Is the brrrr method worth the risk?

[Alyssa Patterson]

How do I go about doing this with 20k in my pocket? 

[Randall Alan]

Quote from @Alyssa Patterson:

How do I go about doing this with 20k in my pocket? 

BRRRR properties are a special breed… meaning they are hard to find right now. The challenge is that when you go to refi, you have to leave 25% of the value in the property.

When you start doing the math it can get tough:

You have $20,000.  On a traditional lender you have to put 20% down.  With the amount of money you have to work with you are almost forced into a hard money lender because you wouldn’t be able to buy the house and fix it up traditionally.  But disregarding that fact for the moment, let’s run a hypothetical purchase:

Let’s say you found a house for $80,000, that for $15,000 in renovations you think could refi for $125,000.  So a $45,000 increase through rehab / forced appreciation.  

A hard money lender usually takes 2% off the top (ie only gives you 98% of the money you borrow), then charges a higher interest rate.  Let’s say 12% to keep it easy (1% a month).

If we work backwards for a moment, if the house appraises at $125,000, the bank is going to require you to leave $31,250 in equity in the property (25%) on the new value.   $125,000 minus $ 31,250 equals $93,750 that they would give you on a refi loan.  

So real quickly you will see that the $80,000 you borrowed, plus say $5,000 to close to buy the property, plus the $4,000 in closing costs to refi the property, plus the $15,000 to rehab the property, plus say 5 months interest ($4,000) exceeds the $93,750 the bank will loan you… so that spread between purchase and ARV isn't good enough to be able to get any cash out of the property.

If you bump the ARV to $150,000 (has to appraise for that - and you won't know if it will until AFTER you have bought it and done the work), the lender will lend $112,500. Your expenses from above equal $109,600 factoring in the 2% the hard money lender took off the top… so you would have a new loan and get $2,900 in cash back at closing.

Finding an $80,000 house that will ARV for $150,000 with only $15,000 in improvements is a TALL order in today's market. It is possible… we have done it a couple of times on phenomenal buys in the past 4 years, but they are very few and far between.

Then there is the risk of it not appraising, cost overruns on rehab, permit issues, vendor delays,  supplier delays,  time delays that run up the interest bill and carrying costs like insurance, electricity, not to mention the downward pressure on the market right now due to high interest rates, which will likely bring housing prices down, etc.  

If flipping, instead of holding, our rule of thumb on any flip is that we have to expect to at least clear $50,000 when we sell the property, because keep in mind you also have capital gains taxes you will have to pay which short term are your actual income tax rate, or 15% if held for over a year (with an income under ~$400,000).

If your question is, “Should I do this?“ I would say the answer is no, not with the amount of money that you have to work with.  it is highly unlikely that you can find a property at the price points mentioned, and you do not have enough in reserve to handle any mess ups. If you could partner with someone that has additional financial resources, it might be a possibility, but on your own it would be a real risky move. 

All the best!

Randy