In my last two articles, I described a case study when a BRRRR (buy, rehab, rent, refinance, repeat) deal goes right and goes really, really right. This week I’ll turn to a deal that’s not quite as fun to relive—a BRRRR deal that went sideways and what you can learn from it.
Our Property Criteria
First, we’ll revisit our property criteria:
- Our total cost into the property will be less than 75 percent of the ARV, allowing us to refinance out our entire investment.
- The property must cash flow with a fully financed 8 percent interest only loan on it (this is what we usually get from our private lenders).
- Note: If a property doesn’t meet this qualification, we would likely flip the property.
- The property must be in at least an OK neighborhood. Blue collar and lower end properties are fine, but we are not looking to buy D properties as rentals. There are just too many headaches and problems.
- Note: If a property doesn’t meet this qualification, we would consider wholesaling the property to an investor who specializes in such areas.
The thing to note about such criteria is that it is obviously based on a prediction of what is to come. No one is omniscient. We are trying to make the best, most informed guess we can, but it doesn’t always work out like planned. I know of almost no real estate investors who haven’t lost money on a deal at sometime in the past.
This leads us to the first point. While the BRRRR strategy is a great strategy and, if done right, can make it so you own a cash flowing property with no money in it, it’s still important to have some sort of cash reserve.
This cash reserve could be savings, or it could be from a partner. But most no-money down strategies for investing, in practice, become low-money down strategies. If you don’t have any money or have very little, a better strategy might be to buy a 4-plex with an FHA loan and live in one unit while renting out the other three. Or perhaps you could find a money partner (they bring the money and you do the work). I discuss this more here if you’re interested.
Our average all in price is 81% of the value. Our goal is 75%, but we have decided to go more for volume, so we have taken deals we might not have otherwise done. We are in a situation where we can do this. If you are more stretched for cash, you need to be all the more picky.
The Sideways BRRRR—Finding the Deal
We found this deal using one of our secondary tactics. It works by just making really low offers on HUD homes that come up on Hudhomestore.com when they become available to investors (after 30 days). We start at 20 percent of the list price and move up 1 percent per day. Every once in a while, you get one.
If you’re interested, Travis Daggett discussed this strategy in detail on the BiggerPockets Podcast sometime back. It worked a lot better in the heyday of foreclosures than today. And while we got a few really good deals out of it, unfortunately this was not one of them.
This property is a 3-bed, 1-bath home located in a decent part of Independence, MO. We got it under contract for $38,127 (you get those kind of odd numbers when going up 1 percent at a time).
The comparables made it look like its value was around $85,000 (which is what it eventually appraised for). The problem with this one was all in the rehab—and more specifically, the due diligence.
My anticipated rehab was approximately $25,000. The items included:
- Refinishing Hardwoods
- Painting Upstairs
- Carpet and Vinyl
- Minor Siding Repair
- Some Sheetrock Repair
- New Electrical Panel
However, I made several major mistakes that caused the project to balloon in cost.
1. Becoming “Attached”
We’ve backed out of deals we’ve gotten under contract in this way before, but the fact we had it under contract did add a bit of a feeling of commitment. Also, it’s a beautiful, old home with a lot of charm. But we don’t buy pretty houses; we buy good deals. As hardened as I am to that, I think those things might have tilted me over the edge to purchase a house that was on the edge to begin with.
Don’t become attached to a property. It’s just an investment. And never be afraid to walk away.
2. Missed Items
The first problem was I missed a key item. That item was the sewer line in the basement. Outside the house was fine, but it was collapsed under the basement floor, and we literally had to jack hammer it up and replace it. We normally scope the sewer lines, and we did on this one too. In fact, after reviewing my notes, I’m still not sure how I missed this. But nevertheless, it was missed. Always scope the sewer lines in old houses, folks.
2. Overoptimistic About What Could Be Saved
If you noticed, I only had painting the upstairs on the scope. That’s because the downstairs paint was almost fine. Almost being the key word.
Touching up paint when you don’t have the original color is quite difficult. And upon closer inspection, there were just enough dings and scratches to merit painting it all.
This is one reason to standardize your materials. Use the same paint colors over and over again because then you can usually touch up turnovers. But be very cautious about thinking you can touch up houses that are close but not quite right. Yes, you can go to Home Depot or Sherwin Williams and have them match a sample, but in my experience, it rarely looks right.
3. Not Factoring Enough for Age
Older houses are usually going to require more work. They also have more “endless money pit”-type situations.
On this house, it had to do with that “minor siding repair” that just kept going and going. In addition, the “some sheetrock repair” was actually “some lath and plaster repair.” Older houses generally have lath and plaster, and while it’s fine when it’s in good shape, lath and plaster is much harder to patch than sheetrock.
Finally, some of the old galvanized plumbing had to be replaced. Sometimes you can get away with leaving the galvanized plumbing, but galvanized pipes tend to corrode, which seriously reduces water pressure. So it’s something to look out for.
Needless to say, the add-on list for this property grew quite a bit during the course of the rehab.
4. Scope Creep
One the most important reasons to create a thorough budget and scope of work up front is to avoid scope creep. It’s a common problem when a project is not well defined; it just grows and grows. And rarely are those additional costs worth it.
In this case, we decided halfway through to add a half bathroom downstairs. It added a lot of convenience to the house, but it also added a good amount of costs and, in the long run, probably wasn’t worth it.
The house ended up looking beautiful.
The numbers weren’t as great, though, and it was hurt all the more by a long lease up and the fact that we were slow to get started on the rehab because of glut of projects we got all at the same time. (You need to manage deal flow, too.) The total rehab ended up going over $40,000, or about 60 percent above my original $25,000 budget.
The property ended up appraising for $85,000 and we’re into it for over $78,000.
If you add our closing costs, we’re in over $80,000. So we’re all into the property for close to 95 percent its value. It could have been worse, of course. We have been upside down before. But this is definitely not how you do BRRRR right.
What to Do When a Deal Goes Sideways
What comes next all depends on your situation, of course. For us, we have the resources to leave money into this property and just move onto the next one. The property rents for $995/month. So, its numbers look as follows:
Vacancy: $1,194 (10%)
Debt Service: $5,052 ($63,750 loan at 5%, 20 year amm)
Cash Flow: $1,694/year
This isn’t great, especially when you have to leave over $15,000 in the property, but it’s not a killer either.
If you don’t want to leave that kind of money in the property, obviously you should just sell. Although on some deals, you may lose money, which, again, is why it’s important to at least have some cash reserves if you are going to do the BRRRR strategy.
Finally, learn from what went wrong and don’t get discouraged by it—although, as they say, a wise man learns from his mistakes. A wiser man learns from the mistakes of others. So, be the wiser and learn from mine.
[Editor’s Note: We are republishing this article to help out our newer readers.]
What deals-gone-bad have you experienced lately?
Let me know your stories with a comment!