Duplex Remodel - High Interest Rate BRRRR?

[Evan Kraljic]

Investment Info: Buy and Hold Duplex in Minneapolis, MN

Purchase

Purchase Price: 302,500

Remodel Budget: 50,270

Initial Loan Terms: 5.125% interest rate fixed for 5 yrs, 25 yr am, 246k loan (80% LTV) - $1953/mo PITI. ~$410/month in HELOC interest payments

Initial Cash Flow/COC return: $599/mo cash flow, 12.95% COC return

*Note: Cash flow assumes 15% expenses combined for vacancy/maintenance/capex, plus $150/mo water/garbage bill, and $75/mo for lawn/snow. I did not count HELOC as cash invested since I deducted the I/O from my cash flow

Refinance

ARV: Appraisal was for 500k (lmao) but should be more like ~400-425k IMO. 450k at most.

Refinance Loan Terms: 5.625% interest rate fixed for 5 yrs, 25 yr am, $332,423 loan - $2562/mo PITI, wiped out HELOC costs

All in costs: $302,500 (purchase) + $6296 (closing costs) + $50,270 (reno) + $5257 (refi costs) = $364,323. Took out holding costs as it was ~equal or less than my agent commission here.

Cash invested: $364,323 - $332,423 = 31.9k

Final Monthly Cash Flow/COC return: $414/mo, 15.57% COC return

What made you interested in investing in this type of deal?

This property fit my buy box really well. It's about a 5 minute drive from my house and I own a duplex on the same street, so I know the area and tenant base well and felt confident in my rent projections.

I also was looking to do one more rehab before I could qualify for another owner occupant property, so this fit the bill as a potential BRRRR opportunity. It's not a crazy deal as it was listed on market, but based on comps I figured I could purchase and rehab for 80% of ARV, leaving little to no $ in the deal. But I also knew interest rates were set to increase with the Fed raising rates so it might not make sense to refinance, so I had to underwrite and be okay with the scenario of holding a chunk of variable HELOC debt as well.

Another thing I really liked was it had one unit vacant and another with lease expiring shortly after closing. The remodel here was a pretty quick 2 month turn and burn and residents were moved in after 3 months. We often think of returns on our money but I'm learning that return on time and brain damage are equally as important building a portfolio. For me, I much prefer to buy a building with a quick path stabilizing it to highest and best use, rather than buying something with way below market rents and turning over 1 at a time or dealing with displacing tenants in general. 

How did you find this deal and how did you negotiate it?

It was listed on market and I set up a showing right away, built some rapport with the listing agent telling her I owned 3 duplexes within a mile or two and that I prioritize being straight forward/easy to work with, and prefer not to negotiate over ticky tack items on an inspection since I’d be remodeling it regardless. That was attractive to the seller and helped get my offer accepted despite 9 total offers on the property (it was listed well under market). This is not an advertisement for myself as an agent as I only have the license to work on my own deals, but just a reminder that you can keep it simple and doing a little extra in terms of assurance of closing can go a long way, both for the listing agent and the seller. 

How did you finance this deal?

Worked with a local credit union. Commercial loan at 80% LTV, 25 yr amortization and fixed for 5 years. Initial interest rate was 5.13%. I used a 90% LTV HELOC on my primary residence to help fund the 20% down, and paid cash for the rehab, ended up refinancing with the same credit union to pay back the heloc funds and a portion of rehab and other costs (see more in outcomes section).

How did you add value to the deal?

All new kitchen and bathroom in both units is where most of the money went. New light fixtures, paint in one unit (vacant unit was painted before listing), refinished hardwood floors. See before and after pictures.

What was the outcome?

I refinanced at a slightly higher interest rate (5.625 vs. 5.125 for purchase). Sounds crazy, but I received almost 83k upon closing the refi which I used to fully payoff one HELOC and put a dent in another. My interest rates are up to 8.5% and may get to 9% on the HELOCs so even refinancing at a larger loan amount and 0.5% higher interest rate, I'm still paying less in interest since I put those proceeds towards paying down my higher interest debt.

I could have actually taken more on the refi loan and approached a perfect BRRRR (lender approved up to 347.5k) but I choose a slightly lower loan amount for a couple of reasons. Main one being that I was limited by needing 1.2 DSCR here, and while my lender was willing to get aggressive with the expense ratio, I want to leave open the possibility to hire a property manager. Also, I like my residents and am happy with the rents I got despite leasing in winter, so I'm not going to push rents but I do expect taxes, insurance, and other expenses to tick up. I don't want to violate my loan covenants because I wanted to push the envelope, so slightly lower leverage made sense for me here.

Lessons learned? Challenges?

Honestly, it’s hard to make cash flow numbers work on 2-4 unit properties in the Twin Cities market, unless you’re willing to do certain niche strategies like section 8, rent by the room, AirBNB, etc. But these are almost always going to come with their own challenges and a lot of times the juice isn’t worth the squeeze, so to speak.

I self manage my small rental portfolio which helps make the #s work and I think this is a good thing to do while starting out to really learn the business, but I’m getting to a point where I know I could manage some more units, but I would much rather focus on the parts of real estate that I’m passionate about - mainly finding deals and executing on the rehab/value add components.

Challenges mostly revolved around having to lease out a different unit unexpectedly during a slow rental market in MN winter, and dealing with an onslaught of maintenance issues at my other properties. Mid December through Early January I easily had more issues than the previous 12 months combined, which normally aren’t too difficult to address but I was stretched really thin with the W2 and putting in another 30-40 hours a week finishing the remodel at this property.

These challenges made it clear that I need to hire out property management in the future, and to do that I will need to find better deals with a better margin to cash flow. My strategy for that is going to be trying to source my own off market small apt buildings (starting in 5-12 range). Don't get me wrong, it's still difficult to make the #s work here, but that doesn't mean I'm not going to try. Also when I learned a few years ago that commercial buildings are valued off the NOI that was a major draw for the process engineer in me lol, I knew I would have to work my way into that asset class eventually.

Did you work with any real estate professionals that you’d recommend to others?

I was my agent here and I’m not recommending myself - not as an agent at least, but down to talk investing.

My lender is Josh Anderson with Ideal Credit Union.

I used plenty of contractors here, you can DM me if you want some referrals

[Drew Sygit]

Well done and like that you didn't short-sightedly take max cashout.