How does BRRRR work when your DTI keeps going up?

Question

Help me understand.How does the average Joe keep rolling endless BRRRRs? The math doesn't make sense because at some point the front end DTI will exceed criteria, even though the investor is more than solvent.

So let's say you have a job that pays $7000/month, and a house that rents for 2500/mo. House is worth 500k.

by these income standards, you can get a cash out refi $350k LOAN #1 at 3%, which is $1475/mo.

These would be numbers for Socal.You buy a fixer and fix it for $350k total. Rent it for 2100/mo. Appraised for $500k.Property tax is $250/mo.Time to refi and get LOAN#2 for $350k. Front end DTI is [1475+250] / [7000+2500+2100] = 15%. LOAN#2 approved.

Repeat for LOAN#3 for $350kFront end DTI = [1475+250+1475+250]/[7000+2500+2100+2100] = 25%. LOAN#3 approved.

Repeat for LOAN#4 for $350kFront DTI = 3x[1475+250]/[7000+2500+2100+2100+2100] = 33%. LOAN#4 maybe approved.

Repeat for LOAN#5 for $350kFront DTI = 4x[1475+250]/7000+2500+2100+2100+2100+2100] = 39%. LOAN#5 REJECTED.

You hit a wall, even though your rent more than covers the mortgage payment for each property.

What am I missing here?

Darius Ogloza · Answer

No strategy works in every environment all of the time.  You have to adopt the strategy that fits your market.  In other words, the market you are investing in dictates the strategy to employ and not vice versa.  Sharks like tuna.  But if there are no tuna around, the shark needs to feed on something or it will die.  It adapts or dies.   In 2008-09, we acquired a couple of rentals at decent prices in California and are now cash flowing very well.  In 2020, money is being made hand over fist in my part of California through fix and flips.  What happens in 2 years?  Who knows.

Whitney Hutten · Answer

@Mike Franco I agree... I don't think BRRRR in Socal is the best strategy.  However, BRRRR does work if you buying the right properties in the right market and underwriting correctly.  You have to play the banks numbers game... not what your numbers say.  So you have to have a property that comps to the ARV you want, and where 75% of the rents MORE than covers the expenses on the property (PITI & HOA)... otherwise known as the DSCR.  Combine this with other credit factors should keep you in the game.  Here is a guide to help as well.

Ryan Howell · Answer

Basically, your scenario doesn't cash flow if you take into expenses, vacancy, property management etc...its not a good enough deal.  If for simplicity you assume you buying deals that meet the 1% rule, I think you'll see the DTI is more constant and your DTI goes up more gradual.  Which means BRRRR may not work in your market or requires more work to find a worthy deal, but house hacking / live in flip, etc may work well.

Ned Carey · Answer

@Mike Franco yes many investors in CA are making a lot of money. They are probably making a lot of money through appreciation on a smaller number of properties. Also many investors have accumulated their portfolios over many years.

You are looking at what you can do today. What happens in three years if the market crashes and your income has gone up. You now have a buying opportunity that you can't see or predict today.

BRRRR is only one strategy to acquire properties. Private lenders partners, owner financing etc are also options.

I often here complaints for CA investors saying they can't do it in CA it is too expensive. I say there is probably a more affordable are within driving distance of where you are. California has poor people too. They have to live somewhere.  I had this belief confirmed when I met an investor from CA on Monday night. She bought property 3 hours north of LA in the $250-300K range.

Mike Franco · Answer

@Ned Carey

Eventually as the rent goes up, it will cash flow better. But even so, eventually a BRRRR investor will hit that DTI limit.

But commercial mortgage... is that how large investors can keep acquiring infinite properties?

As for investing in a 500k that only rents for 2500... that's just what we gotta put up with in socal. We bet on appreciation. Our house values generally rise faster than the rest of the country.

If numbers are this terrible, what are investors actually doing in Socal then? Surely a lot of them are making money

Ned Carey · Answer

@Mike Franco the part you are missing is you have to do deals that work. part of working right is they have to cash flow enough. many areas simply do not cash flow well. The BRRRR strategy will not necessarily work in every market or price range. Right now we are at a very high part of the market cycle. Most deals don't work.

If you think all the rent has to do is cover the mortgage payment you are making a big mistake. I simply can't imagine investing in a property that costs $500 and only rents for $2500.

Now one option is get  a commercial mortgage that bases the loan on the debt coverage ratio of the property not just your personal DTI. Of course those loan will be at higher rates and the cash flow will still have to be enough to justify the loan.

How does BRRRR work when your DTI keeps going up?

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