Too Much Equity to BRRRR?

Question

On page 82 of the BRRRR book it says if a property cash flows $300/month, but has $60k in equity, flipping should be considered due to low ROI.

I have a property that will have $80k into it, including rehab. It will appraise for $185-220k, with resulting equity of $105-140k. So according to the BRRRR book I should flip, right?

If I only find deals like this, I should always flip and never BRRRR, right?

Here is the exact quote from the BRRRR book:

“ How can you know if you should refinance or sell? I advise investors to analyze whether the ROI you will get on a particular deal is as good as the ROI you can expect on your current deal. For instance, if you run the numbers and see you can BRRRR and achieve a 10 percent ROI, but you know you are averaging a 30 percent ROI on most other deals, you may want to sell that property and recover your money to put somewhere else that will give you a better return.

This becomes especially important when you are likely to add more equity to the property than you originally anticipated. If you thought you might make $30,000 on a flip when you first analyzed it, but end up looking at a possible $60,000 profit, that would cause me to look closer at the ROI on my cash flow. If I find that I’m going to cash-flow $300 a month, I can quickly see that $300 a month is a 12 percent return on the $30,000 I would have made, but only a 6 percent return if I’m going to have $60,000 in equity.

This would cause me to consider flipping instead. If done well, I would end up with more capital to put into future properties.”

Joe P. · Answer

I'm a small-time investor wrapping up a rehab on a BRRRR. Here's my thought...exit strategies abound when you get into a rehab for what you just mentioned. I've flirted with the idea myself on this particular property because of how it's turning out so far.

ROI is important but when you're cash out refinancing, technically if you BRRRR'd correctly, your ROI is 100%+ - you put 100k in for purchase and rehab, refi out at say 130k ARV (80% = 104k) essentially covering every dollar you put in. But you are receiving monthly ROI in terms of rent, not paying taxes for your refi (since its not a taxable event).

So I'd offer that while flipping could make sense if you think you're going to do better, I think ROI is not the best metric to use in this case. Rather you may consider a pro forma over the course of several years -- e.g. 60k taxable profit today or say 30k cash flow over 5 years with an appreciating property and equity. Only you can answer what is more important to you and how it aligns with your goals.

I like the idea of passive income, and 60k windfall sounds great. But for my goals, its more important to build the passive income over time. You might be different and want the cash.

All of the metrics and statistics are great ways to evaluate a deal, but when comparing exit strategies against each other, I think you need to determine if the exit strategy aligns with your goals or not or gets you to your goals. Surely a negative cash flowing BRRRR would help to make that determination, or if you can't cash out refi at the value you want...but don't take the short term profit if it won't align with what you're trying to do.

Whitney Hutten · Answer

@Jim Gurtner I think where this becomes an issue is when you go to refinance out, and when you pull all of your equity out, your expenses are so high that you barely cashflow.  Sure, you can get all of your equity out, but now you have another problem where you lack the ability to cashflow in a down market (having $10/month cashflow on a home that you have $0 money in is still infinite returns... but what happens when you have to drop rents $25/month to be competitive?).  I've talked to a few investors lately who have done this.  In this case, it was probably better to flip and then divide that capital to do more deals.

Rather than going with a hard and fast rule, make sure you are comfortable with the numbers.

JD Martin · Answer

There's no right or wrong answer here. It depends on how you would redeploy the money and if you can find anything that will top the return you are getting. In a utopian situation where properties always appreciated, interest rates for borrowing always stayed low, rents always increased and tenants always paid on time, you would probably always leave the least amount of money behind possible, pull your equity and buy something else.

In any case, the BRRRR method generally assumes you are pulling most/all equity possible out of a property. There wouldn't be any reason to leave $60k behind instead of $30k unless your bank wouldn't allow you access to that additional money. On a 75/25 refi, the extra $30k in equity would still allow you to get most of that back (about $22,500) so it's a moot question.

Bonnie Low · Answer

Interesting question @Jim Gurtner. I understand the concept the book is talking about (I have to admit it's been a few years since I read it), and as a principle for evaluating your options, it has merit. ROI is one metric of money management, but it may not be the most important one depending on your circumstance at any given time. The thing about flipping (and we are flippers) is that it's a lot like having a W2 job. Once you stop doing it, you stop getting paid. You're also taxed heavily on the sale unless you're 1031'ing it into another property. Lastly, flipping is a one-and-done experience. You sell it, profit, then move on to the next one. This is why we prefer to BRRRR whenever possible. We're at the stage of our investing career where we need to be building to passive income so we can prepare for retirement so that means acquiring properties to hold on to (granted we could invest in notes or whatever but for us, owning property is our choice of retirement strategy). So we evaluate properties on their cash flow AND appreciation post-improvement to decide if it makes sense to hold on to them rather than to sell. When we go to purchase, we are almost always looking for something to BRRRR and consider fix-and-flip as an alternate exit strategy. If you flip it, you'll have cash to put into your next property and hopefully your cash pool grows every time. But if you BRRRR it right, you'll pull out the cash you invested, gain the cash flow, have someone else pay down your mortgage, benefit from appreciation over time, save on taxes, AND have an asset you can tap again in the future if you want or need to.

Jim Gurtner · Answer

@Whitney Hutten Thank you Whitney! I had not  thought about pulling out so much cash that the property would not cash flow when renting! I can see how that could happen if there was too much equity in a high-value property. Thanks again for your response - it was very helpful!

Too Much Equity to BRRRR?

Most Popular Reply