Alternative analysis of BRRR vs sale?

Question

Does anyone have an alternative way of calculating the value of a BRRRR in terms of future income - present value? Annuity, perpetuity, zero-coupon bond with a speculated maturity value? What I'm trying to solve is finding a present value baseline to compare the BRRRR'ing a property vs selling. Am I overthinking this? Does anybody have a simpler way of comparing the two scenarios?

Specifically, I'm in for $230k on a property that will need another $60k to finish renovating. Once completed, I can cash flow without refinancing, around $22k annually. If rates drop I can refi cash out...dependant on rates. A neighbor has given me an unsolicited offer (no $ amount mentioned) to buy the house so they can level it and improve their property value. I'm trying to analyze what the property is worth to me, in order to sell it?

Thank you!

Deandre P. · Answer

The analysis you are looking for is a discounted cash flow analysis. Figure out your holding period (typically 5 to 10 years) and estimate the annual cashflow for each year of your holding period.  Discount each year by your discount rate and add the cumulative total.  This will get you the present value of the future income stream. This is a brief summary of how a DCF analysis works. A few things you will need to consider are income growth, expense growth and appreciation.  Also, be sure to include the net sale proceeds in your cashflows at the end of your holding period.  Lastly, your discount rate should reflect your preferred rate of return (consider risk, timing, etc.).

Robin Simon · Answer

There are lots of instruments you can use, the purest one would be the true marginal investment - the annual cash flow (CoC) of another property in your market you could buy with the proceeds.  Or typically the 5 or 10 year treasuries would be a standard baseline (much less risk but also much less opportunity for appreciation vs. a SFR).  Your personal tax situation is also low key important potentially as there are a lot of tax benefits in certain cases with a real estate portfolio that can tip the scales

Justin Winn · Answer

I want to say that I think @Deandre Prescott gave the best answer to calculate what the money could do and how it may perform with the options you have. Second point that I didn’t see anyone address is your time, and how you value your time. Once you have completed the DCF calculations if they are relatively close, I think I would then consider which one gives me more time back to, find more deals, spend with family, hang out at my hobby spots…

Best of luck.

Andrew Postell · Answer

@Dave Foster thanks for the clarifications here.  This is greatly appreciated.  @David M. thanks for pointing these things out.  Always great to hear the right information.

David M. · Answer

@Dave Foster

Thanks.  Like I mentioned, its all about the "facts and circumstances."  Trying to do a "quick investment" is always fraught with risk 1031/tax-wise.

Dave Foster · Answer

@David M. and @Andrew Postell, I'm going to muddy the waters even further unfortunately.  There is no statutory holding period that qualifies a property for 1031 treatment.  It is all about your demonstrable intent.  If your intent was to hold for productive use in business trade or for investment then it qualifies for a 1031.  If your primary intent was to resell then it is inventory and does not qualify for a 1031.

The supposed magic at one year and one day is that "normally" that would qualify a property for long term capital gains.  And the property would have been reported on two consecutive tax returns. And the purchase and sale are on two different tax returns.  So it's really mostly smoke and mirrors to rely on that.  There are case rulings over the years that said allowable holding periods could be 2 years, 2 calendar years, and 2 tax years.  Unfortunately legally interpreted that could be anything in between 2 days and 730 days.  So demonstrable intent is the key - not the holding period specifically.

But here's a little known fact that gets lost in the shuffle - there is no guarantee that a property held more than a year is always going to be a long term capital gain - let alone qualify for 1031 treatment.  There are cases where holds of well more than a year were treated as ordinary income because of the intent and practice of the seller.

Hold of less than a year - Will always be ordinary income.  May qualify for 1031 in unique circumstances

Hold of more than a year - Will almost always be a long term capital gain.  Will usually qualify for 1031.

Just enough gray to hang yourself isn't it.

David M. · Answer

@Andrew Postell Yeah, not sure I understand your response or if we are saying the same thing...  If you flip a property or 100, the IRS considers it sale of inventory and NOT of investment property.  There is no case/argument to made about it, and you will/should pay the 15.6% self-employment tax.  Of course, 'consult with a qualified professional,' but we have been over this over and over again on BP.  The usual attempt to work around is try to go after making it look like an investment property by doing "stuff" to support that as "facts and circumstances."

As for 1031's, I think it a min 1yr 1day to follow I think a de minimus ruling to qualify the property as a an investment property.  This kind of follows the above issue in trying to qualify the property as an investment.  @Dave Fosterpls confirm/correct.

Otherwise, I'd agree that its difficult to really calc an "apples to apples" case of brrr vs flip.  If anything, there are lots of of criteria to calc and "opportunity cost" values as well if you include the 1031 since your equity is "stuck" as you continually "trade-up" until normally death.  But, at this point, I don't think this was part of the OP's question.

Andrew Postell · Answer

@Ryan Braman it sounds like you are (more or less) comparing a "flip" to a "buy and hold".  This isn't quite a fair comparison.  If you flip the property - essentially repairing the home and selling it - you get the immediate return on your money.  You are also subject to "short term capital gains" on your taxes.

A "buy and hold" property gives you cash flow, appreciation, and principle buy down (that helps grow your equity as well).  When you do sell, you have "long term capital gains" taxes or "deferred" taxes through a 1031 exchange.  You have none of those options with a "flip" property.  It's a totally different strategy.

Likewise, if you "wholesaled" the property, then you don't have any of the rehab costs now either. Each of those is a totally different strategy with different "out of pocket" costs and different benefits to them.

The fair comparison would be to take the ARV of the property and then ask this question:

If I were to take a standard down payment requirement on a "turn key" property at the same ARV and hold it long term would my "cash on cash" return be better or worse?

So if the BRRRR property provides better returns (use a 5 year analysis) over that "turn key" property THEN it's worth doing the BRRRR method.

I hope that makes sense how I am describing it.

Andrew Postell · Answer

@David M. if you are an active real estate investor doing multiple flips per year, yes, you can make the argument that your "flipping" income is "regular" income and therefore taxed at the 16.5% ratio.  But if you only have 1 property...and are analyzing it to keep or to sell, it would be hard to argue that selling one property should be taxed at a lower rate.  As always, consult your tax professional (maybe I should have put that caveat in my opinion above).  One other thing to keep in mind, to qualify for a 1031 exchange you would need to hold your asset for 2 years.  So 2 years to defer your taxes to a later point.  We are usually deferring to a later point where the taxes are $0.  Just something else that you don't get if you are flipping properties.  Also, speak with a 1031 exchange administrator for full details on that technique.

David M. · Answer

@Andrew PostellFYI:  flips are taxed as active, ordinary income, NOT as short term capital gains.  The IRS sees the flipper as selling inventory and NOT investment property.  So, the profits are subject to self-employment tax as well

@Ryan Braman I think there are probably any number of ways to try to calculate this.  However, they all hinge on a number of assumptions.  Also, I think it depends on your investment strategy and your needs/goals.  It potentially sounds like you are just interested in figuring out your best return as opposed building a rental portfolio to hold for a decade or two (especially if you follow the other advice to only do a 5yr analysis).  In the near term, it is just what can you get in hand (pre or post tax...) vs what might you think can you get in the next 3-5 years.  Yes, if you want, you can run it like a bond valuation with irregular coupons, then add in all the long term investment parameters.  Its up to you.  Good luck.

Alternative analysis of BRRR vs sale?

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