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!

[Ryan B.]

Can you share the purchase price, ARV, repair/reno costs? It sounds like a lower purchase price - better discount to market - would have helped, but I'm just speculating. Can you wait on the refi for 6 months and allow time for additional high-season sales to produce better comps?

[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    

[Dan Gengler]

Thanks for the response guys

@Damir Kamber:

1/2. The average $/ft are from sold comps within the last year and within 5-6 blocks of my address.  These comps were from this past summer.

3. The current balance is right at $250K. If I were to get the 310/315K appraisal like I'd expect based on comps, it would be right at 20% ARV. Like I said in my post, I wouldn't be opposed to putting up some extra money to get it across that threshold if necessary. One large problem I'm having is the 1 mile radius. At about 1 mile from my property, the values do drop quite a bit and the neighborhood changes a lot. Because the appraiser didn't know the neighborhood intimately, all of the "comps" she included were right at the boundary of that mile radius which is what really dragged down my valuation. This is a problem I may just have to deal with but is there some that use less than a 1 mile radius (1/2 mile, 1/4 mile) if enough comps are available?

4. Ultimately, my goal is to refi into a 30 yr conventional mortgage to forego the PMI payment and be able to lock into that interest rate now before rates begin to rise into the near future. We'll be purchasing a new one 1 year from now and with this one on a conventional mortgage, it would leave us more possibilities for the next purchase when the time comes, whether it be FHA again, conventional or other types. I'm more interested in the asset value and longer term cash flow than the near term cash flow though that is a consideration too.

I will definitely look into the portfolio lending once I'm looking for the second property.  Thanks for the tip on that one!

[Mark Vejnar]

@Dan Gengler

Refi appraisals tend to be more conservative as they are purely hypothetical - as @Damir Kamber previously commented.  However, you can help the appraiser from the standpoint of the cost approach, and the income approach.  Do you have a copy of the purchase appraisal? Do you have financial records detailing each cost incurred during the rehab? Do you have before and after photos? Sometimes showing these data to the appraiser can give him/her a better view of where the property was, and where it is now. (Incidentally, always ask them to review their data while smiling and acting super friendly and overjoyed to be having the discussion.)

As it sits, the appraiser has essentially determined that your property lost value due to the rehab. While the law of diminishing returns certainly applies, it's also true that people tend to like shiny objects. Your property will probably command higher rents due to its condition and amenities, and you will have less maintenance expenses moving forward because of what's been performed. This impacts NOI. Thus the expenses you incurred should drive up your value from both the income and cost approaches to value. It also extends the economic life of the property - which only helps from a cost approach standpoint. Talk with your CPA to get good numbers on how your updates and upgrades affect depreciation, and then discuss this with your appraiser.

The bank will do whatever they want, but it can't hurt to try. While many appraisals give the sales comparison approach the most weight, there are plenty of times when the sales comparison approach to value is not applicable. This is why the appraiser is supposed to reconcile all three approaches - even in an apples to apples arms-length SFR appraisal.

[Brent Coombs]

@Dan Gengler, many Lenders don't allow a re-appraised value to be updated until after 12 months - and maybe your Appraiser was assuming the same? But now that it HAS been more than a year, you might get all your recent comps / average per sq ft taken into proper account?

Welcome to BP. All the best...

[Alan Brown]

wow, sorry that's been such a cluster.  My first thought is:  how is your team?  Do you have a good realtor there that sees your vision for your future and wants in on that future business, whatever it is?  Because he/she should be able to pull the comps for you, look them over, and be able to guess at what the appraiser would be coming up with...  If there's ever any question about my listings reaching appraised value for a sale, (and even if there's not) as a listing agent, I'll plan to meet the appraiser there, schmooze them (not in a sticky sweet way,  but just be VERY pleasant and welcoming) and offer my comparables, and why I have it priced like I do.  #1, it's my job to do that, really, so he/she won't object or be defensive (hopefully);  as an owner who's paying for their report, you should have that right as well, and if it's a good appraiser, they love information, and it might even make their job easier.  If they're defensive or obviously not doing their job well, there are ways to report them:  talk to you lender.  

Which brings me to one of the other parts of your team:  lending;  a portfolio lender who knows you and sees what you're trying to do long term, stands to make some money off of you and should be very helpful, and be a good resource for you to bounce ideas off... Milwaukee should be a great place to find this person to help you... Pick all of their brains until they can't take anymore, and then go pick some more.  But network your team so that you know exactly what to expect and don't feel guilty asking questions... If you were in my locale, I'd love to have you buy me lunch, help you any way I can (which us usually quite a bit), and plan to help you find the next project or sell one, or maybe have you tell your buddy at work how great I am and to use me when they sell, and be your realtor for life!

Network for the right people to help you!

cheers   

[Tim Stadler]

Hi Dan.  I'm new to Whitefish Bay also.  We just purchased a duplex a few months ago that is not far from yours.  Ours is not a huge return on investment relative to what we put down, but we moved here mostly as a lifestyle change (it's an awesome area!).  However, It sounds like yours was a great deal at $260,000.  As a general rule, if you can get 1% a month you are doing great and you are right there.  As far as rents are concerned?  There are 1 Bedroom Apartments behind Sendik's on Silverspring that are going for $1900 per month!  You might be able to get more rent.  

[Marcus Auerbach]

I agree with Tim and it pays to do the research. We are just about done with a SFR rehab in Brown Deer and the future tennant is currently paying $2435 on the east side for a town house. The owner is one of the large corporate players and quite frankly touring the place it hardly seems worth it (well, I guess that's why they are moving out). Check out rents and offerings from the big players, they do a lot of research and are a great benchmark when you are setting your own rent.

[Zach Ward]

1) My experience I've had better luck with small home town banks and credit unions who know and use same appraisers. Also, regardless of any upgrades, my credit union lender disclosed to me they have to use the "market value" or purchase price of house for first 12 months so was pointless to redo another appraisal for first year.

2) After first year we ordered three appraisals for a blanket loan covering three houses. I asked to meet with appraiser and walk around to "get an idea of what process is like" to learn more. That's how I pitched it anyways. Simply small talked and was nice but not a kiss @$$. With basic repairs and some needed cap improvements my appraisals improved. A. purchase price 82k/appraisal price 107k, B. purchase price 25k/appraisal price 37k, C purchase price 46/appraisal price 46K (new property I was buying)

First of these properties came with a 20% DP at time of purchase before I blanket loaned all three into one loan. Property C being the new purchase. I was able to acquire the third house with just Equity from first two houses.  Since then have bought two more using strong equity position.

3) Point is you have to buy at a discount from get go to improve later value quicker...depends also on appraiser. three appraisers may give three different prices but sure as hell don't hurt to show up and put a face to that paper they will be signing later.

4) DONT OVER REHAB...repair what has to be repaired to make livable and make it presentable. We all are guilty of doing too much sometimes. If you are buying and holding I like to make presentable and functional. I'm not living there just collecting rent checks.

5) I will literally knock on doors and call "for rent" signs or talk to neighbors standing outside to get an idea of what I can actually get for rent. I always use conservative numbers when doing my math. Any extra I make is just a bonus to me.

6)  No education is free ;)

[Kevin Siedlecki]

@Dan Gengler -

1) The roof, furnace, and paint really shouldn't affect the appraisal at all. It's a common misconception that making things a little nicer makes the value go up. It really doesn't, at least not significantly. To make a significant change in appraisal, you need to change the footprint of the property: add a bathroom, bedroom, or finish some unused space to create more living space. In addition, appraisals on purchases almost always come in just above the purchase price. If you've done your homework before buying, then it's a racket, just another middle man to pay.

2) Maybe - extrapolating from the numbers you've used at price per square foot, your ARV is at best 15% higher than your purchase price. Since I'm using the high end of the comp price per square feet, how nice or new the kitchen and bathroom are won't do much for that. You're not going to suddenly sell for $150/sq ft when the highest comps are selling for $128/sq ft. Again, doing the math on the numbers you've provided, you have a 2400 square foot house, so your ARV is $308,000. You're in it for $290,000, so even with that most generous appraisal, you can only cash out about $230,000, not even enough to pay of the first mortgage, never mind get your money back.

3) Just hold it for now. Your refinance would be for lower than your current loan - that is not how BRRRR works, but you're probably close to living for free. You have set yourself up well for a long-term cash-flowing property; you just put a little more into it than you hoped.

[Kevin Siedlecki]

Ha just realized that post was almost a year old. It popped up as recent because of the recent reply.

[Damir Kamber]

Zach Ward very well said my friend. 👌

[Damir Kamber]

Dan Gengler would love to hear an update on the property. Hope all is well.

Cheers,

Damir

[Zach Ward]

@Damir Kamber I'm definatley no pro yet but after half a dozen "learning"houses I like to keep my concepts simple. Can't tell you how may people I've come across that know way more than me and only invenstment they have is their 401k

@Dan Gengler the fact that you've jumped in means you are already ahead of many. So many people want to become expert mathematicians, logistic experts, real estate gurus, physicist...you get the idea...before they jump in. Learn the basics. Get some blood and sweat on you. Learn more as you invest more. (I do read everything I can and talk to whomever I can, but I don't let fear of ignorance hold me back. If my numbers make since then I try  to find reasons not to pull trigger. If I can't I buy)

And yes I revived the thread while bored at my day job :)

[Damir Kamber]

I'm reading The Art of War now and it talks a lot about resistance. I completely agree with the importance of pulling the trigger because in this industry you learn the most by doing deals.

Cheers,

Damir

[Dan Gengler]

Hi All! A lot has changed since my original was post. We were eventually able to get the refinance that we were looking for, but it did take a bit longer. In October of 2017 (about 2.5 years after original purchase) we were able to close our refinance. We went from a 30 year fixed FHA mortgage to a 20 year fixed. All in, we didn't have to bring any money to refi closing and even left with a $450 check. The difference in the monthly payments is ~$80. This was the first time attempting the refinance again since we were rejected the first time.

The main motivation for us was to lock in the long term mortgage rates while they are still low and while we are still using it as our primary residence as well as getting rid of our PMI at the same time. Knocking 7.5 years off of our loan was an added bonus. Our projected cash flow once we rent the unit that we live in is still pretty solid, despite the added monthly payments. All in all, we were very happy with the outcome. Ultimately, the thing that we were most happy with was the appreciation we've seen since our purchase which made the refinance possible.

Since the last post, we were able to purchase our second property in the same area.  That one was a similar duplex but required much more considerable rehab, which was not unknown.  The previous owner was very interested in a seller finance which is what we ended up doing and what made this doable for us. That property is currently stabilized following our rehab, fully rented and cash flowing extremely well.  We are now looking for a third property!

We are certainly a testament to staying the course despite a setback.  Can't wait to go for more!

[Thomas S.]

When a bank does a appraisal the appraiser is working for the bank and they are instructed to appraise very conservatively. What you should do is hire your own appraiser that will give a unbiased appraisal. Assuming it is favourable take that to a small bank or credit union and see where it takes you.