BRRRR refinance risks

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Hello BP forum. I've never BRRRR'd yet and I'm in a learning phase. Everyone here has been great about sharing knowledge and stories. I'm getting acquainted with the risks of any investment and am wondering about the refinancing risk of BRRRR.

The whole idea is to get a good refinance to pull your money out of the first property and move to the next. If the ARV appraisal comes back low it can halt your progress (or can it?)

My question to experienced BRRRRers is how often has that happened? What did you do? What are the upsides and strategies to deal with it. Looking for stories, insight, calculations etc.

I watched the BRRRR podcast with David Greene and he showed how you can get hammered on the appraisal but still have a good ROI but I am not sure I understood his math as it was pretty fast. What's the "for Dummies" version of dealing with that risk?

I'm curious about how likely you all think that is based on past experience.

Hi @Seth Tipton .  Yes lower than expected appraisals can always happen.   The good news is you can still make the numbers work.

For example, let's say you buy a house for 100k, put 50k of work into in and expect the ARV to be $200k. In a perfect world you get the 200k appraisal and can most likely pull out your original 150k investment as the lender is financing 75% of 200k.

Now let's say the appraisal only comes back at 180k.  Most lenders will give 75% of that 180k so you'll recoup 135k leaving 15k in the deal.  Keep in mind you still only put in 150k to get an asset work 180k, you just didn't have a large enough spread to recoup all your funds.  This doesn't make it a bad deal, it just hurst your velocity of money as you have less funds to go to the next deal.  

You can run your numbers to figure out your Cash on Cash.  For example, let's say after all expenses, capex, vacancy...etc you're casfhlowing $400/m.  That's 4800/yr which is a great return on your 15k that was left in the deal.  

Oh ok, so even if you get slayed on the appraisal that would be a 32% ROI on a 15k investment (in the form of 15k debt)

So it would be the same as if you took 15k to a stock investor and asked them to put it into something that returns 32%. So even a disaster BRRRR could work out as a good investment.

Another question I have is if you pay cash initially, no initial mortgage, is the refi process different? In that case it isn't actually a "refi" because it was never financed by the bank in the first place. I just started the BRRRR book so I am sure I will come to that.

@Seth Tipton - a bad appraisal isn't very common, but they do happen.  It's just an occasional blip to be aware of.

...and there is an opportunity to revise the appraisal if there is factually incorrect information contained within the report.  The hard part is understanding that the appraiser works for the bank, not you, so you have to send the information to your lender and get them to have the appraisal revised.  It's not common either, but a good tidbit to know!

When starting out.... plan to leave money in the deal. Honestly, plan on leaving money in every deal even when you get the hang of it. It’s highly likely you will not be able to pull every penny out (not necessarily a bad thing, either) due to going over budget, low appraisal, market shifts and a lot of other things.

@Seth Tipton - An appraisal coming back at 180k vs 200k is not necessarily a disaster.  Usually it's a factor of multiple things that effect your deal.  

Going back to the above example, let's say your rehab went over the estimated budget and ended up being 75k not 50k.  In addition that ups your holding costs as it was a longer hold time and you're now all-in for like 180k not the original 150k.  The appraisal comes back low because you were too aggressive with your comps and you only appraise at 170k.

You're now all-in for 180k and only pulling out 127k (.75 of 170k); leaving 50K+ in the deal.  

In a lot of ways, being able to get ANY of your initial capital back while still retaining the asset and continuing to cash flow is a major win. My first property I didn't know about the BRRRR process and assumed I would be leaving my entire down payment in the house for the long term. However when rates dipped this summer I was able to cash out refinance half my initial investment back. That's awesome. If I knew better I would've done things different, but I'm happy getting anything back out and still getting to keep the property.

Originally posted by @Tom Shallcross :

@Seth Tipton - An appraisal coming back at 180k vs 200k is not necessarily a disaster.  Usually it's a factor of multiple things that effect your deal.  

Going back to the above example, let's say your rehab went over the estimated budget and ended up being 75k not 50k.  In addition that ups your holding costs as it was a longer hold time and you're now all-in for like 180k not the original 150k.  The appraisal comes back low because you were too aggressive with your comps and you only appraise at 170k.

You're now all-in for 180k and only pulling out 127k (.75 of 170k); leaving 50K+ in the deal.  

 Yikes that's much worse and really underscores the necessity forba reliable contractor. It would be a 9% return basically like if you put 50k into a 401k. 

I hope that is rare but it looks like an easy mistake to make.

Like all (most?) real estate deals, you make the money at purchase. You have a bit more wiggle room because of your longer outlook (as opposed to a flip), but you still need to buy at the right price.

I personally don’t think you should get to a point that you’re surprised by an appraisal. You should have your comps, compare them to your renovated property, and err on the low end. The appraisal should never come back lower than the lowest comps, so you should be good. If it comes back higher, you’re golden.

I’ve had a few come in 5% lower than my estimate, which is a lot... but reviewing the report, I understood where it came from. I probably could have gone back and requested another appraisal, but it wasn’t a huge impact, so I looked at it as a positive of having a lower loan and more cash flow! :)

Yes one of the things I've picked up on surfing through the forums is to avoid narrowing in so much on the numbers and forgetting the real life aspect of real estate. Nobody is going to pay 400k for a house when most of their neighbors only paid 250k.