Cincinnati, OH · Member since 2018 · 85 posts · 29 votes
Hello everyone!
I have an opportunity to potentially do a BRRRR deal where the current owner of the property funds the whole rehab (refresh 2 bathrooms and a kitchen) and I pay him back when I do a cash out refi.
After I pay back the current owner/lender, I'll be left with potentially $5,500 cash in my pocket and the monthly cash flow will be $78/month. Would you do this deal?
This would be my first rental property and a great learning opportunity. I wouldn't have to pay anything out of pocket during the process.
The $78/month takes into consideration a 30yr mortgage at 5% interest rate, 18% of rent set aside for vacancy, maintenance, and CapEx, property taxes, and $65/month in insurance.
I haven't fully assessed this, but I feel rent may be able to be raised. Hasn't been raised in over 6 years. But at a conservative estimate, $78 isn't a whole lot.....but it would get a deal under my belt as a learning opportunity.
Hey Nicholas,
How did you arrive at 18% for all those expenses? The standard is usually 7% for repairs and maintenance, 7% for CapEx (usually you can get away with 5% on a BRRRR if you're doing many big ticket items like roof, water heater, etc, but since you only mentioned bathroom and kitchen, I'd keep it at 7% to be conservative), vacancy from 8-10%. Property taxes aren't usually estimated as a percent. You can have your realtor calculate your likely property taxes after the final assessed value of the property. In my area (Wisconsin) if you purchase a $100K house, you're looking at around $1.5K a year in property taxes, $3.5K per year for a $200K property and so forth. You'll want to get a solid grasp on this number since it will be a big expense.
You'll also need to consider what utilities the landlord (you) will be paying for. In some areas, its common for the landlord will be stuck paying for water and sewer, and garbage. So you need to factor that into your analysis if that's the case for your area. In some areas, you might be able to get away with sticking the tenant with all those utilities, just depends on the market.
A good common rule of thumb is that 50% of your rental income will go to expenses, NOT including mortgage expenses. So if you're only at 18%, you might be significantly low balling your estimated expenses.
But when you verify all your numbers and are still looking at $78/month of cash flow, for a first deal that's pretty good, if it's a reasonable mortgage. I wouldn't be accepting $78/month of cash flow on a property with a mortgage of $300K, but around $100K is good. Hope this helped and good luck!
- Lucas Duce
Investor · Akron, OH · Member since 2016 · 2k+ posts · 4k+ votes
7y
When do you take ownership of the property? I would be hesitant to do all the Brrrr work without at least some type of ownership stake in the property. Who is running the project? Who is making design decisions? If not you, at least make sure you have a backup plan where you are paid for your labor if the deal falls through.
Hey Nicholas,
How did you arrive at 18% for all those expenses? The standard is usually 7% for repairs and maintenance, 7% for CapEx (usually you can get away with 5% on a BRRRR if you're doing many big ticket items like roof, water heater, etc, but since you only mentioned bathroom and kitchen, I'd keep it at 7% to be conservative), vacancy from 8-10%. Property taxes aren't usually estimated as a percent. You can have your realtor calculate your likely property taxes after the final assessed value of the property. In my area (Wisconsin) if you purchase a $100K house, you're looking at around $1.5K a year in property taxes, $3.5K per year for a $200K property and so forth. You'll want to get a solid grasp on this number since it will be a big expense.
You'll also need to consider what utilities the landlord (you) will be paying for. In some areas, its common for the landlord will be stuck paying for water and sewer, and garbage. So you need to factor that into your analysis if that's the case for your area. In some areas, you might be able to get away with sticking the tenant with all those utilities, just depends on the market.
A good common rule of thumb is that 50% of your rental income will go to expenses, NOT including mortgage expenses. So if you're only at 18%, you might be significantly low balling your estimated expenses.
But when you verify all your numbers and are still looking at $78/month of cash flow, for a first deal that's pretty good, if it's a reasonable mortgage. I wouldn't be accepting $78/month of cash flow on a property with a mortgage of $300K, but around $100K is good. Hope this helped and good luck!
- Lucas Duce
Rental Property Investor · Memphis, TN · Member since 2017 · 155 posts · 151 votes
7y
Sounds like a win win to me! I would be all over that, assuming you are closing on it first before the owner starts funding for repairs. I would suggest getting a 3rd party professional inspection to be safe. I always suggest that to my BRRRR guys investing in Memphis because eventually the bank is going to send their inspector and you want to make sure you've checked everything off the list.
Rental Property Investor · St. Petersburg, FL · Member since 2017 · 3k+ posts · 4k+ votes
7y
@Nicholas Morgan what is the current rent? You say you've set aside reserves of 18% but repairs arent cheaper based on rent. 18% of a $2000/mo rental should be plenty, 18% of a $750/mo rental is far too little.
If you're reserved properly, I'd probably do the deal.
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
7y
expenses way low this will not end well.. saw this happen time and again last decade investors BRRR take out max leverage and only make 100 a month.. they lost those houses in droves.. too much debt to little cash flow and absolutely underestimating costs.. this is a loser in a non or very little appreciating rental market.. I know most will think its great and might be on paper in execution though.. UGH>
Real Estate Investor · Springfield, MO · Member since 2017 · 1k+ posts · 2k+ votes
7y
No, not a chance. 30 year mortgage is too long. You won't build any equity via loan amortization for almost 8 years, and that's a LONG time.
I never go over 15 years, and even that feels long. To give you an indication, I started in 2005, so I'm just NOW getting close to the halfway point on the first house I bought and put on a 30-year term. And my equity in the place is only about 28%. Yeesh...
$78/month is chump change. You'll learn more (and EARN more), working for an active fix 'n flipper. That is, after all, what you said this deal is all about...education. Learn from a Pro who has done 50+ deals vs. screwing it up yourself on your dime.
By the way, saying things like "I'd put $5,500 in my pocket" is of course not the same thing as making a $5,500 PROFIT. It's just a fancy way of saying "I'm going to borrow a bunch of extra money." On a 30-years note, it would take you almost 6 years to pay back that amount with your $78/month cash flow. Bleh....
18% is too low for expenses + vacancy + CapEx. Realistically set aside 30%.
Slow down a bit. Find a better deal. Get educated working for someone else, so when THEY screw up you can learn and when they succeed...you can also learn and earn!
No, not a chance. 30 year mortgage is too long. You won't build any equity via loan amortization for almost 8 years, and that's a LONG time.
I never go over 15 years, and even that feels long. To give you an indication, I started in 2005, so I'm just NOW getting close to the halfway point on the first house I bought and put on a 30-year term. And my equity in the place is only about 28%. Yeesh...
$78/month is chump change. You'll learn more (and EARN more), working for an active fix 'n flipper. That is, after all, what you said this deal is all about...education. Learn from a Pro who has done 50+ deals vs. screwing it up yourself on your dime.
By the way, saying things like "I'd put $5,500 in my pocket" is of course not the same thing as making a $5,500 PROFIT. It's just a fancy way of saying "I'm going to borrow a bunch of extra money." On a 30-years note, it would take you almost 6 years to pay back that amount with your $78/month cash flow. Bleh....
18% is too low for expenses + vacancy + CapEx. Realistically set aside 30%.
Slow down a bit. Find a better deal. Get educated working for someone else, so when THEY screw up you can learn and when they succeed...you can also learn and earn!
this current form of BRRRR running around bigger pockets is going to bury people.. between losing money on the remote rehab.. to thinking 100 a month is safety to taking refi proceeds and thinking its profit .. then when it does not work they have tied up their credit rating for what maybe 1200 month if all goes perfect.. its one thing for locals like yourself but if the best U can do is as described above its not a wealth builder on any level.. there just seems to be some irrational exuberance on these low end rentals or should I say non appreciating assets with next to no cash flow.. just because they get into them with little cash or get a little back. your still tying up a very valuable loan slot. And risking your fico..
Real Estate Investor · Springfield, MO · Member since 2017 · 1k+ posts · 2k+ votes
7y
@Jay Hinrichs, I agree that the oft-touted BRRRR method is going to outgrow it's shine before much longer. But how much longer I don't know. If people can BRRRR a house and stay in it for at least 5 years, there's a chance to make a few bucks and get the loan down enough on a 15-year note to get a reasonable refinance. Per $100,000 borrowed, year 5 should show a $25,000 equity roughly on a 5% note, plus hopefully at least $10,000 in appreciation in a modest market like my own. Not exactly Steve Jobs wealth, but do that x10 houses at $35,000 equity each and I could be happy with $1/3 million total equity and not a penny of my own in the deal after 5 years. Decent place to start learning anyway. 10 years is where it starts to get fun as you should be somewhere in the neighborhood of $60K in amortization + $20K in appreciation x 10 units. Closing in on one $1 million at that point.
There was some guy the other day bragging about "taking $20,000 extra" out of a house via a BRRRR. Hmmm.... that just makes it $20,000 harder to refinance when the rate starts adjusting or the economy tanks. Can't eat the pie before it's baked and expect that strategy to last very long.
I want at least $100 positive cash flow per $10,000 in the deal. My houses get that, so a true 12 CAP even though that's commercial language I'm using for residential deals. Yep, works good for a "Ma and Pa" self-managing investor such as yours truly. And I do pay myself a 10% management fee on top of that.
Investor · Santa Barbara, CA · Member since 2013 · 658 posts · 315 votes
7y
You need to give us more details before we can say if this is a good deal. No money down, we all like that. If you will get +$5,500 after refinance then you expect to have substantial equity immediately, also good. What is the ARV (after repair value) compared to similar properties in the area? What is the sale price + rehab cost you will be giving the current owner? How much is the rent, property tax, insurance. Are you familiar with the neighborhood, would you feel safe living there?
Cincinnati, OH · Member since 2018 · 85 posts · 29 votes
7y
Hey Everyone,
Thanks for the input!
I apologize for some of the confusion I caused. Let me clear some of this up....
My friend has held this property for 8-10 years or so and it's been a good cash flowing rental for him. He bought it at the market drop back around 2010. He wants to sell this property and purchase a property closer to his primary residence. He's in no rush to sell, but willing to work with me for a win for both of us. We haven't ironed out all the details yet, but the arrangement may look something like this:
- Friend pays off remaining mortgage balance of $62k
- Friend deeds me the property for free
- Friend funds the rehab - he expects $15k - $3k for each bathroom remodel and 7k for kitchen and 2k for misc
- ARV = 130k - potentially more. Non-updated properties nearly identical are selling for 130k right next door (cookie cutter house neighborhood)
- My friend would get reimbursed for his mortgage payoff, the rehab loan, plus $15k (this number hasn't been officially determined yet, but 15k would be the upper end of what he gets)
- I would get any remaining money from the cash out plus be left with the rental property.
- Should be a win-win: he offloads his property with no work and I get a rental for the work I do (all of it I'll do myself)
Property numbers:
Mortgage balance: $62k
ARV: 130k
Cash out 75% = $97,500
Expected Rehab: 15k
Pay friend total of $92,000 = 62k(mortgage payoff) + 15k (rehab) + 15k (cash)
Cash Flow = $70 (I was away from my spreadsheet when I posted initially, so I was off on cash flow value)
-------------------------------
Another option my friend is open to is flipping the property and just selling it after the work and splitting the profit 50/50. However, I think we'll both be hit with capital gains tax. But maybe that's a better way to go.
You need to give us more details before we can say if this is a good deal. No money down, we all like that. If you will get +$5,500 after refinance then you expect to have substantial equity immediately, also good. What is the ARV (after repair value) compared to similar properties in the area? What is the sale price + rehab cost you will be giving the current owner? How much is the rent, property tax, insurance. Are you familiar with the neighborhood, would you feel safe living there?
This property is 15min from my primary residence. I would feel safe living here.
I do admit I need to do better research on current rent in the area. Rentometer doesnt show a lot of rentals in this area, but I do know a large portion of the houses in the area are rentals. So I need to dig into that more. Perhaps go driving again and hope to see a For Rent sign.
The average BRRRR deal that I see only generates $1,000-$2,000 in annual cash flow and that'll likely get wiped out at your first vacancy. I think $78/mo is a little on the light side, but it's not uncommon. My question is why are you "cashing out?" I almost always leave money in my refinances. As long as I have less than 20% as the long-term investment, I'm better leveraged than conventional finance. My strategy/goals are to refinance at least 80% of my money back with a mortgage of 45% or less of the rents. I also keep ample reserves or some kind of back up capital that is easily liquidated (credit cards, stocks, etc.)
The BRRRR method is not a "cash flow" method in 90% or more of all deals. It's a growth strategy. Let the tenant cover the overhead and build equity from a leveraged position. If you're looking for cash flow, hold in cash or sell owner finance as those are much better cash flow models. I also always incorporate principal paydown when a home is performing well. This allows for faster equity buildup, especially when working with a 30 year am. It's almost all interest for several years as @Erik W. mentioned above.
Investors are BRRRRing with very small margins from heavily leveraged positions. This is why Jay keeps harping about how dangerous of a strategy it is for newer investors. It only takes one speed bump to derail your asset and I promise you that speed bump is always around the corner. I'm dealing with it from wind/storm damage at one of my rentals. I have ample reserves, but it still hurts when you have to dip in to $5,000 for reserves for a deductible or pay out of pocket. This is a newly remodeled home with a good tenant. Not even a pig in a tough neighborhood with a suspect tenant and it still hit a speed bump about 18 months after a huge investment.
If the home is already considerably under market, you certainly need to raise the rent, especially if you are investing in renovations. Even if it means not keeping the current tenant beyond their current lease, you should get the rents up at least a little.
Point being... understand leverage, cash flow, equity, and overhead. Whatever you do... don't spend that $5,500... you're probably going to need it at some point.
I think that there's opportunity with the deal, but make sure that you have some back up capital and a secondary exit strategy lined up. Holding on to leveraged properties for even 5 years will usually double your invested capital... but getting there can be a rocky road, especially if you are not prepared.
Flipper/Rehabber · Indianapolis, IN · Member since 2019 · 31 posts · 19 votes
7y
@Nicholas Morgan You start with $0 and end up with a cash pile of $5,500 and a cash flow of $78/month - an ROI of infinity is by far the best return you can get. Plus, all that learning/information with none of your own money at risk is the cheapest education you can buy. I say "YES"!
Rental Property Investor · Lewisville, TX · Member since 2018 · 63 posts · 16 votes
7y
Hi @Nicholas Morgan there is a lot of wisdom in these posts and I think everyone here all have valid points because it's so important to get that first deal closed. However, like you, I am new REI as well, only having closed one property, I can understand how the scenario you are faced with is very tempting; but maybe, you should take a step back and really take a moment to look at this as logically as you can because the numbers will never lie to you. Think about analyzing the property's number from the view of " what's the worst outcome" for you personally if you moved forward with the numbers you presented in your post and if you moved forward with new numbers that set aside more for your expenses. Give some thought to how it would impact your life and how/if you could bonus back from the impact.
Only you can decide what's a good deal for you and if you can begin to build your business off of a cash flow of less than $100 per month, but the numbers won't lie to you if you are honest about with them. You may also want to ask yourself: what else can I do to make this a better deal, is there enough space to add a bedroom for cheap, can i get the seller to lower the price, what else can I do to turn this into something profitable, etc...
Being new to this, I am sure you have been told how important it is to take action and to land that first deal ("even if its break even" per some of the podcasts) but just be sure to approach this as logically as you can because you are going to learn ton from the experience even if you don't buy.
Investor · Charlotte, NC · Member since 2018 · 77 posts · 41 votes
7y
@Nicholas Morgan Property taxes seem steep for a house that price IMO. If your concern is cash flow consider taking a lower LTV. This looks like is assumes 75% when you refi which is normal but you don't always have to take that big of a mortgage. Maybe only take 70% LTV to pay back the principal amount and if the profit for your friend isn't ironed out yet you have some room to wiggle.
Investor · Santa Barbara, CA · Member since 2013 · 658 posts · 315 votes
7y
Your friend is going to just hand over $38k in equity? I wish I had a bunch of friends like that. This is sounding like a decent deal to me, especially if you don't have the cash for a down payment to pursue other properties. You are beating the 1% rule, have a very nice equity buffer, some positive cash flow, decent neighborhood and no money down. I agree that I would not pull that last $5,500 out of it unless you need it for an emergency fund. The cash flow is not real confidence inspiring but if you have a good job, are able to save monthly and have reserves that will help. Five years down the road you might be getting $170 monthly cash flow. If things aren't going well that $38k in equity gives you a lot of room for a profitable exit strategy.
Real Estate Investor · Springfield, MO · Member since 2017 · 1k+ posts · 2k+ votes
7y
I think we've got some misconceptions here on the numbers. You're saying ARV is $130K based on non-updated cookie cutter homes next door. That's not ARV: that's FMV (fair market value) today. If that's the case, then all I'd do is buy the house off your friend and turn around and sell it "as is" for $130K, pay off his mortgage ($62K), hand him his profit ($15K), forget the rehab, and pocket the remaining $53,000. That would be outstanding money for basically doing no work at all.
Let's try again: what will it sell for TODAY "as is" no repairs? (FMV) What will it sell for after full rehab? (ARV) Don't use the dated house next door as a comp: use a home that is in the same condition you plan to rehab this one to for $15K costs.
Rental Property Investor · Philadelphia, PA · Member since 2018 · 42 posts · 9 votes
7y
@Nicholas Morgan - we never purchase thinking in appreciation - we work towards Cash flow - because cash flow is king. however if you want this to be your first experience go for it.
Real Estate Agent · Austin, TX · Member since 2015 · 5k+ posts · 3k+ votes
7y
@Nicholas Morgan no. Cash flow is your defense against losing the property. BRRR is going to cause a lot of pain when down with these thin margins that people are doing it with.
