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Updated over 7 years ago, 04/05/2017
Accumulating Rental Properties
I'm working on finding a rental property as my first deal. For right now, I'm focusing on pretty much turn-key properties. If I stick with this and spend all of my money allocated for real estate on this first property, how would I go about getting my next property (and more after that)? If I was to get a loan for 80-90% of the equity in the house, I'd quickly reach the point of diminishing returns and I might have a 'seasoning period' to take into account as well. It seems like this isn't the best way to build a portfolio. Or it would just take forever to save up enough to buy the next house each time (depending on my savings rate, of course).
I have no experience w/ renovations, but I feel like BRRRR is the only way to build a portfolio in a reasonable amount of time.
@Chris Masons that's a good idea about showing it before closing (if allowed). I'll try to implement that myself.
How are you financing most of your deals? It doesn't seem like you're buying super cheap stuff, adding a lot of value, and refinancing. Are they mostly multi-family or SFR?
Hi Andrew,
I generally put 20% down and as of my last 6 deals I brought on a partner so essentially 10% comes out of my pocket.. I generally won't invest unless I can achieve a minimum of 12 to 14% cash on cash returns....
I have built up a portfolio consisting on multi families (largest is a 4 fam) single families, and as of lately condos....
I find that your biggest return will come from multi families.. (from a cash flow perspective) If you do not currently own consider buying a 2 family and owner occupying one unit.
This is a great way to get your feet wet and gain experience.
best regards,
Chris
hi @Andrew Merritt,
to answer your question. in 2005 we used a commercial loan. Prior to 2008 you could just get one secured by the property to be purchased, even if not owner occupied. no more! in 2016 and now we are using a combo of capital and personal equity, but eager to try the true BRRR with a business loan next year, assuming that we have built up enough equity in the rentals to get a loan. This only works for us because we are aiming at small properties that we can handle outside our "real" jobs
Originally posted by @Andrew Merritt:
Thanks @Lee S., this is the counter argument to my strategy that I was thinking about and it seems like a good way to go as well. It just seems like you can get to a higher cash flow rate more quickly this way. Where do you find most of your deals, on auction or just off the MLS?
Andrew, welcome.
You need to develop a strategy for off-market deals. That's where the best deals are found. Currently the market is flooded with buyers and not enough deals. Even my partners who own 1,400 units struggle with the same thing. They raised money from Israeli and Chinese investors and they see a lot of capital flowing into MF properties. But going back to the offmarket, that's really the best to find quality properties.
One simple idea, find properties behind on taxes. Those sellers would be motivated. Or find properties that look a little shoddy compared to the area they are in. Go ahead and talk to the tenants about the property management. Or if the building is small enough, ask about the owner. Is the owner ever around or is managed by a 3rd party?
We are are seeing is that investors from the East and West coasts are investing in places like AZ, TN, TX, etc. And the focus is on Class B/C properties. But absentee owners also a lot of times leads to mismanagement. We see that also where properties are mismanaged and they end selling because they couldn't make it work. Obviously the goal is to find such properties. But that requires a strategy and a plan. I'm not saying online you won't find anything, you certainly can. But having a more pro-active approach of going after them rather than waiting for them to pop up online is a better approach.
Build relationships with MF brokers in your area. Google them. Tell them to put them on their email blast. Hope this bit helps. If you need any more help, I'd be happy to answer.
@Andrew Merritt I have pretty gone the 1st route you mentioned by buying two "turn-keyish" properties and renting them out and have two comments you may or may not find useful.
1. You don't need to buy a newly renovated 100% turnkey property to benefit from a more conservative rental strategy. When I say turn-keyish I mean a modest but quality home in a stable area that requires around $5k of work to increase rent by 20-25%. For example, I recently purchased a property that was in great condition but had really ugly paint colors and older kitchen cabinets (pictures below). I purchased the property and painted it a more neutral gray, fixed some of the warn down baseboards, replaced some really ugly window fixtures and stained the kitchen cabinets a natural wood color (all in around $4k of work some self performed some contracted). I was able to rent the property for $1,200 a month and 6-months into the renal it is on track to generate a 19% cash on cash return.
Before
After
2. Like all investments higher return generally means higher risk. When the BRRRR method works out there is no question it pays a higher return than a more conservative rental strategy. However, a successful BRRRR requires the economy remain strong, that you find a significantly undervalued property (your valuation needs to be correct), perform all renovations without any problems or cost overruns, get the renovated property appraised at the value you want, find a lender willing to give you close to an 80% loan appraised value loan, find a quality tenant in the up and coming area etc. It is definitely possible that all of these things work out but requires a lot of research and work and it is important to know what your limitations are in the case that things do not work out as planned.
From your profile it looks like you have a wife and new child (congrats!) which I would imagine drastically changes your risk tolerance. As long as you put in the hard work and put together a well thought out contingency plan I am sure you will be successful with either route. Good look!
@Account Closed wow, I didn't realize that little of an investment would increase rent that much. Also, I like your 2nd point. I read about all of the successes that people have in real estate that I often forget about the possible negatives. That being said, I think the market will get even better near me soon as there area lot of good manufacturing jobs coming in (Volvo) and plenty of other solid industry here too (Boeing, military, etc). But you're right, you never know what could happen.
@Account Closed I disagree a little bit with your #2 point. Economy is irrelevant if you're choosing to buy turn key or do a BRRRR, either property will be hit in value. If you're trying to decide between the two, it means you have enough money for the down payment on a turnkey. Neighborhood is also irrelevant to the argument, you have to assume same class of neighborhood for both to make a comparison. You cant compare the two and assume the BRRRR is in a war zone and the turn key is in an A area, in fact, I think most turn keys are in lower class neighborhoods and you can get yourself into a higher class neighborhood for less by doing a BRRRR.
What happens if I buy a BRRRR and I miss my numbers in one way or another? Instead of 25%+ equity and no cash in the deal, maybe I only end up with 15% equity and a little money left in the deal. Still better off than buying a turnkey. So, from your example, the only way a BRRRR would be more risky is if you are using high cost money for the purchase and rehab and can't get a high enough appraisal for the refinance. However, We are comparing from the stand point of having enough money for a down payment on a turnkey anyways so this point is also moot.
If you have the time, it is infinitely more profitable to do a BRRRR over a turnkey. How do I know this? My return is infinite, while those buying turn key are getting 10-15% cash on cash with a pile of their money locked into the property, I have none. It will take a turnkey buyer ~a decade to make their initial down payment back, I've got all my money back in 6 months. A turnkey buyer is stuck in the property and can only sell at a loss for years (commissions etc, most bought above retail value), a BRRRR can be sold at a profit once rehab is done in 2-3 months. I can now take my money and repeat again immediately, the turnkey buyer has to lock up another 25% down payment to do another one and may have to save up for a long period of time to repeat.
Can you tell which one I favor? I wouldn't even consider a turnkey, ever.
Before a start my diatribe on why cash flow properties are better than BRRR in my opinion I need to clarify that my post did not advocate buying just renovated pure turnkey investments at market value. My strategy is to buy quality but modest properties with a below market price to rents ratio.
Back to your comments. You are correct thatboth properties will be hit in value. However, as long as your rental is cash flow positive short term variations in the value of the home is irrelevant. With a BRRRR your return is completely reliant on short term fluctuations in the real estate market since your profit is based on the ability to sell for a profit.
Real estate values fluctuate significantly more than rental rates. The Price to rent ratio in Chart 1 Below shows a fluctuate that is exactly correlated to the value of real estate proving prices tend to fluctuate long term while rents remain relatively constant. Chart 2 shows the SF inflation adjusted home prices swung over 40% in both directions 4 times since 1980. On top of home prices a BRRRR is also subject to the financial stability of your contractor.
It is not the amount of money you put down that makes the BRRR more risky to finance but the type of loan. With a BRRR you are generally using some type of short term loan with a balloon payment and must complete construction, get the appraisal you expected and find a bank willing to give you a loan based on that appraisal. This is inherently more risky than a traditional fixed rate loan.
There is no doubt that the best performing BRRRR investments outperform the best performing cash flow properties. As I stated in my original post higher risk comes with higher return.
That being said, a good cash flow investment returns a practically tax free 15% annually and can be reinvested in another revenue generating asset. A 15% CoC return rental with proceeds reinvested will exceed the initial down payment in six years. The example below shows the exponential growth effect rentals can generate.
Year 0:
5 Properties valued at $100,000 each $500,000 total
Down payment $100,000 total
Year 6: $100,000 in cash flow purchases 5 properties (10 total)
Year 12: $200,000 in cash flow purchases 10 properties (20 total)
Year 18: $400,000 in cash flow purchases 20 properties (40 total)
Year 24: $800,000 in cash flow purchases 40 properties (80) total
Yr 24 you are generating cash flow of $240,000 annually and have built up almost over $3 million in equity (assuming no appreciation or $4.8 million assuming 2% growth)
In this example 24 years from now (when I am 53) I would be cash flowing $240,000 a year with $ 3 million in the bank all generated from a passive investment.
Chart 1 Chart 2
@Account Closed it seems you are unaware of what the 2nd R stands for in the BRRRR strategy. It stands for RENT, therefore your example of short term price fluctuations hurt the BRRRR strategy is wrong, it's a long term rental just like a turnkey, it's not a flip. My point was that selling for a profit is an OPTION with a BRRRR but is not with a turnkey.
As for the financing, if you can get a purchase loan for a turnkey, you can get a refinance loan for a BRRRR. If you work the numbers right you also have a 25% cushion built in, meaning you could be off by 25% on ARV and or rehab costs and be no worse off than having just bought a turnkey from the beginning.
It seems you don't get these concepts. If you're happy coming up with 25% everytime you buy a property then go for it. However, Basic math says that doing it that way is significantly inferior to the BRRRR strategy. You also continue to skew the facts in order to make one strategy seem more favorable or less risky when in reality these facts are irrelevant because they are the exact same for both strategies. Run your numbers again with the BRRRR strategy having left no money in each house and instead investing that money in the market at 7% annual return. Oops.
So let's agree that the person contemplating either strategy is looking in the exact same neighborhood for both, has money for a down payment, and has good credit (will need it either way), both will be kept as long term rentals. Now, argue your method is actually better based on the math instead of tilting the playing field irrationally.
Lee S. The main profit driver in a BRRR investment comes from the increased value generated by the renovation that allows you to pull money out through a refinance and invest in another property and do the same thing.
The rental portion of the BRRR is really only done because it is a requirement to refinance and the only real requirement is the rental be cash flow positive until it can be sold. Under the BRRR mindset you would never want to sit on the rental property when you could sell the property pay off the loan and put the rest of the property value to work.
Let's look at a BRRR example 100k property 20% down or 80k loan + 25k improvements over six months to post construction value of 178k. Carrying costs for six months (1k annual insurance, 1k annual taxes, 2.5k annual interest, 2k exterior maintenance, 1.5k utilities & security) = 8k /2 or 4K. So you already have $49k equity invested.
Great investment: construction goes as planned property appraisers at 200 and you pull out 140 - 80 = 60 or a quick 33% return $ to invest. A year later you sell for 200 pulling out another 60k for a total increase in equity of 75k.
Minor Problems: contractor cost overruns and construction schedule delays). To pay for either of these items you need to cough up more cash say 10% cost increase 2.5k and 1 month delay 650. 53.15k. With minor problems the BRRR investor needs 53.15k in capital.
Obviously financing is another pitfall here. I don't not accept that if you can get a turn key loan you can get a BRRR refinance loan. Banks change their appetite for investment real estate loans all the time. You may have great credit and $ in the bank but if the policy is purchase price + improvements it is what it is.
Major Problems: Local housing market tanks and your contractor walks off the job after his other clients stop paying leaving him bankrupt. Your property is a construction zone that can't be rented and your loan is already underwater and no one wants to buy a half finished property. The BRRR investor needs significant capital to finish this project.
Two Cash flow investments 100k 20k down x 2. 40k down compared w 49 in BRRR. Same 650 a month carrying costs and 200 principal payment. Every month the property isn't rented you pay $850. The property is always in sellable/rentable condition, no fronting construction costs. Worst case scenario you rent at a few hundred a month loss best case you pull out 8k in cash flow a year all tax free while paying down principal.
If you have the BRRR process down more power to you and I'm sure you'll beat my returns.
@Account Closed just wow, there you go again tilting the playing field in an attempt to make your method appear to be superior. No need for all the dancing, I'll break it down super simple for you ok?
Two exact houses, each worth 200k when ready to rent and rent for the same amount. We will exclude closing costs to keep the math simple so you can follow along.
Your Method, Put your 25% down. You're now into the home for 50k.
My method (True BRRRR) I buy the house for 100k, put 50k into it (including 2nd closing costs, carrying costs, and whatever other nonsense you want to come up with), refinance out the entire 150k. I'm now into the house for ZERO!!!!!!! Can I say that any more clear? Do you need pictures?
Now, we can put both houses into your long term passive model above and guess what we get? The exact same thing. Ah, but guess what? Just to keep it simple I take my left over 50k and invest it in the stock Market at 7% average return. My returns CRUSH yours.
You can go ahead and make up all kinds of nonsense like you did in your last post. Guess what? You could buy a Turnkey and immediately have issues also that you didn't see pre purchase right? Should I throw in a ridiculous hypothetical and say "and we all know that turnkey renters trash houses 10x as badly as those that rent BRRRR homes'? NO? Because that is how ridiculous your argument is.
Oh, you say this strategy can't be done? Already done it twice, as have countless others on these forums. I have locked in equity? So do you, except it's your hard earned cash and for me it's nothing, I can tap it or not in the future by selling if I want but my strategy is long term hold so it's IRRELEVANT. What's my time worth? Hmm, on my last one I put maybe 5 hours into the house, I'll take that pay rate (50k compounded over decades at 7%). Contractors did all the work.
Do yourself a favor and read this post slowly and carefully and do not respond, you're embarrassing yourself.
@Lee S. I think you need to reread all of my prior posts before personally attacking me.
I HAVE NEVER STATED ONE METHOD IS BETTER THAN THE OTHER and HAVE NEVER SAID BRRRR IS IMPOSSIBLE. In fact I have now stated three separate times good BRRR investments make significantly more than rental investments and good BRRR investors make significantly more than rental investors.
SO LETS BE CLEAR I AM NOT BASHING BRRR AS AN INVESTMENT STRATEGY. I am simply stating that BRRR comes with more risk than a passive rental strategy and has the potential for more unexpected capital contributions. AGAIN THAT DOES NOT MEAN BRRR IS A BAD METHOD AND MANY INVESTORS HAVE PROVEN THE RISK CAN BE WELL WORTH THE RETURN.
Your refusal to acknowledge the fact that both investment philosophies can be very profitable is extremely odd. One investment does not fit all and risk tolerance, time, experience, capital, etc. all shape each investors philosophy. Your insistence that there is no downside to BRRR and it is superior to a rental in every way and for every person is also confusing.
These are two separate investment strategies so the scenario where each investor buys the same property and puts in the same renovations is not a valid one. The two investment strategies have a different goal and different investment criteria. This different criteria values properties differently. For example, in the area I am investing there is no scenario in which spending $50,000 to renovate a $100,000 property would increase my CoC as a buy and hold. i am 100% sure using my criteria I could find a rental that generates a greater CoC return than the 100k property that had 50k in renovations. AGAIN THIS DOES NOT MEAN THAT RENOVATION IS A BAD IDEA FOR BRRR INVESTORS OR THAT THE BRRR METHOD WILL NOT GENERATE MORE CASH FLOW OVERALL. Rental income is just one part of the revenue stream in a BRRR and is 100% of the revenue in a rental. So while the ideal rental property can generate a higher return from rental income than the ideal BRRR the ideal BRRR will generate significantly more overall income.
It is no different than comparing stocks and bonds. An bond portfolio provides a more conservative stable cash flow while a stock portfolio provides the potential for much higher returns but is more aggressive. One is not better than the other. It is simply a matter of preference and each choice involves trade offs. Your argument is the equivalent of saying you can buy a stock that offers the potential for equity growth and provides a dividend that is equal to a bond without taking on any more risk. That is just not how the world works.
I will reiterate one last time to make sure you don't misunderstand my point. BRRR INVESTING IS A GREAT STRATEGY WITH THE HIGHEST POTENTIAL FOR RETURNS. HOWEVER IT COMES WITH A DIFFERENT SET OF RISKS THAN OTHER INVESTMENT STRATEGIES AND AN INVESTOR NEEDS TO BE AWARE OF THE RISKS AND REWARDS OF EACH STRATEGY.
In my original post I shared a strategy that has worked for me and discussed the risks and REWARDS of the BRRR method. In no way did I infer that the BRRR method or the people following it are inferior to me and my strategy. I have not attacked you personally or questions your investment acumen. You need to realize that discussing the pros and cons of your strategy and sharing a personal preference that differs from you is not an attack on you or your philosophy.
@Account Closed not reading all of that. Point was made very clearly, in sure you just threw in more negative hypotheticals for the BRRRR while completely ignoring similar risks buying turnkey. Not interested in debating the strawmen and moving goal posts.
@Lee S. Actually the complete opposite. I made it clear that I have never said BRRR was a bad investment philosophy and in fact have said the opposite that it can be A GREAT INVESTMENT.
I also stated that you being personally offended by people who use other investment approaches and attacking them personally is counter productive.
Finally I stated that insisting one investment approach is better in all ways than others is unrealistic and doesn't acknowledge differing investment goals and risk tolerances.
However, I have a feeling you did read my comments and instead of acknowledging that you personally attacked me after misinterpreting my point you choose to pretend you didn't read it. CLASS ACT BROTHER.
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Originally posted by @Andrew Merritt:
I'm working on finding a rental property as my first deal. For right now, I'm focusing on pretty much turn-key properties. If I stick with this and spend all of my money allocated for real estate on this first property, how would I go about getting my next property (and more after that)? If I was to get a loan for 80-90% of the equity in the house, I'd quickly reach the point of diminishing returns and I might have a 'seasoning period' to take into account as well. It seems like this isn't the best way to build a portfolio. Or it would just take forever to save up enough to buy the next house each time (depending on my savings rate, of course).
I have no experience w/ renovations, but I feel like BRRRR is the only way to build a portfolio in a reasonable amount of time.
Despite what some books and or coaching programs will lead you to believe rental portfolios are great for parking existing capital and building long term wealth. Not so much for quickly creating it.
@James Wise I understand, just trying to figure out which route I want to take