I am a relatively new listener to the BiggerPockets podcast and have no real estate investing experience. However, I am thinking about getting into it and want to learn as much as I can before diving in.
That being said, I am having some trouble wrapping my head around BRRRR, particularly when it comes to the refinancing part. I know that this is a topic that gets discussed a lot, but I haven't seen anyone answer my specific question. So here is my understanding:
Buy - Suppose I buy a house with my own money for $80K
Rehab - I spend $20K fixing it up and the ARV is $130K (so I am $100K all in at this point)
Rent - I rent it out instead of flipping, which also helps with the refinancing. Let's say I can rent it out for $1000.
Refinance - So I go to the bank and do cash out refinancing and let's say I get the $100K I put in back. So now I have ~23% equity and $100K in cash.
QUESTION: What I haven't heard talked about is that now I just went from having no mortgage payment to having a mortgage payment on a $100K loan. So yes, I got $100K in cash, but now I have a mortgage payment cutting into my cash flow. So based on a quick cash out refinance calculator estimate with a 4.3% interest rate, I got a monthly payment of ~$700. So now I go from having a cash flow of $1000 per month to $300. Over the course of 30 years, that adds up to about $252K in lost cash flow from paying down the new loan. So I understand the time value of money and being able to make another deal, but wouldn't I also be losing out on a ton of money over the course of many years by doing this? It seems like if I was only occasionally buying rental properties, it wouldn't make sense to BRRRR. Assuming all of this makes sense, how frequently would I need to buy properties for BRRRR to work?
Your assessment is more or less correct (though you can probably expect to pay a higher interest rate on an investment property mortgage).
It all depends on your goals - if you want maximum cash flow in the short term, then by all means pay cash and carry no debt. The problem with this is it isn't very scalable - you'll eventually run out of cash.
BRRRR lets you build a portfolio of rental properties using other people's money.
To really see the full potential, carry it forward 20 years. Let's say you stopped building your portfolio after two properties because you ran out of cash and wanted to maximize your cash flow on those two units.
Whereas, Person B used the BRRR method to acquire 27 rental properties, and (for the most part) his tenants paid them all off with 15 year fixed mortgages. He sacrificed short term cash flow for long term equity, cash flow, and basically...wealth.
Who is enjoying the better retirement income in 20 years?
Howdy @Nico Timpani
First and foremost you must understand the primary objective of the BRRRR strategy. Acquire an infinite number of rental properties without having ANY of your own cash in the deal. Secondary is Cash Flow. I want positive Cash Flow (minimum of $100 per month/unit). But, I want my Cash back so I can do another deal, then another, and another, and so on .... If I keep a big chunk of my money in the property to make it have great cash flow, then I can go to the next deal. Then why even bother with this strategy. Look for regular Buy and Hold deals. Save up for the next one. It's a much longer process.
Thanks for all the information everyone! Your responses helped me understand the long term benefits of BRRRR and after doing some math on it, I definitely see how BRRRR can pay off in the long run.
First, good luck and find a deal that works for you then go find another. Repeat until you reach financial goals.
The choices you are contemplating are like comparing apples and oranges. They are both fruit but completely different in taste. Each one is fine depending on what you're hungry for. Then only way you "lose out" in either scenario is if income cannot cover ownership and debt if applicable.
There is no better returns available for cash money today than rental real estate. If you can afford to buy properties for cash and keep them debt free, that's the biggest cash on cash return you'll find out there today. But many of us can only do so much and need lending to keep the inventory growing.
That being said some caveats:
Liability: debt free properties are prime targets for attorneys/creditors.
*Leverage: Property rich and cash poor is problematic when there are interruptions in cash flow that strain your ability to meet debt obligations.
Lending: At some point you my hit a wall with being able to get financing. Each lender has rules to how much they lend in any one area and to any one individual.
*Equity: We may like to think that the difference in value and debt is "our equity". I see 30%+ equity as insurance against anyone or anything that can threaten your ownership of a property.
Tenants: What vacancy factor you use in your cash flow calculations is very important and one that seems to be always too low after the fact. Use 10% even with the properties that are "guaranteed" income. I.e.: a vacant single family home is 100% vacant. A 4-unit with one empty unit is 25%. Until you have enough units to somewhat ignore this variable, go with the worse case scenario that still make the numbers work.
*These are two sides of one coin and are on a continuum. More leverage, less equity. And vice versa. Would you rather own $500,000 worth of real estate with a 40% equity position or 1,000,000 with a 10% equity? Can you guarantee adequate cash flow during ownership to cover all ownership costs? Leverage and equity will recalculate the risk depending on the % of each and monthly income. They will also influence how you sleep at night.