Why don't I ever hear about people losing money doing BRRRRs?

Question

Answer

@Mike SchorahHow exactly do you loose money on a BRRRR?You may end up not being able to cash out refinance all the cash you put in, but you’ve not lost anything. Even if you over renovate it’s still not a realized loss unless you sell. My first BRRRR I had cash in the deal I couldn’t get back at refinancing. However, I got all that back in cash flow in the first 3 years of renting it, on top of covering all expenses. Now it’s churning out cash, but I don’t have a penny in the property now.You really have to work hard loose money on a BRRRR IMHO. Its like stocks. It’s only a paper loss until you sell and make it a realized loss.

Answer

@Mike Schorah not many people want to share failures. If you don't get enough money back after the refi to repay your hard money loan you'll be subject to the penalties outlined in your agreement with the hard money lender... Often you'll be paying a very high interest 10-15%+ for any short-term loan carried after 6+ months. What happens if you don't pay off your credit card balance at the end of the period? Similar situation

Answer

Well, hurts your credit is somewhat subjective. If you are on-time with payments, your credit should always be good. Having more loans out will hurt your credit score to some extent. Terms with your hard money lender can vary. Most lenders are content to just keep raking in 5-20% interest as long as you want to pay it. Some will have some balloon payment that's required. If you buy a house with HM and there's a lien on it, when you refinance that lien is going to be wiped out because they're going to pay it off. If the loan is more than you can refinance out, you'd have to bring a check to closing.

Answer

@Mike Schorah "giving them cash flow" is very similar to repaying the outstanding loan... Your using your money to pay them. Repayment won't just be tied to the deal, it can/should be tied to you personally. I wouldn't let this "what if" scenario scare you into not taking action. If you buy right and manage the rehab the chances you won't be able to pay back a hard money lender are low. When you start looking for hard money lenders you will ask them what happens "if" you're not able to repay within the expected term.

Answer

There's nothing here to fail. All you are doing is taking your equity back out of the property. In a worst-case scenario, you have more in the property than what it is worth. But all of it is paper losses (or gains) until you sell the property. Example: You buy for $100k and put $50k into the property. You anticipate that you're going to let it season 6 months and then it's going to be worth $200k, and you're going to pull out 75% loan to value. When you go to get it done it only appraises at $150. You only get $112k back out of it. That means you left 38k behind in the house. So you didn't get everything back that you hoped, but you didn't "lose" anything. Now if you sell the house in a year and it sells for $125k, then yes, you lost money, but the BRRRR had little to do with the loss - it would have sold for $125k regardless of whether you pulled your money out or not. The only extra loss you might see is in the closing costs you paid to get a loan back on the property. I've done a bunch of BRRRRR. A few times I left money behind. No big deal. The difference still was $100k sitting fallow vs $20k sitting fallow (the amount I left behind). If you're using the money to make good smart investment purchases, your ROI should still be fantastic.

Answer

It happens. It never goes to plan. Just like flips a rehab can cost more, appraises for less, etc. The good thing about appraisals is you can get a 2nd one done if it comes in low. You can also send comps to help support the ARV so you have a better shot.

Answer

@Caleb Brown @Tony Gunter @JD Martin @Jon Kelly Thank you all for your responses. So if you don't get enough back from the refinance to pay off the hard money lender, it just hurts your credit or will they take the entire home? You couldn't negotiate a payback in the form of giving them cash flow?

Answer

@Jon Kelly @JD Martin Thanks for the responses. If the loan is more than I can refinance out, I'd have to bring a check to closing... ...How much of a check would I need to prepare myself for to bring? For example, if it's a $54k property with $19k rehab... Is there a rule of thumb like a certain percentage of the purchase price or rehab that I should be prepared to have in reserves (just in case something goes horribly wrong or over-budget) just in case the refinance can't pay the loan back?

Answer

@Mike Schorah there's no rule of thumb here... let's just think about the math. $54k + 19k = 73k all in cost. Let's say 100% of it was financed with hard money, so you owe the hard money lender $73k. Let's say the property appraises for $80k and your new lender allows 75% LTV. Your loan is $60k (80k X 75%). $60k goes towards repaying your hard money lender. $73k - $60k = $13k you still owe your hard money lender.

Answer

As @Tony Gunter said it all starts with buying right. The old saying you make your money when you buy is true I'm BRRR as well. If failure means not getting all the cash back out when the property is refied then I guess the plan failed. But as long as the property appraises enough to cover the private money loan and the cash out of pocket has to stay in for a while I don't see that as a failure. The money isn't list, just not readily available for a few years. Not an ideal situation but definitely not a failure. They key is to run the numbers before buying.