It is common for real estate investors to think that profit is generated through cash-flow. We pay $1,000.00 per month for property and collect $1,500 per month in rent. Every month we are “making” $500.00.

While this is somewhat true, it’s not always where “profit” truly lies. This is particularly true in owner financed wraps.

It is actually possible to be paying $1,000 per month, collected $1,000 per month and be reaping HUGE profits.

Profit in a wrap is not equal to the cash-flow, but rather that net interest payment. Sure, there can be profit just in the difference in the two notes. For example, if I take over a note of $100,000.00 and give a new note to an end buyer for $150,000.00, I have immediately created $50,000.00 in profit (equity).

But monthly profit is simply the difference of interest collected and interest paid. In fact, that is 100% of the monthly profit. Always. Every time. It’s never more than that. It’s never than less than that. It is always, forever, equal to the net interest. Always. Did I pound that point home?

As an example. If I pay $1,000.00 in principal and interest to an underlying lender, but collect $1,000.00 in principal and interest from the new buyer (now the new borrower), I have $0.00 per month in cash-flow. But I can still have monthly profits.

If my $1,000.00 payment to the underlying lender breaks down such that $500 is applied to principal and $500 is interest, but the amount I collect is $900 in interest and $100.00 in principal, then my profit is $900.00-$500.00 (the net interest) or exactly $400.00.

But I received $0.00! So how can that be true? Well think of the difference that was just created in equity. Remember, I owed $100,000.00. Now I owe $99,500.00. I was owed $150,000.00. Now I’m owed $149,900.00. Instead of $50,000.00 in equity, I now have $50,400.00 in equity.

Another way to think about it is this: I have put $400.00 into a savings account and $0.00 into my pocket. Sometimes, there is cash-flow. So perhaps I pay $1,000.00 but collect $1,200.00. If my payment is $500.00 to interest and $500.00 to principal, and the payment I receive is $700.00 to interest and $500.00 to principal, I’m actually making less money than in the first scenario, even though I’m collecting more! That’s because there has been no change in the equity, although I get $200.00 cash.

So when evaluating a possible Sub2 to Wrap scenario, it’s important to always look at net interest. While cash-flow seems like profit, it’s not always where the profit lies. Even worse, sometimes, your equity can go down even as you cash-flow. Look at the PI payments, compare and make sure your deal generates a profit, not just a cash-flow.

Every year, StepStone Agents come together and sacrifice a Saturday earning no money for themselves. They aren’t at the river, enjoying family or friends and certainly are not having a nice lazy weekend.

Instead, they are setting up tables, registering golfers, conducting games and running credit cards. Instead of planning their next project, they are helping to raise money for someone else’s home construction. Instead of showing buyers around or selling a house, they are helping to build a free house for someone else.

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