Factoring reserves into BRRRR Analysis...do you?

Question

The main strategy behind BRRRR as I understand it is if done correctly you can recover your original investment with a refi and go do it again (repeat).

When you analyze a property do you include your reserve fund (for simplicity let's just say 6 months PITI) in your analysis when determining whether or not to buy a property using the BRRRR strategy?

If you don't - then to me you are setting your self up for spending that 6 month reserve out of pocket every time you buy a property. Let's say you do that 10 times in a year and the reserve is $6000.00 - it will cost $60K cash out of pocket in that year to do the BRRRR Strategy and have sufficient reserve for each property you purchased. So to me - i think i should factor in this expense and essentially underwrite it into my deals analysis.

However my concern is - does factoring this additional expense in make it unrealistic criteria and properties too difficult to find? Or should a prudent investor buckle down and do more work to find the right deal to meet his criteria? I think the answer is obvious that you should factor it in, but would love to hear from the BP Community.

The more I learn about R/E investing the adage "you make money on the purchase" seems to be more and more true. I haven't done a deal yet, but gearing up to.Any thoughts are welcome. Thanks All.

Travis

Israel Garavito · Answer

@Travis Hawthorne

We always factor in 230-250/door/year for replacement reserves for every property in acquisition and increase that amount yearly, proportionally. We underwrite it as part of our acquisition and the deal has to make sense with the reserve amount in place.

We also include an operating reserve or 1/2 to 1.5 months (depending on the property and the business plan) of expenses in operating reserves.  As we stabilize and refinance we will modify as needed.

The deal has to make sense with replacement reserves (which you will pay out eventually) and operating reserves (which keep the business running in potentially difficult situations, like COVID).  At refi you can modify, and when you sell you get the money back either way.

Daniel Zapata · Answer

@Travis Hawthorne you should definitely have money in reserves as a backstop until the property can build up it's own reserves. I invest in the Sacramento area and haven't found a BRRR deal yet where I get 100% of my money back. I'm ok with leaving some money in a property if I'm getting a good enough return on it.

Joel Calkins · Answer

As a new investor being strapped for cash seems like a common trend. Especially when applying the BRRRR strategy I like to calculate for a higher downpayment to get more out of the refi.

This being said in my opinion calculating a good amount for PITI and CapEx will give you a good cushion and mitigate the blow to your bank account. Also with the current moratorium on rent payments and uncertainty in the job market accounting for reserves has never been more paramount.

If possible find a deal that isn't on the border of cash flowing with all of your expenses paid for because in the real world something is going to break and tenants are going to screw you over. So plan for it!

Daniel Zapata · Answer

Travis,

I factor in the reserves as part of the cash flow analysis when the property is stabilized, typically 6-12 months after acquisition for me. Hopefully you've addressed most of the potential issues during your renovation, so you're just filling up those reserves for a while after stabilization.

Israel Garavito · Answer

@Travis Hawthorne

Yea we underwrite with those numbers for acquisition and ongoing operations.  I am not sure if the numbers work for single family or smaller multi family (may not be sufficient, as in MF there is less %income lost/unit in vacancy).

Travis Hawthorne · Answer

Thanks@Daniel Zapata. That clarifies a bit for me. Sounds like it is optimistic to expect to get 100% of your money back on every BRRRR. Leaving a few grand in it isn't the worst I suppose.

@Israel Garavito - great insight. As an example let's say you are analyzing a duplex with a PITI of $1200 month for simplicity sake. In your model are you saying you would include $460-500 (230-250 door) for replacement reserves plus $600-1800 (1/2 to 1.5 month) which comes to a total of $1060-2300 in total reserves for the duplex during underwriting? The way you described it is how I personally view it - that reserves should be listed as an acquisition cost in the same way that we view property cost, rehab cost, purchase closing costs, (the list goes on).

Travis Hawthorne · Answer

@Daniel Zapatael Zapata - good point. If you just renovated then something major going wrong in the first 6-12 months seems unlikely. With your approach the result seems to be you're not spending your own cash on reserves and can keep it working for you in other capacities. However in my view that property isn't stabilized yet if there's no reserve fund. If to your point it takes 6 months to a year to do that so be it. I guess what I was hoping for so to speak is that disciplined inventors can find the right deal to ensure that on the refinance you actually get a little cash back above and beyond your cash outlay for acquisition to account for the reserve fund. I know that's possible, but not sure how realistic it is to make this a criteria on every deal. My worry is if that was a criteria than I wouldn't do many deals.

@Joel Calkins - thanks for your input. Agree 100% on allocating for capex and PITI in a general sense. Question is more about if you make it a standard in your deal criteria that on the refinance of your BRRRR you get cash back above and beyond your initial cash outlay to account for the reserves and truly recover 100% of your investment. Otherwise even if you do a "perfect" BRRRR and get 100% of your acquisition cost back, you still need to have a reserve fund which will be an additional cash outlay at some point. Sounds like @Daniel Zapata just let's that fund build in the first year through rent accumulation.

Factoring reserves into BRRRR Analysis...do you?

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