BRRR strategy - question about the last R

6 Replies

My friend has 2 houses.  The 1st house was bought in 1999 for $45,000 and he bought it with cash, lived in it while he re-modeled/repaired it, and then bought a 2nd house in 2012 for $100,000 with a conventional home owner's 30-year loan, which he moved into in 2013. He now has rented his 1st house out at $875 per month the last two year  and that house appraises for $100,000.  His home owner's insurance and property tax bill comes to $2,600 per year.  I was just sitting down with him at dinner and going over the numbers:

1st house: rental income of $7,900 per year(net rental income) - $1,975(federal tax rate of 25%) = $5,925 ; cash-on-cash return is $5,925/$100,000 = 5.95%

2nd house: $75,000 conventional home owner's 30-year loan with 4% interest (he already paid off $25,000 of the initial loan) = $3,000 per year payment to bank

Net income = $2,925 to pay off the principal of the 2nd house's loan.

I told him he would be better off getting a real estate lawyer and/or accountant to help make sure he gets his depreciation deducted from his 1st house in order to increase his cash-on-cash return.  I also thought it would be better for him to cash out refinance his 1st home to pay off his 2nd home.  Is it called a home equity loan or what is it called?  Here are my numbers on my suggestions:

1st home: rental income $7,900 per year (net rental income) -  $1,066(federal tax of 25% on $4,264 since $3,636 is tax deductible due to depreciation [$100,000/27.5 years]) - $3,000 (new home equity loan yearly payment at 30 year 4% rate) =$3,834; cash-on-cash return is $3,834/$25,000(home equity loan cashed out 75% of the value of the house to pay off the 2nd house) = 15.3%.

2nd home: paid off

Net income = $3,834 per year to put in stock market at average annual return of 9-11%, which compounds annually.

Does this make sense to the experts on this forum?  Please critique.

You first need to learn what Cash on Cash return means.

It has nothing to do with taxes or depreciation.

When I'm asked to define it, I always use the same definition for cash.:

When you use it, the form it takes, must be able to make change, or it isn't cash.

In addition, if the properties have been already owned, it isn't CoC Return. CoC return is for the first year and is in place to show how much of your initial CASH spent/used is returned in the first year of ownership.

Agreed, my cash-on-cash return is not perfect because I only know my friend bought the 1st house for $45,000 and I don't know his true rehabilitation costs.  He did not share that info with me.  $100,000 is the best estimate I have since he did do a lot of work on the initial $45,000 investment.  

DEFINITION OF 'CASH-ON-CASH RETURN'

A rate of return often used in real estate transactions. The calculation determines the cash income on the cash invested. Calculated as:

Cash-On-Cash Return

INVESTOPEDIA EXPLAINS'CASH-ON-CASH RETURN'

For example when you purchase a rental property, you might put down only 10% for a cash down payment. Cash-on-cash return would measure the annual return you made on the property in relation to the down payment.

Cash out divided by cash in=CCR...with the operative word being "cash"...not cash influenced by something else.

Now, to the actual question.

Too many gaps in information to answer it.  For me, and based on your initial focus of refinancing to get your cash back out, there isn't enough info.

Here is what I use to access a rental.  There are TWO (2) Golden Rules I follow:

GR#1 - Never under any circumstances, ever, ever, "spend" your cash.  Use it an unlimited number of times, but never "spend" it.  This is where CoCR comes in.

There are three Analysis criteria I use to execute this:

C#1:  You must get enough cash back (actual cash) within a very short period of time to move/invest into the next deal.  Have to keep your cash working for you at as many "jobs" as you can find for it. I have access to an Equity Loan Program...cash back/out within about 2 months tops.

C#2:  When you refi at 6 months (most lenders require 6 month seasoning), you must have a minimum Net Cash Flow of $????/month.  The actual ??? is defined by you...but don't go under it.

C#3: The property/deal must have a CCR of at least 100%...meaning I get all my cash back out of it within the first year.

If the deal meets this criteria, it satisfies Golden Rule #1.