Question about the BRRRR Method Cash-out Refinance - First Rental Property
Member since 2019 · 5 posts · 1 vote
Hi everyone,
I'm in the process of attempting to find my 1st rental for the BRRRR strategy and I wanted to make sure my math was right regarding the process.
For example,
If I purchase a property for 150K with a 30K rehab, this would make my total investment 180K. I would then initially obtain financing through a hard money lender who wants 20% down on a 180K loan, so I've currently invested 36K into the BRRRR (20% down of 180K hard money loan).
When I go to refinance out of the BRRRR through a traditional lender, I can obtain a loan with 75% ARV of the property? In the example above, would the ARV of the completed BRRR have to be 240K, so 75% of the ARV of the property would equal 180K? That way I could put a loan on the property for a total of 180K through a traditional lender, pay off my hard money lender, and recoup my initial 36K invested into the property. This would be my break even and I could then use the 36K to repeat the process on another property.
Thanks for your help everyone. I have been saving for a while so I want to make sure I understand the math so this first BRRRR is done right!
Hi Kyle, that's correct at a high level. Keeping in mind you'll have interest payments to the bridge lender, closing costs to buy the property (most times hard money lenders charge points), and then refinance costs. The $36k cash out refi could get reduced to $25k or lower depending on all the closing costs. So in this example you wouldn't recycle all of the funds when factoring in the other costs. Another risk is if the property doesn't appraise for $240k but for $230k, it could further reduce your money recycling. How to offset the risks? Buy the property at a lower price. Good luck!
Hi Kyle, that's correct at a high level. Keeping in mind you'll have interest payments to the bridge lender, closing costs to buy the property (most times hard money lenders charge points), and then refinance costs. The $36k cash out refi could get reduced to $25k or lower depending on all the closing costs. So in this example you wouldn't recycle all of the funds when factoring in the other costs. Another risk is if the property doesn't appraise for $240k but for $230k, it could further reduce your money recycling. How to offset the risks? Buy the property at a lower price. Good luck!
Hey Kyle, as a lender of both hard money and DSCR (refi) I am happy to send you over some term sheets which show you exactly what your out of pocket would be, and your cash out would be on the refi. You also need to consider the debt coverage (ie holding costs).
My suggestion on the first is to have a good team. What market are you located in, do you have a good contractor, does the rental comps conform to a healthy DSCR ratio?
The actual cash you leave into the deal is more dependent on a few variables. 1) Was the deal bought correctly 2) how fast can you exit and get it bringing in cash 3) How is the debt structured, and how much cash are you leaving into the deal at exit.
Obviously, the goal is to leave as little cash into the deal as possible, but the other above issues can contribute (almost every deal we have seen go south is from a bad GC).
As a buy and hold junkie i hate saying this, but sometimes its best to flip one first. Go to local meetups, see who is prevalent in the contracting side of things but also find a solid, local lender. Eventually if you establish a relationship with the lender, you can get better terms (if they are direct) Partner with the very well reviewed GC on the first deal maybe...give up a little equity in the deal.
Most lenders are going to (due to experience) give you less - ie 75-80% loan to cost. But once you build your experience with them they will lend 70-75% loan to value. We have a little, rough calculator on our website that shows cash out of pocket on each scenarion.
Message me if you need any additional advice, and GOOD LUCK!!
@Kyle Clover Hmm, I want to provide some feedback on some of the things you stated here just in case:
If I purchase a property for 150K with a 30K rehab, this would make my total investment 180K. I would then initially obtain financing through a hard money lender who wants 20% down on a 180K loan, so I've currently invested 36K into the BRRRR (20% down of 180K hard money loan). - I mean, your math is correct but we wouldn't really work with a Hard Money Lender that would provide this type of financing. You can work with whomever you want to work with of course, but we try to work with HML's that provide us with 100% of financing up to 75% of the ARV. Those types of lenders allow us to execute with as little out of pocket as possible.
When I go to refinance out of the BRRRR through a traditional lender, I can obtain a loan with 75% ARV of the property? - This does depend on some things but 75%-80% is a fair expectation right now. So, if you can imagine, taking out an initial loan at 75% ARV then refinancing at 80% ARV that means when you refinance you can wrap in your closing costs. Don't forget about those. When you purchase a property - you'll have closing costs. When you refinance - you'll have closing costs. So, maximizing that initial loan and the refinance loan will help me come out of pocket as little as possible.
Hope all of that makes sense.
Ok, so the way it works is:
You find a house for 150k and it needs 30k. That's 180k project cost. Divide 180k by .7. You get 257k. Why did I do that? Well, 257k is what you need to sell for. So look up the comps or have an agent look up the comps and figure out what the price per square foot of the comps are, and multiply that number by the square footage of the subject property. If you are 255k I'd say ok it's a possible project. The higher above 257k the better obviously.
Let's say you make an offer for 150k and it gets accepted. You'll need to put down 20%/15%/10% depending on your credit, the market data, and scope of project. Let's say you need to put down 20%. 20% of 150k is 30k. So the lender will fund you for 120k toward the purchase (this is what you get at closing to close on the property) and then 30k will be held in escrow by a servicer(tis money is distributed in draws for when work is completed). Your total loan amount would be 150k (120k + 30k).
You'll pay interest only payments so your loan amount will stay at 150k for the duration. Let's say in 90 days work is done, then 30 days after that you are under contract, then 30 days after that you close on a sale of 255k.
You'll pay 4%-5% in RE commissions
242k left
You'll have costs of the close for title
240k left
You'll pay off your 150k loan
90k left
You'll recoup all your costs: 30k downpayment, 5k closing costs for bridge loan, you've paid 500 in insurance, you made 5 loan payments at 11.5% on 150k - 1200 - 1400 per month (6k), you turned the lights and water on for the guys at the house working (500).
48k left
There will be transfer tax on the sale of 1% - 3% depending on the market.
45k left gross profit
pay 40% short term capital gains tax
Net profit = 27k
For about 5 - 6 months project.
That's why you'll listen to people talk about how to scale and that they want to scale, because as a one off 27k is ok I guess. No one is gonna sneeze at it, but if you could do it 8x per year that's over 200k.
The keys to scaling are inventory, project pace, and resale market. I try to put my clients in with teams that can get rehabs done in 25 - 45 days max and in markets where agents can show me nicely renovated inventory is going under contract in 4 weeks max. When you have something like that set up, there's a path 8 projects in a year.
@Kyle Clover - All great stuff in this thread. If this is your first rental purchase, there's also an option of buying the property with conventional financing then using a HEL or HELOC as second mortgage on the property to get money out. Not as much pressure to BRRRR or sell in this instance. That's what I did for my first two then I'll be doing the classic BRRRR strategy moving forward.