how to calculate profit on owner financed sale

Question

How do I calculate the rate of return I'm earning on my money when I hold a note for owner financing?  Details:

$45,000 (investment = property + rehab)

$58,400 note - 8% int.  5 yr. balloon, $525/mo payments (p+i)

David Collins · Answer

Congrats on the profitable sale, Carlos!

It's almost always more informative and meaningful to separate "rate of return" analyses into the component parts of the situation. In your case, you've executed two transactions, each of which has its own ROR.

(All of the following is pre-tax calcs, of course.) Transaction One: You bought for 45K and sold for 58.4K. Your ROR on that move depends, of course, on the time interval between these two, but simplistically, it's what's called the geometric mean of those two values. For example, if the sale came exactly three years after the acquisition, your annualized ROR was 9.077%, compounded annually. This is your yield for the 'holding period' of the property.

Transaction Two was your decision to "reloan" or "invest" the 58.4K sale proceeds into an IOU. For this investment, your yield--or ROR--is precisely 8%, as indicated by the note's rate.

I've taken a very important liberty by ignoring risk for the moment. A correct ROR assessment should take into account the possibility of default on the note, and any expectations thereof. But I think that goes a bit beyond what you're looking for here.

I hope this helps, and best of luck!

David Collins · Answer

A pleasure, Mr. Santiago...

and just to wrap up, that 2K down payment (I assume you mean you received the 2K in addition to the note?) is just an adjustment to your "Transaction One", as I called it. The simple revision is that you bought for 45K and sold for 60.4K. Your ROR is calculated from the spread between those two, and the length of time it took to achieve that appreciation.

Your ROR on your investment in the Note remains unaffected at 8%. And as you say, this is all expressed in 'pre-tax' terms; the after-tax ROR would necessarily be less.

Take care,

Carlos Santiago · Answer

Yes, so helpful!  I forgot to mention there was a $2K down payment.  and of course, taxes will eat some profit.  Thank you Mr. Collins.