BRRRR...Debt to Equity

[Douglas Curtiss]

I'm interested in starting a longer term portfolio of rentals using the BRRRR strategy. My concern though is by pulling equity out of each property, I'll eventually have 5, 10, 20... properties all leveraged. Of course I would use the calculators to make sure they would cashflow well and that the mortgages would be paid down. My concern is if the market takes a downturn and the mortgages go underwater. If the properties are cashflowing, one can ride this out to an extent, but I would be stressed to have a ton of debt in a down market. So I'm curious what other investors use as a rule of thumb for debt to equity.

[Kim Tucker]

@Douglas Curtiss all of these words on a page sound nice. BUT . . . You did ask about what if there is a downturn? And this is a question you really need to make sure you have everything factored in.

If we have a small downturn or market correction, you should still be fine as all of these fine folks have said. But if we see anything similar to the great recession you could be totally screwed if you don't have the right management, don't have the cash to bring to the table if forced to sell, or if you use portfolio loans.

Back then I saw many BRRRR investors who were not over leveraged who lost a tenant. Then the property was vandalized and not rentable. No extra cash laying around for repairs, so it stayed vacant. No rent to pay the mortgage would it was foreclosed. In this example a good cash reserve would have helped and good management to handle tenant turn over would have helped.

Next on the list were my investors with well managed portfolios with blanket loans across many properties. This type of loan usually amortize over 20 years or so, but have a balloon and must be refinanced every few years. However in the recession the banking commission would not allow any renewals of these loans and no new loans. There was no way to refinance these loans, so without ever missing a single payment, a lot of these were foreclosed.

With the first 2 examples out there 100s of properties flooded the markets, driving down prices. Here in KC in our C and D class areas houses that had been financed at 70k for those not over leveraged or 100k for those that were 100% leveraged were selling for 5 to 10k. The A and neighborhoods fared a bit better with price declines being more absorbable. So the person who had a hick up and needed to sell even though they were well managed and fully rented could not sell because while they may have only been leveraged at 50% they still owed way more than the new market price.

Will we have another great recession, probably not. But there were a lot if investors who didn't ask that what if question in advance and prepare for it, they lost everything and contributed to the huge price declines in our rental markets across the midwest.

So make sure your numbers work and you have a solid cash reserve, we'll over the cost of a furnace because a tenant could burn down you kitchen (had this happen twice). Have good management in place that screens very well so you have less of a chance of no rent for 3 to 6 months while you evict. File evictions early, at one day late. Have a back up property management team in mind from day 1 in case the first one or your turn key provider does not work out. Use single loans for single properties, preferably with private lenders who do not have to answer to the banking commission and have more flexibility on loan terms if there is a problem. If you do go with a portfolio loan, try to have it fully amortize.

One of the reasons, at least in Kansas City that many are very very careful about buying in the C and D class neighborhoods because at the same time all of this was happening in our urban core in the Great Recession, those with BRRRR in A, B, and fringe areas, they were for the most part able to sell because prices were not so over inflated and the properties were easier to rent and keep rented because they were in better areas.