BRRRR Strategy - I don't get it.. what am I missing?
Catonsville, MD · Member since 2014 · 89 posts · 21 votes
Listening to @Brandon Turner's webinar on BRRRR, and his first example looks like this:
So, I think Brandon would still be in the hole after the refinance. Check my logic and figure out what I'm missing:
He's $102,500 in the hole after the rehab. Then he refinances, and has to put 20% down on the $141,000, which is another $28,200. So now he's $130,700 in the hole (102,500 + 28,200). The bank gives him a loan for $112,800, which isn't enough to cover his entire debt; it leaves him $17,900 in the hole (130,700 - 112,800)! Sure, he has 20% equity in the property, which is worth $28,200, but that's not tangible money. What if he borrowed everything and owes people money yesterday?
I don't see the benefit, and I must be missing something. Why not just buy a property already rehabbed at $141,000, put your 20% down, and not owe anybody $17,900? Somebody help a newbie out! Thanks.
@Matt Powell great Q and follow up by you and the community. I think this is one of the areas BP is good for when it is a legit Q from someone who is actually trying to learn (vs someone trying to vette some idea from a guru) You have asked the questions that hundreds of others didn't have the guts to ask but will benefit from reading. Several BPers are paying it forward for you (us) so that someday you (we) can do the same for the newest members. Persevere!
Hi @Matt Powell. I believe you're looking at it wrong. He forced appreciation to $141,000 but only has $102,500 into it. The bank will refinance 80% of the appraised value meaning he'd be able to get his money back and repeat.
Matt:
In the scenario you describe he would net $10,300 at closing (back in his pocket) and have $28,200 in equity.
Thanks @Juan Vargas and @Garry C., but I'm confused. I obviously don't know how refinances work. I assumed Brandon would go to a new bank and say "Hey guys, look at this great house. What's it worth?" And the bank would go "Looks like $141,000! We'll give an 80% LTV, so cough up the 20%." How do they know how much equity Brandon has in it at that point, and how is that tangible to them?
Thanks for your patience. =)
I'll take a stab at this, but I'm going off your numbers since I don't remember exactly what he said in the webinar.
The $112,800 (80% of appraisal value) was the money he got from the bank when he refinanced. He used that money to pay off the money he borrowed to acquire/rehab the house, and paid himself back his money that he put into the rehab.
After refinancing, since his new mortgage only paid 80% of the appraisal value, he has 20% equity in the house. Since he paid off all initial acquisition costs, the 20% equity is his to keep.
So does the bank basically say, "Well, looks like you already have X amount of equity in the house, so we'll take whatever percentage that is of $141,000, and loan you the rest."?
Thanks @Chris Reed. I think I'm starting to get it. So how much equity DID he have in the house after the rehab? I guess since his original loan was for $70k, he had $71,000 in equity (141,000 - 70,000)? How would you calculate that?
They loan you 80% of $141000 which is $112800 The 20%leftover is the equity in the house which equals $28200 .There is only a 100 % to work with. The bank does an appraisal to come up with the $141000
They'll send an appraiser out, which Brandon will probably pay $350-500 for. The appraiser will tell the bank & Brandon how much the property is worth and then bank will refi up 80%. The extra 20% is just a cushion for the bank to minimize risk, in case values go down or if they have to foreclose. Brandon doesn't have to cough up the 20%. It just sits there, untapped. It's Brandon's equity. Theoretically (if the appraiser's correct) he could sell the house for $141K and minus closing costs, etc. walk with the profit (his equity) after paying off the mortgage.
Thanks all. I now understand that Brandon's current equity in the property serves as his "down payment" of 20% on the refinance. How does the bank determine how much equity Brandon has in the property already (and what are those numbers in this example)?
Also, I assume that if Brandon has more than 20% of the appraised value in equity, they'll still loan you the full 80%?
EDIT: Ok, scratch my questions, I think it just clicked. The bank doesn't care how much equity you have, I guess. They'll just loan you the 80%, and it's your responsibility to come up with the remaining 20% if you have to. But Brandon doesn't have to because he's already got that much in equity due to the rehab. Do I have that right now?
Thanks @Chris Reed. I think I'm starting to get it. So how much equity DID he have in the house after the rehab? I guess since his original loan was for $70k, he had $71,000 in equity (141,000 - 70,000)? How would you calculate that?
There's no real way to know what the ARV WILL be when you start, just what you think it will be when you work your magic. Investor do estimations and projections based on comparable properties in the area, but it's not an exact science.
Also remember, the $141K was an appraisal done by the bank's appraiser. Different appraisers, different values. It all depends on what comps they use and what they do and don't notice/factor in when doing the appraisal.
Thanks Chris, but I think I worded my question poorly. What I really wanted to know was how we could calculate how much equity Brandon had in the property post-rehab, after the house was appraised for $141,000. Equity is appraised value minus current mortgage/liens, so I'm assuming that math works out as (141,000 - 70,000 = 71,000 in equity), unless we count his rehab debts as liens. Just trying to get my mind wrapped around how to know how much equity you have post-rehab...
Matt,
The 80% of 141,000 = 112,800.
That covers your all in costs 102,500 with additional money left over. You then can repeat after it's rented.
You still have 20% equity in the property after the refinance.
Hope this helps!
Ryan
Real world example.
I bought a house at the trustee auction last month. It needs some work, but is rentable as is. I'll rent it for a year, then renovate and sell it. (I want to hold it for a year for capital gains reasons.) So I told my bank I wasn't going to do reno right now, wanted to refi it as-is.
Paid $79,000 cash.
Property appraised as-is at $99,500.
Bank will lend 75%, so $74,625.
Cost of refi + appraisal, approx $2000.
Bank will cut me a check Monday for $72,625.
I'll own a cash-flowing rental for $6375.
The majority of my cash I spent last month's auction will be back in my pocket for this month's.
In this case, I ended up about $6K out of pocket for a $100K house. I've done this several other times, and in two instances, the bank ended up paying me more cash than I had in the house. That makes for crappy numbers if you're looking at monthly rental cash flow, because the mortgage is high, but since I plan to sell all these after a year or two, it's great for cash flow.
Thanks Chris, but I think I worded my question poorly. What I really wanted to know was how we could calculate how much equity Brandon had in the property post-rehab, after the house was appraised for $141,000. Equity is appraised value minus current mortgage/liens, so I'm assuming that math works out as (141,000 - 70,000 = 71,000 in equity), unless we count his rehab debts as liens. Just trying to get my mind wrapped around how to know how much equity you have post-rehab...
Ok, I get it...
I just watched the portion of "Using Fixer-Upper Rental Properties to Build Wealth! (BRRRR!)" where he goes over the "Cedar BRRR" numbers. He says he bought it for $70K, had $30K in rehab costs, and $2,500 closing costs. What he didn't mention here is how much the initial loan was for. In another webinar he mentioned that the loan was for $82K and he had $18K of his own money into it (no idea where closing costs went).
So you are wondering about after purchase equity... He says he used a private lender that he met on BP. What he doesn't say (that I saw) was if the lender put a lien on the house. It's expected, but not all lenders do it.
If the lender put a lien on the house, then the after purchase equity was the difference between the value at time of purchase, and the amount on the lien ($82K). His $18K wouldn't factor into the equity calculation.
If the lender didn't put a lien on the house, the after purchase equity was 100% of the value of the house at time of purchase since he would have the title free and clear.
Given the way he phrased the "...and I paid off the lender..." it doesn't seem like there was a lien on the title. ...just a guess though.
To clarify, the ARV doesn't factor into the equity at time of purchase. Only after the renovations have been done and the property reappraised.
Clear as mud?
Crystal clear, actually. Thanks very much. Appreciate your commitment to giving good answers.
So it sounds like liens need to be on the property to be factored into the official equity equation. Didn't know that. But I'm still wondering, does the bank care if you have enough equity in the property to cover the remaining 20% of the appraised value when you refinance, or do they not care at all and will just indiscriminately give you that 80%? Will they run the equity numbers before giving you the 80%?
Crystal clear, actually. Thanks very much. Appreciate your commitment to giving good answers.
So it sounds like liens need to be on the property to be factored into the official equity equation. Didn't know that. But I'm still wondering, does the bank care if you have enough equity in the property to cover the remaining 20% of the appraised value when you refinance, or do they not care at all and will just indiscriminately give you that 80%? Will they run the equity numbers before giving you the 80%?
I think you are confusing appraisal value with purchase price. Since he owns the property at the time of refinance, they are essentially loaning him money based on the value of the property.
If you are getting a new loan for a property that you are going to buy from someone else, then the bank will have a certain amount of the purchase price they will cover according to the rules of the loan program you are using, and a limit of what they will loan based on the appraised value of the property. The buyer needs to cover either the down payment (and possibly closing costs), or the difference between the max loan amount and the purchase price. ...whichever is greater.
The real issue is that there is no purchase price when refinancing, so there is nothing for him to cover. It's basically just an asset backed loan with ALOT of paperwork.
Side note: If there is an existing loan or lien on the property at the time of refinance, the bank can either require they be paid off, or allocate portions of the loan amount to pay off the other debts in order to clear the title before they put their chains on it.,
On the Cash out refi, under 4 loans, they will give you 80% of the appraised value.
BUT, of that 80% if there are any mortgages, liens, debts vs the property the 80% will go to that first, and the left over, minus costs to you.
Yes the bank will not let you do a cash out refi unless you have 20% in equity.
Example I have a mortgage for $170,000 my property is worth $245,000. The bank will let me do a cash out for 80% of the value being $196,000. As part of the cash out I would pay off original mortgage of $170,000 and keep the rest which is $26,000. So my new loan would be $196,000 and value $245,000 leaving $49,000 in equity that I can not touch.
@Matt Powell, I see that you have been progressively understanding BRRRR more clearly. From your original post, let's say that Brandon had enough savings to cover both the 20% deposit on both the purchase price AND the rehab costs ($20k / $100k). So, after the later $140k re-appraisal, although the Bank would loan Brandon a total of $112k (80%), because he already owes them $80k, he might only ask them for the additional $32k, which is CASH, MOULA, DINERO, MONEY - to go get MORE!
$32k is a better deposit for Brandon's next property than he started off with!
The point I am making is: when you refinance, the original loan doesn't have to be paid out. Brandon might still owe 80% of the re-appraised property value, BUT, he now gets to buy ANOTHER property, and another, and another, and so on, with NO further outlay of his own money!
Then gradually, their cash flow pays them ALL down. Cheers...
@Matt Powell Great thread. Thanks for asking all these questions. It clearwd up a few things for me too.
So does the bank basically say, "Well, looks like you already have X amount of equity in the house, so we'll take whatever percentage that is of $141,000, and loan you the rest."?
This post is as far as I went.
Refinance rules are different than a purchase. When you are in title and ask for a loan it's a re-finance.
Lenders make re-finance loans usually at 80% loan to value (LTV), the LTV is based on the costs of acquisition plus rehab costs or the appraised value, whichever is less.
A no-cash-out loan, meaning the borrower doesn't receive any cash generally goes up to 90% LTV, for homeowners, some programs can go to 95%.
A lender usually wants you in title for 1 year, but there are programs with "seasoning" of your ownership at 6 months.
Investors re-finance at 80% LTV. Still on a no-cash-out basis.
Now, you have "portfolio" loans where the lender holds the loan and doesn't sell it, at least immediately. These loans may be on a slightly different basis, but most lenders still follow the guidelines above.
For a cash out re-finance, where a borrower receives cash from the equity in the property, these are generally at 75% LTV or less, for secondary market loan programs and less if even available for investor type loans. This means using a portfolio loan.
A few lenders may do 80% cash out, but that's a bit of wizardry. That usually takes a good borrower with experience for a lender to let you walk away with cash at 80% LTV.
Another issue is that lender's usually don't make loans on a property that is or has been recently held for sale, they don't make enough money under mortgage programs with short term loans. That goes into more of a commercial loan. That can be tougher to get based on experience as well as other business factors. For good borrowers, they may get 80%, for most first time borrowers you're likely limited on a no-cash-out basis. Depends on the lender.
Bottom line, you need to know your ability to borrow and under what terms before you get involved in trying to carry out this strategy.
Lending guidelines are not set in stone across the country, they vary from lender to lender in all types of loans. Secondary market loan programs have basic requirements, ant lender may add additional requirements, called "overlays".
Assumptions are made with BRRRR, 1. that a lender will go to 80% cash-out, 2. the value will be based on the appraisal, 3. that you'll be a strong enough borrower to swing such a loan and 4, that such lending is available in your area. I must say, that's is a bit of wizardry, but it's not impossible. :)
@Matt Powell great Q and follow up by you and the community. I think this is one of the areas BP is good for when it is a legit Q from someone who is actually trying to learn (vs someone trying to vette some idea from a guru) You have asked the questions that hundreds of others didn't have the guts to ask but will benefit from reading. Several BPers are paying it forward for you (us) so that someday you (we) can do the same for the newest members. Persevere!
Thanks @Juan Vargas and @Garry C., but I'm confused. I obviously don't know how refinances work. I assumed Brandon would go to a new bank and say "Hey guys, look at this great house. What's it worth?" And the bank would go "Looks like $141,000! We'll give an 80% LTV, so cough up the 20%." How do they know how much equity Brandon has in it at that point, and how is that tangible to them?
Thanks for your patience. =)
But he already owns the house - perhaps 100%, perhaps he had financing on the original purchase. What he's doing here is taking out a secure loan for 75 - 80% of the new appraised value of the house. This new loan will discharge and replace his existing mortgage (if he has one) and any additional amount may go into his bank account. He will then have a mortgage of 112K with balance 28-29K equity in the house.
Here's a real world example with rounded numbers for simplicity. I partnered with someone who had extra cash laying around. We bought a house for $63,000 cash, which my partner paid $62,000 and I paid $1,000.
I rehabbed the property for $25,000 which I paid $19,000 and he paid $6,000. Then I placed tenants. Then we got a refinance loan. The appraisal came in at $120,000. We got 70% LTV and cashed out $84,000.
We had $88,000 in and got out $84,000. So we only had $4,000 into a $120,000 house. You can't get a down payment that low on a purchase loan! If we had gotten a higher LTV loan we would have gotten more money out than we put in.