Need help understanding the refi part of the brrrr

[Brian Kilpatrick]

To start off I’m TOTALLY new to real estate, and have been wanting to get into it for a while. So I’m finally taking the leap. And need someone to help me understand this.

Ok so I’ve listen to Brandon on his podcast, watched his YouTube videos and watched several others talking about the brrrr method, and I get it....except for one thing. In everything I’ve read/listened/watched they say you are just made “x” on the deal. Say for example I find a house for 100k. ARVs and comps show houses valued at 200k. Spend 30k on renovating, rent the place for say 1000/ month and refinance at 160k. My all in is 130k but now I have a loan for 160k so I have 30k in equity. Now here’s the part I don’t understand. Everything I’ve found on this says you just got paid 30k, but it’s a loan. Loans have to be replayed. How am I making any money other than rent? I see this money could go back into finding another property, but I’m not actually being paid the 30k free and clear. Or am I misunderstanding something?

[Jim K.]

@Brian Kilpatrick

The concept you're reaching for is annual Cash-on-Cash Return.

Here's a scenario to follow along with with your calculator.

Say for example you find a single-family house for $50K, buy it for cash and renovate it for an additional $25K. You have $75K of cash in the deal. You find a tenant for this house who rents it for $1300/month. After taxes, insurance, maintenance, management, vacancy, and capital expenditures, let's say you're putting away $800/month, or $8400/year. For the $75K you initially invested in the deal, you're getting back 11.2% per year. This is an exciting return on invested capital in real estate, but not an extraordinary one.

However, let's say you manage to get the place appraised for $140K. A lender allows you to borrow 75% of that sum against the property for 20 years at 5% interest. That's $105K. $105K-$75K (your initial investment) comes out to $30K extra in your pocket. Well, $5K of that will go for loan origination costs, so the total amount of money you'll take out of the property in this loan is $100K, and that's $25K profit.

Yes, you will be left with a mortgage on the property, which will require a monthly payment of $693. Your monthly cash flow on this property will dry up to a trickle, but all of your money will be out of the property and it will still be putting $1200 in your pocket every year. You will have recovered your entire initial investment, plus $25K more. That money goes into another property. Repeat again, and you have three properties. Repeat 10 times, and you have $12000/year from your rental properties coming into your pocket every year and $325K in cash.

Theoretically, you could go on and on and on. But typically, what then happens is that you would turn around and pour your $325K back into these properties. Pay off the rest of what you owe on the first five you bought with that money. Your cash flow from each property, let's say, jumps up to $800/month from each, $9600/year, and for all five together, $48K per year.

Use that money to pay off the sixth property. Then snowball that into the seventh, eighth, ninth, and tenth properties. Ten of these paid-off properties will net you $96K a year.

Fifteen years from getting $75K in savings together to an annual take-home income of $96K/year and let's say, with conservative appreciation, $1.5M in real estate assets owned free-and-clear. That's a pretty good middle class retirement.

But what most people would then do is sell the portfolio and move on to doing something simpler, with less of a return and less risk.

[Marcus Miller]

Originally posted by @Jim K.:

@Brian Kilpatrick

The concept you're reaching for is annual Cash-on-Cash Return.

Here's a scenario to follow along with with your calculator.

Say for example you find a single-family house for $50K, buy it for cash and renovate it for an additional $25K. You have $75K of cash in the deal. You find a tenant for this house who rents it for $1300/month. After taxes, insurance, maintenance, management, vacancy, and capital expenditures, let's say you're putting away $800/month, or $8400/year. For the $75K you initially invested in the deal, you're getting back 11.2% per year. This is an exciting return on invested capital in real estate, but not an extraordinary one.

However, let's say you manage to get the place appraised for $140K. A lender allows you to borrow 75% of that sum against the property for 20 years at 5% interest. That's $105K. $105K-$75K (your initial investment) comes out to $30K extra in your pocket. Well, $5K of that will go for loan origination costs, so the total amount of money you'll take out of the property in this loan is $100K, and that's $25K profit.

Yes, you will be left with a mortgage on the property, which will require a monthly payment of $693. Your monthly cash flow on this property will dry up to a trickle, but all of your money will be out of the property and it will still be putting $1200 in your pocket every year. You will have recovered your entire initial investment, plus $25K more. That money goes into another property. Repeat again, and you have three properties. Repeat 10 times, and you have $12000/year from your rental properties coming into your pocket every year and $325K in cash.

Theoretically, you could go on and on and on. But typically, what then happens is that you would turn around and pour your $325K back into these properties. Pay off the rest of what you owe on the first five you bought with that money. Your cash flow from each property, let's say, jumps up to $800/month from each, $9600/year, and for all five together, $48K per year.

Use that money to pay off the sixth property. Then snowball that into the seventh, eighth, ninth, and tenth properties. Ten of these paid-off properties will net you $96K a year.

Fifteen years from getting $75K in savings together to an annual take-home income of $96K/year and let's say, with conservative appreciation, $1.5M in real estate assets owned free-and-clear. That's a pretty good middle class retirement.

But what most people would then do is sell the portfolio and move on to doing something simpler, with less of a return and less risk.

 This is great Brian thanks!

[Andrew Postell]

@Brian Kilpatrick I'll answer this a little differently here but we make money in 3 ways in the "buy and hold" world:

1. Cash flow - this is the profit you make between the rental income and the TOTAL debt service (meaning, taxes, insurance, and HOA fees) of the property. We only buy properties that cashflow.
2. Appreciation - this is the appreciation of the asset over time.  If you make renovations the goal is to have IMMEDIATE appreciation but over time, the property should appreciate too.
3. Principle Pay Down - this is your mortgage balance DECREASING over time.  And the renter of your property is paying this down for you.

Anyway, I hope this helps in some way.  Thanks!

[Brian Kilpatrick]

@Jim K. 

Thank you for taking the time to answer my question. Your detailed explanation made it much easier to better understand that portion of the brrrr concept.