will using the brrr method cut into cash flow?

25 Replies

Getting ready to start my real-estate investing journey but trying to get my questions and concerns answered before I start. So this is a very elementary question (sorry)! If you use the BRRR method of investing for buy and hold, won't it cut into your cash flow for that property? For instance once you rehab and then go to refinance you will end up paying a higher mortgage due to the fact your borrowing more correct? ex: buy property for $100,000 mortgage $568 (roughly ) cash out refinance say for $140,000 new mortgage $757 (roughly ). Pros and cons? Again sorry for the elementary question. Thanks

@Clifton Frazier

You are buying a business, not a property.  Similarly, you are improving a business, not {just} an asset.

When you purchase your business for $100K (or $1M) it will be producing $X in revenue and $Y in free cashflow.

When you improve the business, you are not merely renovating the property to make the units more attractive, you are taking measures to lower operating costs (ie. improving the building envelope; putting utilities into the tenants hands, upgrading lighting to LED, etc) and to increase revenue (higher rents, ancillary streams, etc).

When you are finished, not only should your property appraise for {say} 40% more, but your cashflow should have increased by a considerable amount (ideally 30 -  40% ... but, perhaps only 10 - 20%).

@Clifton Frazier you were just given a great answer by @Roy N. But to add to that yes it will but not having any money in the deal allows you to do a second and third which replaces the lost income from a higher mortgage. It’s a risky strategy being highly leveraged. So take that into account. It can however help you grow faster.

Great thankyou for the feed back Roy and Josh.I really appreciate the quick response!

"Cash flow" includes the cash inflow you receive from the refinance.  You just get it at the refinance and don't have to wait for it each month.  Also, cash now is worth a lot more than cash later since that cash can be reinvested and generate compound returns.

A BRRR, particularly one with a lot of value created, can have a lean cash flow going forward (especially in today's high-priced market). Some investors don't care because they have no or little original investment remaining in the property.

To answer your question YES IT WILL. To expand on that answer, you are transferring the cost of rehabing the property to the future tenants when you engage in teh "BRRR" method. Ask yourself this question will the property rent for the same amount after renovation that it will if you don't renovate? Probably not, rents tend to be higher in renovated properties. You can always finance the property put in tenants and wait until your investment "matures" then refinance.

The BRRR pattern does several things for you, as mentioned above:

1st gives you back your cash to go do it again

2nd improves your property which should get you higher rents, with less maintenance.  (Having plumbing up to snuff, is great compared to having to go out yourself or hire a plumber at 2 in the morning.)

3rd gives you the leverage for more deals but not being over leveraged.  I recommend 60-70% leverage.  That will should keep you in good shape.  

4th- safety-  If you have one property and it goes empty, it hurts bad, coming out of pocket with mortgage and expenses. 10 properties, one goes vacant, the others carry the mortgage and expenses.  

Main thing to remember is keep cash reserve, you make your money on the purchase,

I do BRRRR such that I cash out about 65% of the ARV, and that has always been more than my purchase+rehab+refi costs. I also pick the cash out amount so that it is more than my purchase+rehab AND I have enough cash flow to be comfortable managing it as a rental. The refi DOES cut into the cash flow amount, but it blows up the ROI. In fact I dont even know how to calculate ROI since I have "negative" money in the property! And I can keep doing it until I get to 10.

I am a bear of very little brain, but I am not sure if I agree that cashing out the forced equity is "cash flow" as someone explained, nor would I agree that you are buying "a business and not a property."  

Its a very slow process if you want the best financing (6 months to a year seasoning until you can cash out), truthfully it should be called "getting rich slowly!" 

Originally posted by @Mike Dymski :

"Cash flow" includes the cash inflow you receive from the refinance.  You just get it at the refinance and don't have to wait for it each month.  Also, cash now is worth a lot more than cash later since that cash can be reinvested and generate compound returns.

A BRRR, particularly one with a lot of value created, can have a lean cash flow going forward (especially in today's high-priced market). Some investors don't care because they have no or little original investment remaining in the property.

 Mike:

While I understand the "hand-in-pocket" motivation of the statement, I do have to be a little pedantic and disagree that "Cash Flow" includes the funds received during a refinance.  While taking on additional debt will give you cash/capital upfront ... and will consume more of your free cashflow to service it ...  the debt is debt, not cashflow.

Originally posted by @Roy N. :
Originally posted by @Mike Dymski:

"Cash flow" includes the cash inflow you receive from the refinance.  You just get it at the refinance and don't have to wait for it each month.  Also, cash now is worth a lot more than cash later since that cash can be reinvested and generate compound returns.

A BRRR, particularly one with a lot of value created, can have a lean cash flow going forward (especially in today's high-priced market). Some investors don't care because they have no or little original investment remaining in the property.

 Mike:

While I understand the "hand-in-pocket" motivation of the statement, I do have to be a little pedantic and disagree that "Cash Flow" includes the funds received during a refinance.  While taking on additional debt will give you cash/capital upfront ... and will consume more of your free cashflow to service it ...  the debt is debt, not cashflow.

Hey Roy.  I enjoy your posts.  Cash flow is cash flow, regardless of the source.  The amount and timing of it determines the investment return.  For many investors, forced appreciation and refinance is the #1 source of cash flow.  They generate more cash flow in one year of adding value than in the next 5-10 years of ownership.

@Mike Dymski

Perhaps if you are Enron ;-)

I do agree with your assertion that refinancing can be a tremendous source of working capital (cash in your pocket) and a powerful tool for growth.   As you alluded, it can vastly exceed the cash flow of the business.

On the darker side, refinancing can also be a game of balance sheet chess used to smooth "earnings" in a cyclical industry or mask the decline of a faltering business.

Regardless of how you fill your bank account, that portion which we call cash flow should be that which comes from operations.

@Roy N. Great feedback.  The refinance or the sale IS the primary operating business when you are BRRRing or flipping.

Regarding the rate of return on the investment, all mortgage cash inflows and outflows are included, not just the monthly mortgage payments.

I'm not taxed on the proceeds of the cash-out, correct?   Whereas I am taxed on the operating cash flow.  Thus, I don't consider the cash-out proceeds to be in the same "money bucket" as the monthly cash flow.    (and dont count it towards my ROR)

I know personally, I consider the cash-out money to be entirely "delicate seed money", so I push it right back into another cycle.  The operational cash flow I account for separately and may be a bit more prone to spending it. 

Either way though, even if you dont consider the cash-out proceeds to be true revenue, the numbers still look fantastic.  For any newbies considering this method, its a great way to get started!

Originally posted by @Mike Dymski :

@Roy N. Great feedback.  The refinance or the sale IS the primary operating business when you are BRRRing or flipping.

Regarding the rate of return on the investment, all mortgage cash inflows and outflows are included, not just the monthly mortgage payments.

 Mike:

I'm enjoying the back and forth and understand the position of considering all sources of capital/cash as the same from an "everyday practicality" position ... but, I'm not certain my, or your, accountant would agree.

Perhaps it's my background with operational companies (software, telecommunications, etc), but there was always a distinction between earnings & cash flow from operations and capital raised through other means (debt, asset sales, judgements, etc).   While that other working capital is still important to the business, it is does not arise from production.

Now, flipping is another matter as the properties are inventory, not assets of the business.   For a flipper selling properties is no different than a car dealership selling vehicles or a shoe store selling pumps.   The proceeds from sales is the operation revenue of the business.

However, if I am in the business of renting residential or commercial properties, then my revenue comes from rent .... and perhaps some ancillary streams such as laundry, parking (a form of rent), storage (more rent), cleaning services, etc.  In this instance, my buildings, along with the truck and dump trailer my crew use during renovations, are assets of the business used to earn revenue and create cash flow.  

Selling or financing of assets is a balance sheet activity.  If I refinance one of my buildings the influx of capital is offset by an increase in debt. Similarly, if I were to sell the truck and dump trailer, the influx of capital would be offset by a reduction in assets.  In nether of these activities was revenue earned, nor does  the resulting cash flow from the operation of the business.

There are three types of cash flow. Operating, Investing and Financing activity. This conversation started off with a debate about whether a refinance was cash flow and then it turned to where it was operating cash flow. A cash out refinance is a cash flow from financing activity. However, On rental property, as long as cash flow from operations remains positive, I do not think that a cash out refinance is a bad thing. If the funds received are deployed in a productive manner i.e. As reserves  or for another investment then it is not a bad thing. 

@Clifton Frazier Hey Clifton, fantastic question! Yes, this is a catch 22. Do I refinance and end up with a higher monthly payment or do I continue with my constant monthly payment? 

Now, the best approach is to think about your goals.

1. Are you looking to buy more properties? 

2. Are you looking to pay this one property and then repeat the process? 

Undoubtedly, there isn't a silver bullet. Typically, some investors want to scale and grow their portfolio to a sizeable number. So, what that means is that they would take the hit with the higher monthly payment in order to pull out equity to buy the next property and repeat. 

As for the higher monthly payment, the tenants would be paying that unless you are living in the property. If you aren't living in the property then you won't take the hit and since you would typically REFI in a year or so, you can also slightly increase the rent to mitigate the higher mortgage. 

Hope that helps. Thanks! - Ola  

I'll question this answer a bit. The BRRR strategy has nothing to do with the rehabbing of the property. Whether you keep the existing loan or refi cash out, you are still doing the rehab no matter what. So you are not transferring the cost of rehabbing the property to future tenants in any way. Unless maybe you're suggesting that by taking on more debt and lowering your cash flow, you will have less profits to do repairs in the future?

I would argue that you should not do a deal if your numbers don't allow for the gross profits to cover the estimated repairs - whatever they may be. 

"To answer your question YES IT WILL. To expand on that answer, you are transferring the cost of rehabing the property to the future tenants when you engage in teh "BRRR" method. Ask yourself this question will the property rent for the same amount after renovation that it will if you don't renovate? Probably not, rents tend to be higher in renovated properties." 

That being said, the answer as everyone has stated is Yes, if you buy a house and put down 25% and pay rehab out of pocket and then do a cash out refi to pull that money back out - you will have less cash flow after the refi then before simply because the loan will be greater.

And that definitely adds to the risk in investing. You may be able to find the deals where the numbers work to pull your money out each time. But if the deals don't cash flow after the refi, do you still want it? Or if they don't cash flow much at all, do you still want it?  If none of your properties are cash flowing, how are you going to save up money for repairs (both simple repairs like replacing a toilet or faucet and the big ones like a new furnace or roof)?

But here's the thing. If you can do the BRRR strategy and have some decent cash flow (say 150 to 200/mo net profit after estimated repairs), then you can grow a reasonably large portfolio with surprisingly little capital and generate some generational type wealth that no other investment vehicle can offer (outside of the lottery maybe). :-)

Example. Lets say you saved 30k or so over a 3 year period and bought a 150k house for 90k that needed 15k in rehab. You'd have to put down 18k and pay the 15k in rehab outright. There went your 30k in savings.  But now you have a 72k loan that has payments of 400/mo or so. And lets say that generates net profits on your rental of 400/mo.

If you leave that cash in the deal, you have to wait another 3 years to save the same 30k to buy your next house. So in 10 years, you'll have 4 houses making 400/mo = 1,600/mo.

Now lets switch to the BRR method. And after you do that first deal, you do a cash out refi and get your money back. You now owe 105k on the house and your payment is another 175 to 200/mo greater.  So your net profit on that house is only 200/mo instead of 400/mo.  But now you have your 30k back so you can buy another house.

Lets say you buy 2 houses a year doing this. In 10 years, you'll end up with 20 houses making you 200/mo (which is 4,000/mo). Plus you'll have your 30k back in the bank. 

So what does that look like:
BRRR - 20 houses = 3 million dollars worth of real estate
900k in equity capture 
4,000/mo in rental income
2,500/mo in principal paydown
120k/yr in appreciation (4% times 3 million in real estate)

Non- BRR method - 4 houses = 600k worth of real estate
180k in equity capture
1,600/mo in rental income
360/mo in principal paydown
24k/yr in appreciation (4% times 600k)

The numbers above don't reflect growth over time at all either (i.e. Your first two houses bought in year 1 will be worth more in 10 years, your principal paydown more, etc).  But its meant to show just how big a difference your portfolio will look like over an extended period of time.

And thats about keeping the big picture in mind. By giving up a little equity and cash flow in each house, you can grow your portfolio into something that has exponentially more equity, rental profits, principal paydown and appreciation to where its generating more wealth.

I'm pretty close to being in my year 10 of investing right now and I've been doing this since I first started. I'm up to 68 houses now. And those are pretty much the numbers I'm looking at an as an average (i.e. arv of 150k, all in at 70% ARV, loan amounts, etc). I did a blanket loan cash out refi across 7 properties to pull out 100k.

Does that 100k less in equity or 700/mo less in rental profits really hurt me? Not when you consider that the 100k let me add another 10 or more houses and continue to grow the portfolio.

There is definitely some risk to it though. Its a lot easier to have a cushion when your properties are averaging 400 to 500/mo net cash flow versus 150 to 200/mo net cash flow.

But would you rather take on that risk and have 20 properties or 30 properties as opposed to 3 or 4?  I can tell you right now that if I wouldn't have been able to pull my money back out on my deals, I'd be lucky if I would have 3 or 4 properties right now as opposed to near 70......

3 or 4 is a nice way to subsidize your retirement and generate a little income for today. 20 to 30 is a way to create a fantastic retirement and generate a really nice size chunk of income today as well.   Maybe not one you'd retire on necessarily but enough of one where if you lost your job, you wouldn't lose your house......

@Mike Dymski

Based-upon the explanation @Jered Souder provided, I'll have to concede that you are allowed to call capital from financing a cash flow.  Ironically, in all my years in businesses, we've never labelled capital raised from financing - or income from investments - as part of our cash flow.   I guess I'm more fiscally conservative than I realised  {My wife is not going to believe this ....} ;-)

This is one of the things I love about BP ... if forces all farts like me to continually broaden.

Now Jared, I have a follow-on question for you:

Unlike the cash flow produced from operations, cash raised by financing activities (selling of equity or placing debt) comes with an IOU where the {I'm tempted to call it "the real"} free Cash Flow from operations has no strings attached.  In my purview, that makes the Cash Flow from Financing (CFF if you like) of an inferior quality to Cash Flow from Operations (CFO ... or "the real cash flow").    As an accountant, I presume you would keep the two segregated on a cash flow statement (which I guess would make it a statement of cash flows).  As a CPA do you rank cash flow based upon its activity of origin?  

I ask because, as an investor and business owner, it seems to me that I would give weight to {the real} cash flow from operations.

@Roy N. Use of the word "inferior" is accurate. Yes, they are separated on a Statement of Cash flows and Operating cash flows are a much more important metric (for traditional businesses). So you are very much correct. However, in the BRRR context the cash-out refinance is extremely important and in my mind not very risky if managed properly. I think a lot of people are taught to fear debt and that debt is bad. I think this is very wrong. In the BRRR realm, you can get amazing returns by maximizing debt and still be very safe. I am really passionate that, as a real estate investor, you should never pay additional principal towards your mortgage and you should never get 15-year mortgages (vs 30-yr). The reason is that though it does increase your earnings and operating cash flows slightly, it is very bad for your overall cash flows and for your current ratio (in the case of 15-year mortgages). debt is not risky if you have the assets and liquidity to support it debt. If you own a $100K property, I would rather have 20K cash and a 90K mortgage than have 5K cash and 75K mortgages (with all else being equal). You can expand this out with using Millions rather than thousands. I would even prefer this given a small interest rate spread (say 4% on 75K and 4.5% on 90K). If you look at your real estate as a business, you have to consider not just your operating cashflows and your earnings but also your overall cash flow, liquidity (current ratio, reserves) because that's what keeps you safe and enables you to buy more deals.

@Jered Souder

Thank-you for the response.

   

I'm going to guess you do not remember when mortgage rates were in the 15 - 19% range back in the 1980s ;-)

While I agree that one should not fear debt, it does need to be respected.  Folks also need to be the master of their debt and not its servant. Additionally,  I {personally} believe we should call it debt and not cash flow ;-)

Having ready access to debt - or, credit if you prefer - is a good thing ... it can be an extra buffer to your reserves and contingency.  It can also empower you to seize opportunities to which you would otherwise be a spectator.  However, one need also realize that debt is only a good thing only if the re-invested capital is earning sufficiently more than the cost of the debt.

In your example, whether I would hold the 20K cash / 90K mortgage or the 5K cash / 75K mortgage would greatly depend on the prevailing interest rate and where my best return would be had.   Another factor would be whether the mortgage was on an investment or my primary residence (mortgage interest on your primary residence is not tax deductible in Canada, so you pay your personal mortgage in after tax dollars).

On lighter note ... not much fear of my getting a 15-yr mortgage (or a 30-year for that matter) as they are a U.S.A. phenomenon which do not exist here.   That said, I prefer short term (3 - 5 year), variable rate mortgages ... but that is a whole other discussion.

Originally posted by @Mike H. :

I'll question this answer a bit. The BRRR strategy has nothing to do with the rehabbing of the property. Whether you keep the existing loan or refi cash out, you are still doing the rehab no matter what. So you are not transferring the cost of rehabbing the property to future tenants in any way. Unless maybe you're suggesting that by taking on more debt and lowering your cash flow, you will have less profits to do repairs in the future?

I would argue that you should not do a deal if your numbers don't allow for the gross profits to cover the estimated repairs - whatever they may be. 

"To answer your question YES IT WILL. To expand on that answer, you are transferring the cost of rehabing the property to the future tenants when you engage in teh "BRRR" method. Ask yourself this question will the property rent for the same amount after renovation that it will if you don't renovate? Probably not, rents tend to be higher in renovated properties." 

That being said, the answer as everyone has stated is Yes, if you buy a house and put down 25% and pay rehab out of pocket and then do a cash out refi to pull that money back out - you will have less cash flow after the refi then before simply because the loan will be greater.

And that definitely adds to the risk in investing. You may be able to find the deals where the numbers work to pull your money out each time. But if the deals don't cash flow after the refi, do you still want it? Or if they don't cash flow much at all, do you still want it?  If none of your properties are cash flowing, how are you going to save up money for repairs (both simple repairs like replacing a toilet or faucet and the big ones like a new furnace or roof)?

But here's the thing. If you can do the BRRR strategy and have some decent cash flow (say 150 to 200/mo net profit after estimated repairs), then you can grow a reasonably large portfolio with surprisingly little capital and generate some generational type wealth that no other investment vehicle can offer (outside of the lottery maybe). :-)

Example. Lets say you saved 30k or so over a 3 year period and bought a 150k house for 90k that needed 15k in rehab. You'd have to put down 18k and pay the 15k in rehab outright. There went your 30k in savings.  But now you have a 72k loan that has payments of 400/mo or so. And lets say that generates net profits on your rental of 400/mo.

If you leave that cash in the deal, you have to wait another 3 years to save the same 30k to buy your next house. So in 10 years, you'll have 4 houses making 400/mo = 1,600/mo.

Now lets switch to the BRR method. And after you do that first deal, you do a cash out refi and get your money back. You now owe 105k on the house and your payment is another 175 to 200/mo greater.  So your net profit on that house is only 200/mo instead of 400/mo.  But now you have your 30k back so you can buy another house.

Lets say you buy 2 houses a year doing this. In 10 years, you'll end up with 20 houses making you 200/mo (which is 4,000/mo). Plus you'll have your 30k back in the bank. 

So what does that look like:
BRRR - 20 houses = 3 million dollars worth of real estate
900k in equity capture 
4,000/mo in rental income
2,500/mo in principal paydown
120k/yr in appreciation (4% times 3 million in real estate)

Non- BRR method - 4 houses = 600k worth of real estate
180k in equity capture
1,600/mo in rental income
360/mo in principal paydown
24k/yr in appreciation (4% times 600k)

The numbers above don't reflect growth over time at all either (i.e. Your first two houses bought in year 1 will be worth more in 10 years, your principal paydown more, etc).  But its meant to show just how big a difference your portfolio will look like over an extended period of time.

And thats about keeping the big picture in mind. By giving up a little equity and cash flow in each house, you can grow your portfolio into something that has exponentially more equity, rental profits, principal paydown and appreciation to where its generating more wealth.

I'm pretty close to being in my year 10 of investing right now and I've been doing this since I first started. I'm up to 68 houses now. And those are pretty much the numbers I'm looking at an as an average (i.e. arv of 150k, all in at 70% ARV, loan amounts, etc). I did a blanket loan cash out refi across 7 properties to pull out 100k.

Does that 100k less in equity or 700/mo less in rental profits really hurt me? Not when you consider that the 100k let me add another 10 or more houses and continue to grow the portfolio.

There is definitely some risk to it though. Its a lot easier to have a cushion when your properties are averaging 400 to 500/mo net cash flow versus 150 to 200/mo net cash flow.

But would you rather take on that risk and have 20 properties or 30 properties as opposed to 3 or 4?  I can tell you right now that if I wouldn't have been able to pull my money back out on my deals, I'd be lucky if I would have 3 or 4 properties right now as opposed to near 70......

3 or 4 is a nice way to subsidize your retirement and generate a little income for today. 20 to 30 is a way to create a fantastic retirement and generate a really nice size chunk of income today as well.   Maybe not one you'd retire on necessarily but enough of one where if you lost your job, you wouldn't lose your house......

 Hey Mike,

My main issue as an investor is very little starting capital. I'm very interested in using the BRRRR method but my question to you is do you think it is a mistake to borrow the down payment to purchase the property? So going back to your example, say I borrowed the 18k deposit with with private money, and negotiated to pay them monthly amortized for x yrs at y rate, with the intention of paying them the loan in full after the seasoning and refinancing. Is that something that would be possible or am I missing any crucial details?

My biggest weakness is structuring deals to where I am able to competently pay any investor back their portion lent. I do realize that a major downside would be extremely over leveraged, but I would like your opinion on my thought process.

@Effram Barrett

If you borrow the downpayment, how are you planning to finance the balance of the purchase?

A conventional lender is not going to underwrite the property if you have none of your own equity invested and are borrowing the downpayment.

Originally posted by @Roy N. N. N.:

@Effram Barrett

If you borrow the downpayment, how are you planning to finance the balance of the purchase?

A conventional lender is not going to underwrite the property if you have none of your own equity invested and are borrowing the downpayment.

 So with that question, I gather that I would need to find a private lender to finance the entire project (which is the golden unicorn) 

Or come up with the down payment via saving, wholesaling, or sweat equity. I appreciate your response

Originally posted by @Effram Barrett :
Originally posted by @Roy N. N. N.:

@Effram Barrett

If you borrow the downpayment, how are you planning to finance the balance of the purchase?

A conventional lender is not going to underwrite the property if you have none of your own equity invested and are borrowing the downpayment.

 So with that question, I gather that I would need to find a private lender to finance the entire project (which is the golden unicorn) 

Or come up with the down payment via saving, wholesaling, or sweat equity. I appreciate your response

... or have it gifted to you.

Originally posted by @Roy N. :
Originally posted by @Effram Barrett:
Originally posted by @Roy N. N. N.:

@Effram Barrett

If you borrow the downpayment, how are you planning to finance the balance of the purchase?

A conventional lender is not going to underwrite the property if you have none of your own equity invested and are borrowing the downpayment.

 So with that question, I gather that I would need to find a private lender to finance the entire project (which is the golden unicorn) 

Or come up with the down payment via saving, wholesaling, or sweat equity. I appreciate your response

... or have it gifted to you.

 Do you mind elaborating?

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