BRRRR Accounting for tax increases after rehab

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BRRRR Accounting for tax increases after rehab

Michael Downs
Member since 2019 · 19 posts · 1 vote

I'm new to REI. I jumped into my first BRRR deal and closed a couple months ago. Rehab is pretty much on schedule and on budget but as I'm getting to the rental phase I'm getting a little nervous about my cash flow after rehab.

I bought a distressed property in the Chicago suburbs for $135k and am on budget for $40k rehab with ARV of $230-$250. Planning on taking $175k cash out on refi and the numbers will work at rent of $2200/mo estimating $150/mo cash flow.

My concern is that taxes in this town are ridiculous. It’s an 1100 sqft 2/1 that will be a 3/2 after rehab. Taxes before rehab are $6500 a year. If the rehab causes the taxes to increase dramatically that could deplete my cash flow significantly.

To my question: Does anyone have a way that they evaluate for tax increases after rehab to plan ahead for the increase when its re-evaluated? I’m sure it’s cause it’s my first deal that I’m getting a little nervous but I’m wondering if I may just be better flipping although that doesn’t fit into my financial planning as well.

Any advice would be appreciated

Mike

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  • Sean McCluskey
    Rental Property Investor · Newport Beach, CA · Member since 2017 · 218 posts · 138 votes
    6y

    @Michael Downs This is definitely a big piece that many newer investors don't account for. You'll want to find out the tax rate and tax appraisal standards for your market, and include that in your proforma.

    For example, in Indianapolis where I'm investing, taxes on rentals are 2% of appraised value, and appraised value is technically updated every 4 years but it can actually increase to equal your purchase price much faster than that, so I build it into my numbers from the first month to make sure the deal will still cash flow.

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  • Andrew PostellPro Member
    Lender · Fort Worth, TX · Member since 2016 · 8k+ posts · 6k+ votes
    6y

    @Michael Downs if all of those numbers are correct then this is a very good deal. As mentioned above knowing tax rates will certainly help you calculate what your new tax bill will be. However, in our market the tax appraisals office usually doesn't assess the property at full market value.  So while using the tax rate for us is good practice, we are usually over estimating.  Over time, I just base the number on experience and can get pretty close to what it will be later on.

    Now, as far as your deal specifically, higher valued properties usually don't rent as effectively as lowered valued properties.  Now, this is market specific of course but two $100,000 properties usually rent for more money than one $200,000 property.  And that's why we usually target lower valued properties.  I'm speaking in general of course.  

    The other things we can't see - what does your "refinance" loan look like?  Is it a 30 year loan?  A 20 year loan?  What is your rate?  What are you using for an expense ratio?  Maybe that should be tweaked some?  Hard to say.  But if you can provide a few more details on the deal maybe we can help point you to some other suggestions to help with cash flow.  Thanks!

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  • Michael Downs
    OP
    Member since 2019 · 19 posts · 1 vote
    6y

    @Sean McCluskey

    Thanks for the response. I will have to do a little more research into the way reappraisals are scheduled and try to figure it into my spreadsheet for evaluating deals. Do you find rent increase correlates with tax increases to compensate for it over time?

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  • Michael Downs
    OP
    Member since 2019 · 19 posts · 1 vote
    6y

    @Andrew Postell

    Thanks for the quick response. There is a lot of good information in you’re response. It got me doing some research... I like it!!!

    The property gets reassessed every 3 years and assessed values look like they are much less. Average tax rate is 1.38% of “assessed fair market value”. And there is also a possibility of an exemption for 4yr tax freeze after rehab but I’ll have to look into if this is available for rentals or if it has to be primary residence.

    I was hesitant to purchase this as a buy and hold because of the price. I would have preferred a $100k property but this fell into my lap and I knew the numbers would work and didn’t want get caught in an analysis paralysis situation. But if I don’t have any money in the deal at the end of the day I’m more than happy to have cash flow. In the area market it is hard to find anything, even severely distressed for $100k.

    Now to your refi questions. I paid cash for the property and rehab. (I know... I'm new to this and will start working my way into leverage and lending options) I found a lender for cash out refi that preapproved me for 30yr fixed either 75% LTV at 5.85 or 70% LTV at 5.5%. (This was the best option I could find because I have to purchase in LLC due to my full time career and financial risk issues). Depending on ARV I could take more than the $175k initial investment out but the loan payment would start to reduce my ROI at above $175k. As far as expense ratio, I haven't encountered this as a regular metric others use for single family but have seen it in multifamily analysis. My understanding is that expense ratio = operating expense/gross operating income, which mine is at 10%. Is that the correct equation and what info does this bring to your decision making? I probably haven't applied it to enough deals to know if it's good or bad.

    Let me know what you think and thanks for taking the time to jump into the details with me.

    Mike

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  • Andrew PostellPro Member
    Lender · Fort Worth, TX · Member since 2016 · 8k+ posts · 6k+ votes
    6y

    @Michael Downs aha!  I am so glad we talked this through.  It sounds like you are receiving a Fannie/Freddie type of loan. When you buy with cash it does get a little tricky and I wrote an article on how you need to structure your transaction so your rate will be LOWER.  Should be about .5 lower at least.  That will help with cash flow.   You can find the article HERE

    Now, I do use 15% with my expense ratios. Again, this is in my market though. So something doesn't seem to quite add up...rent of $2200....insurance of $100?....taxes of $276....mortgage payment (even at 5.75%) = $1050....so your rental income is $2200...your PITI = $1426....which equals a NET profit of $774.  We need to get to the GROSS number...but what am I missing here?  Is this a condo?  Help us fill in these blanks....or let us know what you are doing to get to $150 or less in cash flow.  Something is either missing or a piece of math is not adding up.

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  • Michael Downs
    OP
    Member since 2019 · 19 posts · 1 vote
    6y

    @Andrew Postell

    Thanks for taking the time to dig into this and sorry it took a couple days to respond but I wanted to research this and give you a proper response.

    This was a good exercise in finding CORRECT info on the property and learning how the tax calculations are performed. The 1.38% I found based on a simple google search didn’t correlate at all with my actual tax statement numbers so, after digging into it, found that it is effectively 3.94%. I think this is the source of the numbers discrepancy. It also gave me the opportunity to scour my spreadsheet and make sure all was accounted for.

    Assessment last year was for $165500 which, IMO, is above what it would have gone for on MLS. Taxes at that number were $6512.50/yr = 542.71/mo. I didn't account for this increasing after rehab. If ARV is 230k and the assessment value is similar to market value as it was before rehab, I think I'm in trouble. This would correlate with yearly taxes $9045.04 which comes to $753.75/mo which eats up another $200+ if monthly profit.

    For financing, I am purchasing through an LLC so Fannie and Freddie loans are not available. I know there is a lot of discussion on how LLCs aren't necessary but I've been over this with my attorney extensively and the LLC is necessary.

    So I've found other lenders that have me preapproved for a 75% LTV at 5.85% fixed for 30 yrs. So being conservative at ARV of $230k cashing out 75% = $172.5k and payment of $1018.00/mo

    Assuming $2200/mo at 5% vacancy = $2090/mo

    So PITI = $1879.02/mo

    Payment and interest $1018/mo

    Insurance $107.27/mo

    Taxes $753.75/mo

    NET = 210.98

    Add garbage/sewer at $50/mo and Cap Ex at $100/mo (being conservative. I know BRRRR should reduce need for cap ex)

    That brings me down to

    GROSS = $60.98/mo.

    So it doesn’t put me to negative cash flow but it is a hit to my expectations but I think it is still manageable for a first property and one that I had built in expectations for problems so I wouldn’t get too discouraged.

    I'll have to see what happens with the ARV and tax assessment afterwards but I think I'll hang onto it and see how it goes.

    Good lessons to learn and will have to apply it to the next one before I make the leap.

    Thanks

    Mike

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