In the middle of a BRRR... Need advice!

[Dan Gengler]

HI All,

First post on BP!  I am a relatively new RE investor in the greater Milwaukee area.  Just over 1 year ago, my wife and I bought a Duplex on the border of Shorewood and Whitefish Bay.  For those outside of the area, this is one of the most or thee most A+ neighborhood in the metro and has a mix of single family houses and small multi family properties. Typical renters are families or young professional couples making well over the median income (on average). 

At that time we purchased the house, the previous owner had just put on a new roof, two new furnaces and repainted the exterior to ready the house for sale. We paid $260,000 (about $108/sq ft.) for the house and financed it with an FHA loan with 3.5% down on a 30 year fixed mortgage. The average in the neighborhood is about $118/sq ft - $128/sq ft. for duplexes so we feel we got a great deal on our first property. When the sale went through, the appraisal magically came back exactly for the value of the purchase price, which was almost identical to the last city appraisal that was done prior to the roof, furnaces and painting.

Soon after we closed, we completed substantial renovation work on the house, putting a new kitchen and bathroom and electrical panel in the upper unit, adding central air and completely repainting both units, landscaping the entire yard, adding an additional parking space to the property and adding new fixtures to the bathroom and kitchen in the lower unit.  All in, we put about $30K for rehab which we paid for completely in cash.  All work was completely permitted as well.

For the last year, we have been living in the upper unit and the lower unit has been rented out to a tenant that pays $1225/month.  Our plan is to live in the upper unit for another year (2 years total as our primary residence) and then move to another duplex that we would purchase at that time. Essentially a "house-hacking" strategy.  We're pretty confident we could get about $1400+ per month for the upper once we rent it out.

The problem I now have is the refinance part of the BRRR. I've talked to a few banks about doing a refinance into a traditional mortgage to get out of the PMI charge. With the ARV (have very similar comps withing last 6 months and within 5 block radius) of the house and the equity that I currently have in it, it should be sitting at 20%+ LTV. Also, since we bought the house, home values and sales have increased over 10% Y/Y in our neighborhood. We had an appraisal done with a large bank at the 8 month mark because they said that they appraise on ARV and they'd refund the appraisal fee if it doesn't work out. The appraisal came back nearly identical to the purchase price meaning the refinance fell through.  I'm not opposed to putting a minor amount of additional cash in to ensure I get the 20-25% LTV but don't want to put over $10K in.

My questions are:

1. Given all that has been done in upgrades as well as skyrocketing prices in the area, is there any way to ensure that an appraisal is realistic to ARV/present value and not just tied to historical sales price.

2. Am I using the BRRR strategy wrong?

3. Any other advice on the process?

Sorry for the long explanation but I wanted everyone to have an accurate background story. Any help would be much appreciated!

[Damir Kamber]

Hello @Dan Gengler and welcome to BP!

Few questions first: 

1. When you say that the average prices in the area are $118-128/sq ft., are those numbers based on comps in the area or where are you getting those numbers from? 

2. When you were doing your due diligence prior to purchasing this property, did you run the comps in the 1 mile radius for other multi-family properties? What did they look like? 

3. What is your current balance on the loan if you don't mind sharing? 

4. Are you only wanting to refinance the property to get rid of the PMI or are you trying to extract some cash/line of credit for your next project? I just recently did a HELOC for my primary residence and the bank based the comps on the most recent sales my neighborhood (luckily everyone was selling at the time) and they gave me 80%LTV so the numbers looked something like this: Appraised for 330K so 80% was 264K minus what I owe on the house was how much the line of credit was.

Now to answer your questions to the best of my ability:

1. Given all that has been done in upgrades as well as skyrocketing prices in the area, is there any way to ensure that an appraisal is realistic to ARV/present value and not just tied to historical sales price - There is no way to insure that your property will appraise to the ARV when doing a refi with a traditional bank. When refinancing, the most banks will only look at the recently sold properties in the area (comps). I suggest you go with a smaller local bank, maybe a portfolio lender since they work with investors and have different lending programs at their disposal. 

2. Am I using the BRRR strategy wrong? - I don't think you are using the strategy wrong, I just don't think you got as good of a deal as you thought you did. Now, on the other hand, you are potentially looking at a very good cash flow once you rent out the entire property and could make your money back(cash you put into it) in the first two years. At the end of the day, it all depends on what your end goal is for that property and in your general investing strategy. 

My rule has always been to find a deal that will cash flow where it gets me a 10-14% return on my investment. Appreciation is only something you bet on, if it happens great but if we get into another downturn (which is likely to happen again soon), I want to make sure that I am not upside down because I got a great deal to begin with. Always remember: You make money when you buy, NOT when you sell.

Hope that helped at least somewhat.

Cheers,

Damir