New to Real Estate · OH · Member since 2020 · 6 posts · 1 vote
Hi, I'm new to real estate investing and I'm really enjoying the BP community!
The BRRRR method seems like a great choice for our goals, but even after watching the BP video on cash-out refinancing I'm confused about one thing:
Doesn't the cash-out refi increase the mortgage payment, which would decrease your cashflow?
I'm reading a lot about focusing on cashflow in Brandon's book, this blog, etc. and a lot of properties seem to only have $200/month or so in positive cashflow, so it seems like cashing out 80% of your equity could easily raise the mortgage payment to the point of eliminating the cashflow.
Huntington, WV · Member since 2016 · 40 posts · 45 votes
6y
Hey Kyle,
You're probably correct. The BRRRR method has some great advantages to it, but it might eat into your monthly cashflow in the short term. I think the best benefit of BRRRR is that you can control real estate for little to no money out of pocket. It's possible these deals cashflow, which is a huge bonus, but I think you get more benefit from the other pillars of RE wealth building: appreciation, mortgage paydown, and tax depreciation. If you could have $0 into a deal for a $300K home after refinancing out and it only 'cashflowed' $15 a month, but you had a modest 2% annual appreciation, had a standard 30 year amortized mortgage, and could depreciate your annual wealth creation would look like this:
Annual Cashflow: $180
Annual Principle Paydown (1st year): $4128
Annual Appreciation: $6000
Wealth Generation 1st year: $10,308
So you'd add $10,308 to your wealth on the first year - in addition to any equity you captured on the acquisition and rehab, which would only accelerate with compound interest on the appreciation and amortized schedule paydown, AND BEST OF ALL you'd have your cash out of the deal to do it again and add to your portfolio, accelerating your growth even faster.
If you listen to some of the more recent podcasts, David and Brandon have started talking about cashflow more as 'defensive' as it helps protect your investments and pay all of the monthly expenses to control the property and let it grow, but the real wealth generation is through appreciation, paydown, and rent increases over time while you control it.
Hope this helps and others may have other thoughts on the method!
Real Estate Investor · Palm Beach County, FL · Member since 2017 · 3k+ posts · 2k+ votes
6y
Yes it increases the mortgage payment and decreases cash flow because the loan is based on a higher value. If it "eliminates" your cash flow then it wasn't a good BRRRR deal to begin with and would be better suited as a flip.
Hi!
Welcome to BP.
Yes, cash out Refi would increase your mortgage payment. so why do it?
1 - it will increase your cash on cash return, as you now have less of your money invested in the deal.
2 - now that you have fixed up the property, it is possible you can rent it for more than you started at.
Huntington, WV · Member since 2016 · 40 posts · 45 votes
6y
Hey Kyle,
You're probably correct. The BRRRR method has some great advantages to it, but it might eat into your monthly cashflow in the short term. I think the best benefit of BRRRR is that you can control real estate for little to no money out of pocket. It's possible these deals cashflow, which is a huge bonus, but I think you get more benefit from the other pillars of RE wealth building: appreciation, mortgage paydown, and tax depreciation. If you could have $0 into a deal for a $300K home after refinancing out and it only 'cashflowed' $15 a month, but you had a modest 2% annual appreciation, had a standard 30 year amortized mortgage, and could depreciate your annual wealth creation would look like this:
Annual Cashflow: $180
Annual Principle Paydown (1st year): $4128
Annual Appreciation: $6000
Wealth Generation 1st year: $10,308
So you'd add $10,308 to your wealth on the first year - in addition to any equity you captured on the acquisition and rehab, which would only accelerate with compound interest on the appreciation and amortized schedule paydown, AND BEST OF ALL you'd have your cash out of the deal to do it again and add to your portfolio, accelerating your growth even faster.
If you listen to some of the more recent podcasts, David and Brandon have started talking about cashflow more as 'defensive' as it helps protect your investments and pay all of the monthly expenses to control the property and let it grow, but the real wealth generation is through appreciation, paydown, and rent increases over time while you control it.
Hope this helps and others may have other thoughts on the method!
Investor · Boulder, CO · Member since 2016 · 1k+ posts · 1k+ votes
6y
@Kyle Richey Yes. The refi will decrease your cashflow. If done correctly, you should still have money coming it. Personally, I look for 15%+ COC returns with all reserves figured in AND $175 cash per door (my average is MUCH higher). In this case, I can costs and still be competitive in a soft market.
Now... by refinancing, you are also able to increase your velocity of money to pick up more projects which can offer protection. If you hold 1 assets, you are 100% occupied or 100% vacant. If I hold multiple assets all underwritten well and cashflowing, if one experiences issues, the others can pick up the slack.
This does mean you need to have cash reserves as well, in the case of some black swan event, so you can keep all assets going.
The counter argument is that if someone is holding a property all in cash they are more protected from this event. I disagree. 1. If their tenant is paying they are loosing out on more income. 2. They still have expenses like insurance and taxes to pay. 3. They are a larger target for lawsuits due to their equity position (yes, lending can be viewed as a "defense" tactic).
Cashflow is KING and so is cash. The key here is to invest from a position of strength and resist temptation to be overleveraged.
New to Real Estate · OH · Member since 2020 · 6 posts · 1 vote
6y
@Whitney Hutten This is awesome, thanks so much! I love what you said about being 100% occupied or vacant, and it's great to hear that $175/month profit per door is totally doable. I'm really curious: Is that for single- or multi-family?
Side note: I was born in Boulder and I'm thinking of investing in Colorado. :)
Rental Property Investor · Gilbert, AZ · Member since 2016 · 3k+ posts · 4k+ votes
6y
@Kyle Richey the correct answer is - it depends. The only way to know the answer to your question correctly is to do the numbers. Here is an example:
Say you have a property that is now worth 100k. When you bought it in 2018 it was worth 85k and you got a loan on it for 64k amortized over 20 years when the interest rates had risen to 5.75%. Your monthly principle and interest payment would be $449 per month.
Now let’s say you can refinance it at 4% (because rates have come down a lot) and you can get a loan at up to 75k with closing costs of only $1000 because your bank like you. Your bank is now letting you amortize the loan for over 25 years instead of only 20 years. Now the payment would be $396 and you would have an extra 10k in your pocket.
So the correct answer is it depends on loan amount, interest rate, and amortization schedule.
I am currently doing a refi on my commercial building right now. My building is valued a couple hundred thousand dollars more now than is was just a couple of years ago. My goal is to suck out between 100k and 150k for reserves and keep it in the bank. Because my loan was at 5.5% and I can get the loan at 3.75% now, the monthly mortgage payment is only going to go up by about $300 a month. The refi is going to ultimately cost about 7k, but I’ll be able to get 100k to 150k out of it. So is it worth it to me right now to have that extra money in the bank for $300 a month? Absolutely. Even though my cash flow will go down a bit.
Investor · Boulder, CO · Member since 2016 · 1k+ posts · 1k+ votes
6y
@Kyle Richey Like Shiloh said... it depends. I think midwest is pretty doable to get $175-$250 a door after all expenses and reserves. In CO, that is not the case. CO is more of an appreciation market, rather than a cashflow one.
New to Real Estate · OH · Member since 2020 · 6 posts · 1 vote
6y
@Whitney Hutten Good to know, thanks! I'm curious: What % of gross rent is recommended for reserves? Or is it more of a total amount (e.g. X months of expenses saved)?
Investor · Boulder, CO · Member since 2016 · 1k+ posts · 1k+ votes
6y
@Kyle Richey Proper deal analysis is more detailed than just setting aside a percentage because your vacancy, capex, and maintenance will differ market to market, pm to pm, deal to deal even. In my markets, I've done the research:
Vacancy 8%-10% (8% is 1 month rent)
Capex 5-7% (This depends on my level of rehab... I will go higher).
Maintenance 5-7% (This depends on the pm and the deal... I will go higher).
Make sure to fully understand what these are in your market. Your PM is your best resource. And holding more in reserves is always better than not enough.
@Kyle Richey Yes. The refi will decrease your cashflow. If done correctly, you should still have money coming it. Personally, I look for 15%+ COC returns with all reserves figured in AND $175 cash per door (my average is MUCH higher). In this case, I can costs and still be competitive in a soft market.
Now... by refinancing, you are also able to increase your velocity of money to pick up more projects which can offer protection. If you hold 1 assets, you are 100% occupied or 100% vacant. If I hold multiple assets all underwritten well and cashflowing, if one experiences issues, the others can pick up the slack.
This does mean you need to have cash reserves as well, in the case of some black swan event, so you can keep all assets going.
The counter argument is that if someone is holding a property all in cash they are more protected from this event. I disagree. 1. If their tenant is paying they are loosing out on more income. 2. They still have expenses like insurance and taxes to pay. 3. They are a larger target for lawsuits due to their equity position (yes, lending can be viewed as a "defense" tactic).
Cashflow is KING and so is cash. The key here is to invest from a position of strength and resist temptation to be overleveraged.
What would be considered an appropriate equity stake if 100% is at risk for lawsuits?
Investor · Boulder, CO · Member since 2016 · 1k+ posts · 1k+ votes
6y
@Jim Chuong What ever your are comfortable with to reasonably lose. You will be doing several things to protect that money: being a good landlord, repairing all health and safety items quickly, liability insurance, umbrella insurance, maybe an llc, etc. In the end, your investment is "at-risk", so protect it :)
@Jim Chuong What ever your are comfortable with to reasonably lose. You will be doing several things to protect that money: being a good landlord, repairing all health and safety items quickly, liability insurance, umbrella insurance, maybe an llc, etc. In the end, your investment is "at-risk", so protect it :)
How do you personally balance between 100% equity at risk of lawsuits and 100% debt at risk of default?
Investor · Boulder, CO · Member since 2016 · 1k+ posts · 1k+ votes
6y
@Jim Chuong. I'm so glad you asked. So once I have a rehab complete and refinance out to 75-80% LTV, I now have little/none of my own money in that property because the equity in the property is what I forced in the value. As far as mitigating default, I do 3 things: 1. Make sure the rents MORE than cover all expenses by at least 25% (most of mine or 50-60% coverage). The banks underwrite this as the DSCR 1.25 or greater. I can slash rents to stay competitive. 2. I carry 6-12 months of reserves for all properties so I can weather any bumps in the road (coming really handy right now with COVID-19). 3. And even if I had to fire sale in the middle of the '08 recession (which was a 19.8% decline), I'm still breaking close to even... while it would be painful to lose that equity position, I can fire sale and walk away. Lastly, you have your loan arrangement with the bank where you might be able to hand the keys back to the bank in lieu of foreclosure. For those reading this in the middle of the COVID-19 pandemic, you can also mitigate default by working with SBA to get grants and loans, and talking to your lender about forbearance options.
As far as lawsuits, I'm doing these things: 1. Be a great landlord and fix all health and safety items immediately (reserves!) 2. Carry good liability insurance to protect me from my properties 3. Put leverage on the property to lessen the chances of being a cash target 4. Have an umbrella policy in place to coordinate insurances and protect my properties from me 5. Then put the properties into an LLC (some argue to do this by equity position or individually)
Real Estate Agent · West Hartford, CT · Member since 2016 · 449 posts · 476 votes
6y
@Kyle Richey it seems like you got your answer from others here but I'll add my 2 cents. When you BRRRR and you get the new ARV a bank will most likely loan 75% of that new value (75% LTV). BUT.... you DONT have to take the full 75%. Maybe your ok with a 65% LTV and having a lower mortgage payment.
There is a happy medium between too high of an appraised value and too low. If its too high and you take a loan at 75% of the ARV you may be left with little cash flow but all your down payment recouped.
On the flip side- if the ARV is too low... you may be stuck with a good amount of your cash in the property but high cash flow. My point being... it's up to you what you would rather have depending on what the ARV comes in at.
On the most recent BRRRR I did.... I was left with $1200 cash flow after PITI and 75% LTV. I was only able to pull out 70% of my initial investment but for me...... I was OK with having some capital stuck in the deal for the extra cash flow.
@Jim Chuong. I'm so glad you asked. So once I have a rehab complete and refinance out to 75-80% LTV, I now have little/none of my own money in that property because the equity in the property is what I forced in the value. As far as mitigating default, I do 3 things: 1. Make sure the rents MORE than cover all expenses by at least 25% (most of mine or 50-60% coverage). The banks underwrite this as the DSCR 1.25 or greater. I can slash rents to stay competitive. 2. I carry 6-12 months of reserves for all properties so I can weather any bumps in the road (coming really handy right now with COVID-19). 3. And even if I had to fire sale in the middle of the '08 recession (which was a 19.8% decline), I'm still breaking close to even... while it would be painful to lose that equity position, I can fire sale and walk away. Lastly, you have your loan arrangement with the bank where you might be able to hand the keys back to the bank in lieu of foreclosure. For those reading this in the middle of the COVID-19 pandemic, you can also mitigate default by working with SBA to get grants and loans, and talking to your lender about forbearance options.
As far as lawsuits, I'm doing these things: 1. Be a great landlord and fix all health and safety items immediately (reserves!) 2. Carry good liability insurance to protect me from my properties 3. Put leverage on the property to lessen the chances of being a cash target 4. Have an umbrella policy in place to coordinate insurances and protect my properties from me 5. Then put the properties into an LLC (some argue to do this by equity position or individually)
PM me with Q's!
Thanks @Whitney Hutten
Do you have an example where you cashout refi @75% and the new rent was able to achieve a DSCR of 1.25? From my experience, that extra leverage drops the DSCR unless you run unsustainable operating expenses of <50%
Example. $100k SFR. $1k rent/mo. $20k down.
$50 rehab
$200k appraised after reno. $2k rent/mo (generous)
Investor · Boulder, CO · Member since 2016 · 1k+ posts · 1k+ votes
6y
@Jim Chuong. The reason your DSCR is high is you have a loan on a $200K asset. I specialize in more workforce housing. So I'll be all in for purchase and rehab for $70-75K on $100K asset. The asset will rent for $1000-$1050 so my rents are covering more than 1.25 of the PITI+HOA.
@Jim Chuong. The reason your DSCR is high is you have a loan on a $200K asset. I specialize in more workforce housing. So I'll be all in for purchase and rehab for $70-75K on $100K asset. The asset will rent for $1000-$1050 so my rents are covering more than 1.25 of the PITI+HOA.
Gotcha. Thanks for the response!
There's a constraint set by the most rent you can achieve on the finished product. And to work backwards from there
Investor · Boulder, CO · Member since 2016 · 1k+ posts · 1k+ votes
6y
@Jim Chuong Correct. At some point, rents level off and no longer rise directly with the home price. If you hold a property long enough, you will have the same effect happen but you see it in your return on equity numbers.