90,000)
PMT: 0
FV: 145,135.71 (The answer to Step 1)
The house would have to appreciate at 4.79% in order for Billy to meet his yield goal.
Note that after Billy owns the house, he can keep it as a rental, refinance it with a bank (to get his invested capital back out of it without selling it), sell it for cash, sell it on terms, move into it, or do whatever else he wants to with it.
For many people interested in getting into real estate investing, it's a real struggle to find financing to purchase a property and/or to find a suitable property to purchase in the first place. This approach might solve that problem for Billy, while putting extra money in my pocket each month for a decade... which I can use to do other investing, retire debts of my own, enhance my lifestyle, or anything else I want.
What do you think? Would you buy a house like this? What about selling a house that you own? Let us know in the comments!
