Understanding refinancing How does BRRRR work?

7 Replies

Sorry noob question regarding refinancing. I searched the "browse forums" and did not find an answer. I'm not understanding how the refinance works at maintaining cash flow. What I mean by that is for example say a property is purchased and appraised for $100K. Value is added and now appraised for $150K. Say 20% or $20K was needed to initially purchase the property and $80K was financed at 4%. $10K was needed for improvements bringing a total of $30K of your own money invested into the property. The mortgage for $100K with 20% down at 4% interest is $631.93. Given the home will rent for $1000/month (passes 1% rule), insurance is $1500/yr, taxes are $1500/yr, plus $1500/yr for"other expenses". Monthly expenses including mortgage would be $1006.93 which would put the property into a negative cash flow by $6.93. Given LTV refinance at 80% which equates to $120K. After seasoning a refinance of the property is obtained and all $120K is taken out during the refinance. Now here is my question....when the property is refinanced will the monthly mortgage now be based on the amount that was removed from the new appraisal 80% LTV amount that being $120K? Lets say in this example all $120K was removed. The old mortgage amount of $631.93 is not retained, correct? The mortgage is now based on $120K which would further increase the monthly mortgage payment and thus place this example into further negative cash flow due to the larger monthly mortgage? I can't figure out why BRRRR would work unless you could purchase this property for significantly less than $100K or is that how BRRRR does work? Thank you for any assistance you can provide my confused mind.

Yeah, it can definitely be a tricky subject. I'm brand new too, and just ramping up my education to get started on my first deal. I believe where you're getting mixed up is with the way the purchase should be done. BRRRR almost always is done by paying for the property and rehab 100 percent with cash. Thus, there doesn't exist a loan at the beginning of the process. Let's say I find a home that will appraise for 160k after it's fixed up. I get a good deal on it and buy it for 70k, with cash. I then spend 50k, with cash, rehabbing it because it needs a lot of work. My all-in cost is 120k. I get a renter and then get it appraised for 160k, and now I'm making my first ever arrangement with a lender. I want a cash out refinance and they give me 75 percent LTV, which is 120k. This happens to be how much cash I spent. I now have my cash back, and the property cash flow can cover the monthly payments of the refinance, cap ex, and any other expenses for managing the property. If I chose a good property,this cash flow will be positive. But I didn't need a cash flow to cover two loans because I paid for the house and rehab with cash.

As a side note, if my rehab work was less, say 30k, I would have still gotten the property appraised for 150k (theoretically) and I would have ended up with a cash out refinance actually giving me 20k more cash than I even started with. Alternatively, if the appraisal came back lower than I expected, I might have ended up with somewhat less cash than I had to start.

Hey Trent, 
Great question - I've wondered the same about how the refinancing works too. Just want to simplify your scenario:

1. Purchase at $100k with 20% down = $20,000 Investment

2. Pull a Mortgage for $80,000 at 4% int which equals approx $630/mo expense

3. Spend $10,000 to add $50,000 in Value to the property (Total upfront capital invested: $30,000)

4. Estimated monthly expenses: $1006 vs Estimated Revenue: $1000 = Negative CF

5. Refinance at appraised value of $150,000 with 80% LTV gives you $120,000 worth of equity

6. Existing mortgage of $80,000 nets negative CF ... so how does $120,000 mortgage improve the circumstances?

I think with a BRRR strategy the point is to put that money you've generated (from wise construction and appreciation decisions) to work elsewhere. You've essentially generated $40,000 with $30,000 which has multiplied your original investment by 1.3. The sacrifice is that you now increase your debt which means your payments will rise... but the trade off is that now you can buy a second piece of real estate with that money and keep the cycle going.

I'd be curious to hear from a lender/broker how the refinancing adds up too. Is it also assumed it takes on the interest rate of the existing mortgage? What if mortgage rates have changed by the time you refi? Can you only refinance at the end of the term of the mortgage? (P.s. I am Canadian so we may have different rules)

Originally posted by @David Ripplinger :

Yeah, it can definitely be a tricky subject. I'm brand new too, and just ramping up my education to get started on my first deal. I believe where you're getting mixed up is with the way the purchase should be done. BRRRR almost always is done by paying for the property and rehab 100 percent with cash. Thus, there doesn't exist a loan at the beginning of the process. Let's say I find a home that will appraise for 160k after it's fixed up. I get a good deal on it and buy it for 70k, with cash. I then spend 50k, with cash, rehabbing it because it needs a lot of work. My all-in cost is 120k. I get a renter and then get it appraised for 160k, and now I'm making my first ever arrangement with a lender. I want a cash out refinance and they give me 75 percent LTV, which is 120k. This happens to be how much cash I spent. I now have my cash back, and the property cash flow can cover the monthly payments of the refinance, cap ex, and any other expenses for managing the property. If I chose a good property,this cash flow will be positive. But I didn't need a cash flow to cover two loans because I paid for the house and rehab with cash.

As a side note, if my rehab work was less, say 30k, I would have still gotten the property appraised for 150k (theoretically) and I would have ended up with a cash out refinance actually giving me 20k more cash than I even started with. Alternatively, if the appraisal came back lower than I expected, I might have ended up with somewhat less cash than I had to start.

Thanks so much for the reply David. I'm not sure how I missed coming into your first deal with an all cash offer but what you have said really makes sense. I've been reading David Greens book on BRRRR and now that I think about it I recall something in there he mentions about a full cash offer to start BRRRR. I guess I glossed over it due to thinking that coming in with enough cash to buy a first deal outright is a bit of a stretch for me and probably most people. I guess my next book is Brandons no and low money down otherwise it will be another 3 years before I can start. I'm assuming there is plenty of info in here on utilizing a HELOC for your first deal? If you're ever interested in a meet up let me know. Thanks again!

 

Originally posted by @Dylan Earl :

Hey Trent, 
Great question - I've wondered the same about how the refinancing works too. Just want to simplify your scenario:

1. Purchase at $100k with 20% down = $20,000 Investment

2. Pull a Mortgage for $80,000 at 4% int which equals approx $630/mo expense

3. Spend $10,000 to add $50,000 in Value to the property (Total upfront capital invested: $30,000)

4. Estimated monthly expenses: $1006 vs Estimated Revenue: $1000 = Negative CF

5. Refinance at appraised value of $150,000 with 80% LTV gives you $120,000 worth of equity

6. Existing mortgage of $80,000 nets negative CF ... so how does $120,000 mortgage improve the circumstances?

I think with a BRRR strategy the point is to put that money you've generated (from wise construction and appreciation decisions) to work elsewhere. You've essentially generated $40,000 with $30,000 which has multiplied your original investment by 1.3. The sacrifice is that you now increase your debt which means your payments will rise... but the trade off is that now you can buy a second piece of real estate with that money and keep the cycle going.

I'd be curious to hear from a lender/broker how the refinancing adds up too. Is it also assumed it takes on the interest rate of the existing mortgage? What if mortgage rates have changed by the time you refi? Can you only refinance at the end of the term of the mortgage? (P.s. I am Canadian so we may have different rules)

Thank you for the reply Dylan. Your summary was much better than how I posed my question. You are spot on with point #6. With your clarification I guess my question would be is a $10K increase (going from $30K to $40K) with a property with negative cash flow worth it? With the refinance the negative cash flow would probably be closer to a couple hundred dollars not $6.93 with the first financed mortgage. How can you get started on BRRRR if you can't come in with an all cash offer and cash to renovate? You also bring up a valid question about interest rates at the time of refinancing. Thanks again!

Originally posted by @David Ripplinger :

Yeah, it can definitely be a tricky subject. I'm brand new too, and just ramping up my education to get started on my first deal. I believe where you're getting mixed up is with the way the purchase should be done. BRRRR almost always is done by paying for the property and rehab 100 percent with cash. Thus, there doesn't exist a loan at the beginning of the process. Let's say I find a home that will appraise for 160k after it's fixed up. I get a good deal on it and buy it for 70k, with cash. I then spend 50k, with cash, rehabbing it because it needs a lot of work. My all-in cost is 120k. I get a renter and then get it appraised for 160k, and now I'm making my first ever arrangement with a lender. I want a cash out refinance and they give me 75 percent LTV, which is 120k. This happens to be how much cash I spent. I now have my cash back, and the property cash flow can cover the monthly payments of the refinance, cap ex, and any other expenses for managing the property. If I chose a good property,this cash flow will be positive. But I didn't need a cash flow to cover two loans because I paid for the house and rehab with cash.

As a side note, if my rehab work was less, say 30k, I would have still gotten the property appraised for 150k (theoretically) and I would have ended up with a cash out refinance actually giving me 20k more cash than I even started with. Alternatively, if the appraisal came back lower than I expected, I might have ended up with somewhat less cash than I had to start.

I guess technically the BRRRR process on your first deal should more accurately be named BwCRRFR (Buy with Cash, Renovate, Rent, Finance, Repeat)?

@Trent Willey Yeah, I think there's a lot on here about using a HELOC to secure your initial capital. That's actually my plan. Once I have my HELOC set up, it will look like cash to any seller, since a HELOC let's you use it for whatever you want. Another thing people do to get their initial capital is take out a loan against their 401k (I used this strategy to afford the down payment on my primary residence). 401k loans are cool because any interest you pay actually gets paid into your 401k, since really you're just borrowing from yourself. There are quite a few ways people get creative about securing cash for a deal. I think some of them are brought up in David Greene's BRRRR book. It might be worth going back and reading some of it again. (I actually just bought both his books on Friday and read all the way through them in just a few days. Great books!)

I'll send you a connection request and, if you like, I'm happy to discuss whatever topics you feel like via private messages, if you want.

@Trent Willey

You don't have to buy with cash. Lets say you get a foreclosure for $100k with an after rehab value of $150k. You put 20% down on the $100k house. You put $10k into it and now it is worth $150k. 

Now think about this.

You have a mortgage of $80k with $30k cash into the project.

After rehab, you refinance at a Loan to Value of 75%, which would put your new mortgage at $112.5K (this is 75% of $150k valued home).

So pretty much, you are taking $112.5k mortgage out on the house. $80k will go toward the original mortgage and the rest ($32.5k) will go back to you <-- with a $2.5k profit.

I hope this example kind of helps.