Brandon and David were COMPLETELY WRONG in podcast #327

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Brandon and David were COMPLETELY WRONG in podcast #327

Joel Arndt
Hamilton, On · Member since 2018 · 75 posts · 36 votes

First of all, why is there no dedicated BRRRR section in the forums?

Anyway, this is about one point that Brandon and David made in the Bigger Pockets Real Estate Investing Podcast #327. It is an excellent episode and I highly recommend you listen to it. It's all about the BRRRR method.

But I have a beef with ONE point that Brandon made (and David agreed to).

Brandon explains how he is often asked how BRRRRing can work in markets with relatively higher prices. People complain a lot about how expensive it is to buy in their market, making investing in their own backyard next to impossible. That's why you buy David's book "Long Distance Real Estate Investing" because it's is the single most practical guide to investing in properties that you will likely never walk through. David and Brandon make that point first in this episode. 

But then Brandon goes on to say something that I fell is COMPLETELY WRONG.

Brandon says, "Is anyone flipping houses in your market? Because if anyone is flipping houses in your market, you can definitely BRRRR there too."

I understand where he's coming from, and in most cases, this is probably true. But in hotter markets, this isn't always the case.

First, I'm a newb. I've done exactly 1 wholesale deal since I discovered real estate investing 1 year ago. So I look forward to being proven wrong. But from that one deal, and from understanding my market (Hamilton, Ontario), I'll prove that, just because you can flip a house in a market, does NOT mean you can BRRRR as well.

The one deal I've closed was a wholesale assignment to a flipper. I got the house under contract for 430k, the flipper had to put 120k of renos in, and it will sell for 630k - 650k. This house will never cash flow positively as a rental, even if it was converted to a triplex, which would arguable cost more than a straight reno.

Rents are high in that neighbourhood, but not that high. Which brings me to my ultimate point.

The BRRRR method is dependent on many factors, but the single most important factor is the rent you can achieve.

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Steve Vaughan
Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
7y

The value of this strategy or any value-add play in  expensive markets may all be in the equity capture, not cash-flow.  

At the end of the day, when you eventually sell, the important return measure will be your IRR. While monthly COC or yield is easily measurable and therefore hyper-focused on, equity gain will usually be the meat and potatoes of your return, the cf and COC just gravy.

My last BRR (no refi) basically breaks-even, but added 55% equity to my balance sheet.  Fine for more seasoned investors, but tougher for newer ones.

That said, I have always thought the brrrrr acronym  was missing 2 important components- Seasoning and Costs.  Many are surprised they need to season for 6 -12 months or that it costs so much to refi. 

Gutsy post!

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  • Joel Arndt
    OP
    Hamilton, On · Member since 2018 · 75 posts · 36 votes
    7y

    PART 2

    How some investors are using the BRRRR method in my market is converting bungalows into duplexes by making the basement a second unit. This increases the gross revenue on the property, putting it into a cash flow positive position.

    But prices have climbed so much in the last few years that even a duplex doesn't cash flow without it being a sweetheart deal or without putting in at least 100k to 120k down payment. At that point your return on investment drops significantly and it is extremely hard to recover the majority of your purchase price and rental expenses with the refi.

    So really, the BRRRR method enables investors to access cash flow in a hot Market when it usually wouldn't make sense. But even then, there's an argument to be made for finding a better suited market where you can buy more properties with the same amount of money it would take to buy one property in this market.

    Anyway, just because you can flip properties and make money in your market doesn't necessarily mean the BRRRR method is suited for that market as well.

    0Reply
  • Russell BrazilBusiness Member
    Moderator
    Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
    7y

    The rent you can achieve has zero to do with the brrrr strategy.  Lower yield assets might not be your cup of tea, but the yield of the asset has nothing to do with the strategy. 

    [email protected]301-893-4635Podcast Guest on Show #192
    District Invest Group545 Reviews
    WebsiteView Page
    3Reply
  • Joel Arndt
    OP
    Hamilton, On · Member since 2018 · 75 posts · 36 votes
    7y

    @Russell Brazil

    I would argue that the yield if an asset has everything to do it.

    Why invest in one 6% yield asset when you might be able to invest in two or three 12% yield assets in another market.

    The point was about judging the effectiveness of the BRRRR method in a hot market. If you can't bring in the rent necessary to make it a worthwhile investment, then it's time to evaluate new markets. (Which was the original point that Brandon and David made anyway.)

    0Reply
  • Russell BrazilBusiness Member
    Moderator
    Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
    7y

    Yield measures risk. Higher yield properties are higher risk properties. The brrr method is a higher risk strategy.  Combining a higher risk strategy with a higher risk property multiples that risk even further. The problem is so many convince themselves the opposite. They think that higher yield is safe because of the cash flow when in fact the opposite is true. The higher yield is the reward for taking on the higher risk asset.

    This is also an important concept. All properties cash flow.  When they dont, that is because of leverage. The decrease in cash flow feom leverage has zero to do with the underlying risk of the asset or market, but rather that risk eminates from the leverage, and as the leverage increases, so does the risk. This is a fundamental rule to finance that most on the site get backwards as well, including those that promote the brrr strategy. Many think their risk decreases because they have less cash in the property when the opposite is true, leveraging 100% is as risky as you can get with leverage.

    [email protected]301-893-4635Podcast Guest on Show #192
    District Invest Group545 Reviews
    WebsiteView Page
    15Reply
  • Steve Vaughan
    Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
    7y

    The value of this strategy or any value-add play in  expensive markets may all be in the equity capture, not cash-flow.  

    At the end of the day, when you eventually sell, the important return measure will be your IRR. While monthly COC or yield is easily measurable and therefore hyper-focused on, equity gain will usually be the meat and potatoes of your return, the cf and COC just gravy.

    My last BRR (no refi) basically breaks-even, but added 55% equity to my balance sheet.  Fine for more seasoned investors, but tougher for newer ones.

    That said, I have always thought the brrrrr acronym  was missing 2 important components- Seasoning and Costs.  Many are surprised they need to season for 6 -12 months or that it costs so much to refi. 

    Gutsy post!

    17Reply
  • Victor S.
    WorldWide · Member since 2016 · 1k+ posts · 1k+ votes
    7y

    man, these clickbait titles, tho...

    that blanket statement doesn't work every time, you are correct. i ran some numbers on a home with a purchase price of $145k (mls, so the price is obv high(er)) that needed about $35k in repairs to make it nice for an arv of $225k (conservative). profit came out to be about $15k (after closing, carrying, etc.). roughly 20% return on cash outlays (dp, cc, repairs). rent would've been about $1700/mo on this one. refing it @75% would leave me 20k in the deal with about $200/mo CF. Not a BRRRR deal, but you would be getting a pretty solid home in a nice, growing neighborhood, so at the end of the day, the IRR on this thing would be looking pretty solid.

    8Reply
  • Andrew Frishman
    Ridgefield, CT · Member since 2017 · 101 posts · 60 votes
    7y

    One comment I want to make regarding this BRRRR podcast:

    The assumption being:  

    The average single family "newbie" investor / Average Joe" is not going to want to BUY/cash! ...a fixer upper"   for more then $150- 200K..without loosing sleep at night....maybe...(a hard money loan would only add to the stress on a Newbie).

    Therefore....I/ most investors  would have to shop in Housing markets with homes under 200k...

    In my case...living in the northeast....I am restricted to the southeast (NC, FLA, Tenn, Georgia)/ maybe...Midwest.)

    I would have to  long Distance Invest....

    Then I would have to get a team/"Core 4" in the market. I would have to travel.. ..to be boots on the ground to network with contractors //bankers...etc..

    If I overcome the above  hurdles ….. I would have to  place al of faith in my contractor.

    I need to get in the right mindset to take this leap of faith!!

    Any Feedback appreciated...

    0Reply
  • Brian G.
    Rental Property Investor · Los Angeles, CA · Member since 2013 · 1k+ posts · 1k+ votes
    7y

    @Russell Brazil if I could vote 10x on your post above I would! Well said. The financing or lack thereof has zero to do with the underlying risk associated with the asset. I 100% agree.

    2Reply
  • Bob Woelfel
    Investor/Agent · Kansas City, MO · Member since 2017 · 291 posts · 308 votes
    7y

    The rent you can achieve might be the single most important aspect of it for you, but it doesn't mean it is for everyone else.  I'm sure a lot of people do exactly what you are describing, but instead of renting all the units they choose to live in one and let the other tenants cover a part of their living expenses.  Why pay $3,000 a month in rent when you can own a completely renovated building, with equity and only pay say $2,000 a month?  While this place may not "cash flow" either now or in the future, it certainly has given the owners a leg up on where they would have been had they not done the deal.  

    1Reply
  • Joel Arndt
    OP
    Hamilton, On · Member since 2018 · 75 posts · 36 votes
    7y

    @Russell Brazil 

    Yes, higher yield means higher risk, but that doesn't mean higher yield is always dangerous. There are certain criteria that every deal should meet to qualify it as an acceptable risk and keep it out of the danger area. You don't take on a deal where the leverage eats up your comfortable cash flow. Besides, no bank and few lenders are letting finance 100% of the value of the property. The point of the BRRRR strategy is to buy at a deep enough discount so that you can rehab the property, refi at 65% - 80% LTV, and still make money. To your point, the BRRRR strategy actually lets you limit cash in a property and limit leverage, minimizing risk and maximizing yield. 

    How? 

    Rental Value.

    Now to my original point.

    If you can't bring in enough rent to cash flow comfortably over and above your total debt service on the property, it's not a deal and you don't buy it. Now, I realize there's an argument to be made about buying right (at a deep enough discount) to create a better cash flow position, but there is a limit to how low you can buy. An abandoned beat up property surrounded by $600k homes likely won't sell below $400k.  You could flip that and make a tidy profit, but you'd be hard pressed to turn that into a profitable rental. Of course, that depends on what number? The rent.

    I realize I'm getting a little sassy there, but my point is, when looking at a BRRRR deal, it might actually make more sense as a flip if you can't bring in enough rent.

    0Reply
  • Joel Arndt
    OP
    Hamilton, On · Member since 2018 · 75 posts · 36 votes
    7y

    @Steve Vaughan

    Interesting, so you're buying at a discount, creating equity, but not quite deep enough to cash flow? 

    ---

    Seasoning isn't really an active step in the process, although it needs to be factored into your total cost when planning out the rehab. Ideally you refi over the rehab and holding costs.

    Also, the point of the refi is to reinvest your principle as quickly as possible. Why wait 5 - 7 years to access that cash when you can buy two or three more properties within a year and half. Three properties with mortgage pay-down, appreciation (equity build up) and monthly cash flow sound a lot more attractive to me than 1 property with a lot of equity but contributing nothing usable to my bank account.

    Even for season investor, wouldn't you want to have the most use and control of your cash?

    0Reply
  • Joel Arndt
    OP
    Hamilton, On · Member since 2018 · 75 posts · 36 votes
    7y

    @Victor S.

    The clickbait comes from my marketing background. :)

    ---

    So did you end up flipping that property, or did you hold it because of the value of the neighbourhood?

    0Reply
  • Joel Arndt
    OP
    Hamilton, On · Member since 2018 · 75 posts · 36 votes
    7y

    @Bob Woelfel

    Right. I guess I'm talking strictly about a typical BRRRR investment. When you live in the property, that changes your investment criteria drastically and you're no longer looking at the deal through the same lens. The point of a BRRRR is to invest, add value, create cash flow, pull out your principle, then reinvest. That's very different from the person looking to house hack.

    0Reply
  • Steve Vaughan
    Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
    7y
    Originally posted by @Joel Arndt:

    @Steve Vaughan

    Interesting, so you're buying at a discount, creating equity, but not quite deep enough to cash flow? 

    ---

    Seasoning isn't really an active step in the process, although it needs to be factored into your total cost when planning out the rehab. Ideally you refi over the rehab and holding costs.

    Also, the point of the refi is to reinvest your principle as quickly as possible. Why wait 5 - 7 years to access that cash when you can buy two or three more properties within a year and half. Three properties with mortgage pay-down, appreciation (equity build up) and monthly cash flow sound a lot more attractive to me than 1 property with a lot of equity but contributing nothing usable to my bank account.

    Even for season investor, wouldn't you want to have the most use and control of your cash?

    Mine cashflow because I don't bother refinancing anymore.  I just do BRR.  My min ROE is 7-8%. If I were to take the time and pain and pay the $5k to bother refinancing to max leverage they would have neg cf of about $200 per month.  

    Obviously my goals as a 10x Napper are different than someone hunting around constantly for 2-3 new deals per year.  I used to do that.  Bought 19 one year, 9 the next. But we were at a very different stage of the market cycle.  

    If you are in a market where you can purchase 3 good investments per year without having to turn 200 rocks per, go for it.  The effort/reward ratio is too high for me in my market at this time. I need a 20-50 rocks per success ratio to bother.

    If this changes and deal flow picks up, I will actively hunt again.  Thanks for sharing your perspective. 

    4Reply
  • Joel Arndt
    OP
    Hamilton, On · Member since 2018 · 75 posts · 36 votes
    7y

    @Steve Vaughan

    Makes sense. Priorities matter. Really, that's what @Russell Brazil is getting at as well. That's understandable. 

    With your experience, Steve, when you used to do the full BRRRR, which criteria did you look at first? Was the Rental Value or the ARV?

    0Reply
  • Steve Vaughan
    Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
    7y
    Originally posted by :
    With your experience, Steve, when you used to do the full BRRRR, which criteria did you look at first? Was the Rental Value or the ARV?

    Definitely rent value. ARV is more of a flipper or wholesalers' prime criteria I would think. I don't flip anymore. Too much work to lose 40% to taxes and transaction costs too high.

    Mine generally meet the1% rule pre-rehab.  I can obtain my 7% ROE min that way generally. 

    0Reply
  • Joel Arndt
    OP
    Hamilton, On · Member since 2018 · 75 posts · 36 votes
    7y
    Originally posted by @Steve Vaughan:

    Definitely rent value. ARV is more of a flipper or wholesalers' prime criteria I would think. I don't flip anymore. Too much work to lose 40% to taxes and transaction costs too high.

    Mine generally meet the1% rule pre-rehab.  I can obtain my 7% ROE min that way generally. 

     Awesome. Glad I'm on the right track. :)

    When you say 7% ROE, that's after the refi, right? 

    You know, we talk a lot about ROI or IRR or COC, but the ROE get's left out a lot. I don't know if I've ever heard of an ROE rule of thumb... Why did you choose 7%?

    0Reply
  • Mike Dymski
    Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
    7y

    BRRRR is a new term for an age old strategy of adding value and tapping into the equity created. It has been going on in residential and commercial real estate and in other businesses around the world forever. Investors and companies buy other companies (or properties), improve operations, and then leverage that business to buy and repeat. And that strategy is executed on 2 caps and 10 caps alike. The strategy is not linked to the property type...how you want to execute the strategy is.

    2Reply
  • Joel Arndt
    OP
    Hamilton, On · Member since 2018 · 75 posts · 36 votes
    7y

    @Mike Dymski

    Yeah, it's pretty basic, although, not as basic as buy, fix and sell. This small sliver of the real estate investing world happens to be a very practical way for the average investor to scale up their real estate investing.

    Brandon made a point on the podcast that if you can flip properties in a market, then you can definitely BRRRR there as well. I challenged that, pointing out that you could flip in a hot market, but the prices will likely out pace the fair market rents in the area.

    0Reply
  • Mike Dymski
    Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
    7y
    Originally posted by @Joel Arndt:

    @Mike Dymski

    This small sliver of the real estate investing world happens to be a very practical way for the average investor to scale up their real estate investing.

    There is a common misconception on BP that the average investor can scale up faster adding value to a 10 cap versus adding value to a 5 cap.  $1 spent on rehab adds $10 in value for one property versus $20 in value for the other.

    2Reply
  • Steve Vaughan
    Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
    7y

    7% ROE bar after the rehab, yes. Although that's harder to maintain on the houses these days.  I just recalced a couple and what was 7% a couple years is now 5.6% & 6.4%.  Appreciation exceeding rent growth as you mentioned.

    7% ROE is my bar for the risk and effort involved is all.  I'm good with that because it's safe and doesn't make me hunt. It also has tax advantages. Less than 7% and ill start looking for a new home for it. Need 10% in the equities market to account for risk and taxes for comparison. To me those returns are roughly equal.

    I still have dry powder in case an opportunity arises. Not saying everything we have is locked up illiquid earning 7%.

    0Reply
  • Neal Collins
    Developer · Portland, OR · Member since 2014 · 732 posts · 490 votes
    7y

    @Joel Arndt People make this same argument when it comes to wholesaling, flipping, buy and hold rents, etc. "My market is too hot", or "The prices are too high here to ..." 

    You most likely can't wholesaling every off-market property that comes your way. Just like you can't flip every property that needs improvement. Deals do not fit perfectly into one box. They are created through the marrying of finance and negotiation to the asset.

    Right now you may be feeling like there isn't much low hanging fruit on the tree. And there most likely isn't in your area, not like in the years after the recession. Financing has been cheap for a long time now.

    Do yourself a favor and don't put a ceiling on your investing career at this point. If you believe that you can't buy a property, rehab it, pull out money by leveraging it at a new value, and then use the cash out proceeds to go buy another deal, then you've effectively put blinders on. The same thing happens when you tell that narrative to yourself about anything.

    Good luck out there. The next deal you do may be a BRRR!

    0Reply
  • Eric James
    Investor · Malakoff, TX · Member since 2017 · 2k+ posts · 2k+ votes
    7y

    You are correct. Rentals can get poor returns in some expensive markets, where flipping can be profitable. This includes brrr, which is a rental property strategy.

    0Reply
  • Joe SplitrockPro Member
    Moderator
    Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
    7y

    @Joel Arndt completely wrong is a pretty strong way to put it. I thought Brandon actually made a great point, aimed at those people who are continually saying, "there is no deals". The point he was trying to make is that if a flipper can buy a property, rehab, pay sales expenses AND make a profit; then an investor could surely buy, rehab NOT sell and gain equity. Obviously directly comparing flipping to buy and hold is not applicable in all situations. I could buy a house for $800K in California, put $150K into it and sell it for $1.4M to make a nice flip profit. Would I want to buy that property as a rental, of course not. That is pretty obvious though (I thought). 

    The point he made is still valid, that since an investor is not selling the property, what would have been sales and profit actually becomes equity when you hold. You can then do a cash out refinance to pull the equity out. I honestly thought that was a great way to put it in perspective.

    Separate Point

    I did disagree when they said pulling out the equity makes the investment more secure. Their point was pulling out the initial cash reduced risk, which assumes all you care about is the initial cash. Maybe you won't lose the $20K you initially put into the property, but losing the entire property can have damaging effects to your business. The idea that you just leverage everything, then walk away without repercussions is just not how it works. I knew a guy in Michigan who lost three properties to foreclosure back in 2009. He filed bankruptcy and lost everything.

    Equity is what reduces risk. Higher equity is lower risk. Cash into the deal is really unimportant.

    The BRRRR process is actually equity stripping. Or better said, cash out refinance reduces equity and converts the equity to cash. Equity stripping always reduces cash flow, because it increases your debt payment (setting aside term or rates for the purpose of this discussion).

    I always joke that they should add one more R to BRRRR which is for Regret. Not in every case, but you can pull out so much equity that your cash flow reduces to nothing. If you are left without enough cash flow, the business starves. Obviously this is not case in all situations, but it is the risk of BRRRR. Before you pull the cash out, make sure the investment can still cover all expenses, including debt service. 

    BRRRR is not risk free, but no doubt buying undervalued properties is a good strategy to build wealth. I have done it and most every successful investor I know has done it at some point.

    Interesting discussion, thanks for sparking the debate.

    1Reply
  • Drew Brown
    Property Manager · Lansing, MI · Member since 2015 · 170 posts · 59 votes
    7y

    @Joe Splitrock at the end of the day it is all about being able to pay your bills. You could have 10% or 90% equity in a deal, but if you can't pay the creditors at the end of the day things are going to get ugly. This is why you should always have cash reserves or line of credit to cover shortfall issues. It seems like in there show they talked a lot about knowing your numbers? Doing the prep work and analysis correctly and not hoping and praying will allow you for the worst case scenario so that you can cover your butt. All-in-All I felt that @Brandon Turner and @David Greene nocked the show as most 'out of the park!'

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