Trying to Figuring out the BRRRR Formula

8 Replies

I am a relatively new investor that has gotten my feet wet by using my own savings to buy my first deal. The deal was just okay, and now that I have the education of how to actually evaluate, buy, and rent a single family property, I want to do another deal that is much better than my first. I am really interested in the BRRRR strategy, and actually just passed up a deal that may have been a good candidate. But when I worked out my numbers, I think I had to many questions on whether or not I was understanding the strategy correctly and doing the math properly to jump on it so quickly. I was hoping that if I put some numbers up for everyone to look at on this deal, maybe you could help me with some insight on whether or not I am approaching the BRRRR strategy correctly. This way I am more prepared for the next time an opportunity like this comes up.

So here are the details of the deal:

  • 3 bedroom, 1 bathroom single family property
  • Listing requested an all-cash offer
  • The numbers looked like this:
    • Listed on the MLS for $80,000
    • Needed about $20,000 to bring it up to meet or exceed the quality of similar houses in the area
    • Estimated After Repair Value (I think abbreviated ARV) was around $141,000
    • Similar rents range from $1,100 to $1,300

Initially looking at this, my thinking was that the $80,000 purchase price plus $20,000 rehab bill puts me at 70% of the ARV, and my understanding is 75% or under is the target for BRRRR. Slam dunk for a BRRRR strategy, right!? I think so, but my biggest question revolves around the refinance part. My understanding is since I have put $100,000 of my money into the deal, I need to try and get that full $100,000 back out of the deal with the refinance so I can do the last "R" of Repeat, correct?

Running my numbers on the refinance, here is what I think I was seeing (and please feel free to comment on any of the assumptions I used, as I don't have a lot of data to support my estimates).

  • Appraised value estimated to be $141,000, and knowing I can finance up to 80% of that, I could realistic pull out up to $112,800.  I don't think I'll cash flow here, so I ran my numbers only on the money I needed to pull out to have no cash in.
  • Financed amount is $100,000
  • The monthly mortgage payment came out to be $435.59 per month
    • At a 5.125% rate on a 30 year loan, I calculated a 
  • Net Renal Income came out to be $1,140 per month
    • I split the difference of the range and used $1,200 for an estimated monthly rent and added in a 5% vacancy rate.
  • Expenditures came out to be $613.73 per month
    • I used an 11% property management fee, which was $125.40.
    • I used $120 for capital expenditure reserves
    • I used $60 per month for maintenance reserves
    • Property taxes were $225 per month
    • Insurance was $83.33 per month
  • This put me at a Net Operating Income of $526.27 ($1,140 rent - $613.73 expenditures).  Factoring in the mortgage, I came out at $90.68 (526.27 Net Operating Income - $435.59 mortgage) as my monthly cash flow.

So here are my questions:

  1. Am I correct in thinking that I can finance $100,000 to cover my cash in, and use the difference between the appraised value and the financed amount ($41,000) as the minimum 20% equity to stay in the property that is needed by the bank?  Originally, I was trying to run my numbers so that I was financing the amount I needed plus the 20% equity, meaning finance $125,000 so that I could pay myself back the $100,000 and have that 20% equity, but the more I thought about it, this didn't make sense.  At that point, the extra $25,000 from that approach would be cash that I took out as well, correct?  Whatever I finance will essentially be the check the bank would write back to me, while the equity will stay in the property, correct?
  2. Did I approach the math correctly with my BRRRR strategy in looking at how the property would cash flow after rehab?
  3. If it were you, would you have jumped on this deal?  

Thanks a bunch for any and all guidance/comments/tips you can leave me with!

@Gary Lawson ...these numbers are extremely close to nearly everything I look at as well. I look for $200 or more cash flow, but the fact is, the difference between your $90 cash flow and a $200 cash flow goal are some estimates. Estimate on repairs, estimate on rent, estimate on vacancy, estimate on capex, etc.... Estimates are the difference of this being a good or just ok deal! If you are very confident in your estimates, then you may try to recalculate with a lower purchase price. If your estimates are conservative you may have a decent deal.

Howdy @Gary Lawson

Here's how I like to work BRRRR deals.

1. Determine the ARV ($141,000)

2. Get pre-qualified for the Refi Loan. Usually 75% LTV ($105,750).

3. I want my All-in cost to be as close to 70% of ARV ($98,700). This allows for lower than expected appraisal and/or Rehab budget overages.

4. Determine my Maximium Allowable Offer (MAO). ARV * LTV - Rehab - Closing Costs - Holding Costs = MAO ($141,000 * 75% = $105,750 - $20,000 Rehab - $3,000 Closing (example) - $3,000 Holding (example) = $79,750

You can see your numbers are close to what I might use. So, yes you did the math right. However, i would not do this deal as presented because of the poor cash flow. SFR I prefer a minimum of $200 per month. Too much can go wrong with slim margin for error at $90 per month.

@Josh Stanley , good to know these numbers are comparable to what you are looking at.  You and @John Leavelle mention having a $200 minimum cash flow, so I may have to re-calibrate my approach.  As for my estimates on expenses, I am really just guessing.  I only have one property under my belt, so I really don't have a lot of data to base these estimates on.  On your end, do you use your past experience with expenses to develop your estimates, or do you have some other approach I may be able to consider.

@John Leavelle, thanks for your thoughts.  I never considered the holding costs, which I am assuming to be any costs associated with holding the property for whatever time period needed to season prior to the Refinance phase, such as interest on borrowed cash, mortgage payments during rehab, etc. I'll need to include that back into my process.  Also, aiming for 70% is a great idea to create a bit of a cushion.  I'll also be reevaluating my minimum cash flow requirements. 

@Gary Lawson ... John Leavelle makes a great point about Maximum Allowable Offer. He wouldnt do the deal at $90 a month in cash flow, but that doesnt mean he wouldnt do the deal. Understand what that MAO is and make the offer that gets you to a point of healthy returns & cashflow. Or see if there are ways you can improve expenses since Cashflow can be improved by lowering costs or increasing revenue.

Personally, I dont have enough experience to guess. I have to either get quotes or over estimate (which is a risk of losing a deal). Looking at your numbers the only one that jumped out at me was 10% for Capex. That may be high, but you know the property bette than I do. If there is some larger projects that are not a part of your $20,000 rehab budget, then thats probably right. If you are knocking out all the major capital costs up front before renting that number of $120 per month may be higher than what you need (not the end of the world...I find it better to be safe than sorry). I would strongly urge you to use the BRRRR Calculator in Bigger Pockets. Its change the way I think of REI strategy.

On the surface, it appears you are doing everything right.  Make the offer that works for you.  Expect most of them to be declined so no hard feelings.  Move on to the next one.

@Josh Stanley , the CapEx I am estimating in is for the unknown down the road, and is in addition to the rehab budget (which I guess would also be a CapEx). I am figuring that my rehab budget takes care of anything I know about at the time of purchase, but I am also putting money aside so that when my furnace goes out or it's time for a new roof, I have the cash available. This may be a large over estimate in most cases (and hopefully is), but until I actually get some data and a track record, I want to be ready for anything. I guess this is the way I understood estimating capital costs. If I am understanding this incorrectly, and most people are calculating CapEx based on what they know needs to be completed as a CapEx in their determination on whether it is a good deal, I may have passed up quite a few deals that may have been worth an offer.

Thanks again for the advice and thoughts.  It is really nice to be able to bounce some of these things off of someone else with more experience than I have.

@Gary Lawson ....I think you are doing it right.  It just varies greatly.  

For example, the deal we are working on right now we are replacing nearly everything (flooring, Air Conditioner, Electrical, Plumbing, windows, drywall, kitchen cabinets, full bathroom & the room has 20 years left). There is just not a lot left that could go wrong in the near term. I may only use 5% CapEx savings in this scenario because the bulk of large costs should be delayed.

Without knowing your deal, I think 10% is fair. It could even be higher if you know the roof only has ~5 years left but you are not interested in replacing it right away.

@Gary Lawson

When I evaluate properties for cash flow I do have a minimum acceptable amount per unit to start with. $100 per unit for multi family and $200 for single family.  However, I also look for properties that I have room to raise rents after the Rehab.  As @Josh Stanley suggested I have made adjustments for BRRRR deals and lowered the Refinance loan amount in order to improve cash flow to an acceptable minimum. I do not want to make that a common practice since I am trying to reuse the same bucket of money over and over again.

As far as knowing what expense amounts to use. It can be a little more simple than you might think. I start my initial screening analysis using 55% for expenses and current rents for income. If they pass the initial looksy I start using individual expense estimates for a little more closer look. Yes, I use 10% for CapEx. Once the property is under contract I have it inspected to determine the current condition and life expectancy of all major components and appliances. I use this report and and the draft SOW to determine what will ultimately be included in the Rehab and what can be deferred. In most cases my reserves requirement is lower than the original 10%. My investment practice is to only hold properties for approximately 5 years. Then 1031 exchange them for larger ones. So anything not expected to last a minimum of 5 years is included in the Rehab.

For Vacancy I can care less how low a Seller or market average is.  I maintain a minimum of 8.34% in my analysis and budgeting.  That covers one months rent.  If the actual vacancy amount ends being lower then I made more money that year.

PM averages 10%.

Maintenance reserves depend on the age/condition of the property and the quality of tenants.  I like a minimum of $50 per unit.

You can get free quotes for insurance.

Taxes are easy to find.

Utilities.  Call the servicing Utility to get an average on the property.

Once you get a property under contract you will be digging deeper during the due diligence.

Holding costs include (but not limited to) loan payments, insurance, taxes, utilities, HOA fees, etc., that occurs during the Rehab period and up until the property is fully rented. This includes negative cash flow. I routinely use $6,000 initially for Holding Costs estimates for my analysis.

Gary, be sure you understand what is considered CapEx and what is OpEx (Repair/Maintenance) in your Rehab. It makes a difference from a tax perspective.

I agree you seem to be going in the right direction with your analyzing.

Wow, thank you for your time and insight @John Leavelle ! This is incredibly helpful, and gives me a point of reference to go back and check my numbers, assumptions, and way I am evaluating deals. I feel much more prepared to initiate a BRRRR strategy deal. Now I just need to find another opportunity. I have been looking solely on the MLS due to living in another state than where I am investing, and good deals seem few and far between. I have been considering trying out a direct mail campaign but haven't pulled the trigger yet.

Thanks again for all of your thoughts!