BRRRR: Does the Refi eat up your gross rent?

Question

Here's a question for you about the BRRRR. I've put this to the forums and haven't gotten any responses back yet.

Here it is;

When using the BRRRR method, and you refinance to pull the equity out in  the form of cash (75%-85%), that new loan is based on the new appraised  value of the house. Wouldn't that raise your monthly mortgage payment  and in turn eat up what every gross rent you have. I have an example  based on a Duplex I looking at. Here's my situtation: I am looking at a duplex in NJ which is a foreclosure. C-Class/Blue Collar neighborhood.  Purchase price would be approx $90k , repair costs approx $20k, approx  ARV based on multiple realtors is $200-$260k, expected gross rent  $3700-$4100/mth. At $90k purchase price I'd be around $600/mth for mortgage. If the ARV  puts me at let's say $220,000 my payment would jump to $1300/mth. I'd go  from about $160/door (net), into the red.  So for a Buy & Hold investment, what I am missing here that makes  this seem like a crappy deal for long term and a sweet deal in the short  term?

Much Appreciated,

Adam Scheetz

David Fernandez · Answer

Hi @Adam Scheetz,

With the BRRRR strategy, when you refinance a property you bought and fixed, you are looking to first recover your capital to use it again and second, maybe take some extra cash, if your property appraises high enough.

Looking at your example, your total money spent in this property is $110k ($90k purchase price + $20k repairs). Assuming a LTV of 70%, you will recover this capital if your property appraises for $157k. If your property appraises for the $200k you think it may be worth, assuming again a 70% LTV, you can get a loan of up to $140k; $30k more than the capital you have invested.

A few considerations:

1. How do you get a jump in your mortgage payment from $600/month to $1,300/month with only going from a $100k mortgage to a $140k mortgage?

2. Can you share all the expenses that you are including in your analysis? A property that rents for $3,700-$4,100/month with a $110k le a $140k loan should ALWAYS cash flow.

3. Get your rehab numbers well, this  R of the BRRRR strategy is what gets most people in trouble.

4. Your ARV range is too big. There’s a 30% difference between $200k and $260k. Why such a big range? Is it due to different finishes? If so, you should consider adjusting your rehab estimate accordingly.

Matt Rusk · Answer

Where in NJ are you buying something for 90k and only doing 20k in rehab and getting 3700-4100 in rent?

Sean Lambert · Answer

@Adam Scheetz you’d probably only be able to pull about 70% of the value, which would be about $150k.

You would want to take that loan into account to calculate cash flow.  You wouldn’t want to pull so much out that you’re in the red.

Michael T. · Answer

@Adam Scheetz is correct in his numbers and comments here.  If you are all in $110k, you pull out $140k and the property rents for $3,700-$4,100/month there is really no possible way you don't cash flow.

Also, @Matt Rusk has a few very fair questions about the 90k purchase price, 20k rehab and rent of $3,700-$4,100?

If you're not able to make this deal work send it to me and I'll have one of my clients buy it. :)

Robert Leonard · Answer

@Adam Scheetz  Absolutely, that's what can make a BRRRR deal sometimes tricky.

You must run the anaylsis both ways, once using the original mortgage cost and once using the new, and usually higher, mortgage cost. Investors often forget to run the analysis using the higher mortgage cost. There are two ways to negate the higher mortgage cost:1. Being able to demand higher rents because you've renovated the property, then in turn the higher rents cover the increased mortgage expense. For example, if you would earn $1,200 in monthly rents for a net cash flow of $200 before you renovate the property, and then you renovate the property and your mortgage expense goes up by $300 per month, you'd want to make sure you could squeeze out an additional $300+ in monthly cash flow from the rents due to the renovations.2. If that's not possible, you'll want to make sure that the initial cash flow, before refinancing, is high enough so that you can take a hit when you increase your mortgage expense from the refi. If you have $1,000 in monthly net cash flow, then your mortgage goes up $300 per month, you're still going to have $700 leftover. This might not sound like as good of a return/monthly cash flow, but you have to remember that you're now into the deal for essentially $0, and you can put that money into more deals. Also, renovated properties generally have less upkeep/maintenance/capex/repairs, so your overall operating expenses should be decreased, increasing your cash flow. Lastly, a renovated property can usually allow you to obtain higher-quality tenants, which in turn reduces your turnover and your vacancy expense, increasing your cash flow.Hope this helps.

You must run the anaylsis both ways, once using the original mortgage cost and once using the new, and usually higher, mortgage cost. Investors often forget to run the analysis using the higher mortgage cost. There are two ways to negate the higher mortgage cost:

1. Being able to demand higher rents because you've renovated the property, then in turn the higher rents cover the increased mortgage expense. For example, if you would earn $1,200 in monthly rents for a net cash flow of $200 before you renovate the property, and then you renovate the property and your mortgage expense goes up by $300 per month, you'd want to make sure you could squeeze out an additional $300+ in monthly cash flow from the rents due to the renovations.2. If that's not possible, you'll want to make sure that the initial cash flow, before refinancing, is high enough so that you can take a hit when you increase your mortgage expense from the refi. If you have $1,000 in monthly net cash flow, then your mortgage goes up $300 per month, you're still going to have $700 leftover. This might not sound like as good of a return/monthly cash flow, but you have to remember that you're now into the deal for essentially $0, and you can put that money into more deals. Also, renovated properties generally have less upkeep/maintenance/capex/repairs, so your overall operating expenses should be decreased, increasing your cash flow. Lastly, a renovated property can usually allow you to obtain higher-quality tenants, which in turn reduces your turnover and your vacancy expense, increasing your cash flow.Hope this helps.

1. Being able to demand higher rents because you've renovated the property, then in turn the higher rents cover the increased mortgage expense. For example, if you would earn $1,200 in monthly rents for a net cash flow of $200 before you renovate the property, and then you renovate the property and your mortgage expense goes up by $300 per month, you'd want to make sure you could squeeze out an additional $300+ in monthly cash flow from the rents due to the renovations.

2. If that's not possible, you'll want to make sure that the initial cash flow, before refinancing, is high enough so that you can take a hit when you increase your mortgage expense from the refi. If you have $1,000 in monthly net cash flow, then your mortgage goes up $300 per month, you're still going to have $700 leftover. This might not sound like as good of a return/monthly cash flow, but you have to remember that you're now into the deal for essentially $0, and you can put that money into more deals. Also, renovated properties generally have less upkeep/maintenance/capex/repairs, so your overall operating expenses should be decreased, increasing your cash flow. Lastly, a renovated property can usually allow you to obtain higher-quality tenants, which in turn reduces your turnover and your vacancy expense, increasing your cash flow.Hope this helps.

2. If that's not possible, you'll want to make sure that the initial cash flow, before refinancing, is high enough so that you can take a hit when you increase your mortgage expense from the refi. If you have $1,000 in monthly net cash flow, then your mortgage goes up $300 per month, you're still going to have $700 leftover. This might not sound like as good of a return/monthly cash flow, but you have to remember that you're now into the deal for essentially $0, and you can put that money into more deals. Also, renovated properties generally have less upkeep/maintenance/capex/repairs, so your overall operating expenses should be decreased, increasing your cash flow. Lastly, a renovated property can usually allow you to obtain higher-quality tenants, which in turn reduces your turnover and your vacancy expense, increasing your cash flow.

Hope this helps.

Robert Leonard

Terrell Hill · Answer

Adam

Would you be trying to Re-Fi to get the whole ARV out of the property? Thats the only way i see your payment climbing to $1300 P/Mo. (Which is really 1500 ish P/Mo PTI) If there is that much meat on the bone why wouldn't you just Re-Fi for a lower amount and leave some equity in the place and your monthly income will be in the black.What are the taxes? New Jersey, Taxes,UGGGH

Lee Ripma · Answer

@Adam Scheetz

It’s ultimately your call. If you’ve got equity, you’ve got options. So you can refi or you can sell. You’ll renovate differently for a rental vs a flip so if you decide ahead of time you can save yourself on the rehab costs. If you’re flipping to someone else who would hold it as a rental then rehab is the same in either scenario. If you know you can get equity I would usually do the deal. Good luck and keep us posted!

Adam Scheetz · Answer

@Mark Hughes That's what I'm talking about! Spot on example!!! I'm in acquisition mode which is why I set my per/door threshold low at $100. It's just a matter of finding the right amount to refi and not lose my shirt. I'm more concerned at the moment with bank rolling multiple and sequential properties. After a few, I'll shift my methodology a bit. Thank you so much for your spot on example. I'd love to talk to you about your process and experience with the Quad deal.

Irina Belkofer · Answer

@Adam Scheetz you need to verify all numbers: cost of rehab $20K is very low when you're buying house with ARV as high as $260K. Usually it's realistically 60-70% or ARV what your all-in would be.

Then, monthly rents looks too high as well - check at least Zillow and takes the most conservative estimate.

@Mark Hughes numbers look very realistic and still make sense.

Yours look too good to be true.

Mark Hughes · Answer

@Adam Scheetz I did the same thing with a BRRRR last year. Bought a 4plex for $115k all-cash at auction and Reno was $60k. ARV 193K so 75 LTV would be 145k but I only took out $105K loan because I wanted it to cash flow strong. But I could have maxed it out and only kept 30k cash in the deal but I didn’t feel comfortable w the cash flow. I’m glad I did because I ran into tons of red tape w zoning and permitting and that slowed me down an extra 3 months (on top of 3 month Reno plan). Now all 4 units are renting out roughly $625 ea so the cash flow is solid w mortgage payment of around $1k but you need to decide your own balance of how much to pull based on your goals.

If you are in total acquisition-mode then pull out more and use it to buy the next deal/s. But I’ve done lost of acquisition the last 3 years and just looking to add 1 property per year the next few years so I didn’t want to get too much more in debt just to pad the CoC numbers.

BRRRR: Does the Refi eat up your gross rent?

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