BRRRR Strategy - Would you consider this as a good deal?

14 Replies

It is my first time using the BRRR strategy instead of just flipping the house and I must say I am bit concern over the number.

Here are the details:

I paid €141.750K for an apartment using private money to fund the entire purchase price. I spent about € 6K renovating the unit. My all-in cost after all of the renovation cost, financing cost, utilities, refinance fees and closing costs was about €156,000K.

The bank appraised the property at € 220.000K and allowed me to do a cash-out-refinance at 70% loan-to-value. I may take out the full 70% which came out to €155.000, leaving roughly €1K of my own cash into the deal.

I receive an offer to rent the unit for € 900/month on a 8-years lease. Here are some data based on my assumptions for the first year:

  • Rental income: € 10.800
  • Vacancy rate (4%): € 432
  • Gross income: € 10.368
  • Total expenses: € 2.552
  • NOI: € 7.816
  • Mortgage: € 7.159 (30 year loan with 2.55% interest rate, principal & interest)
  • Cashflow: € 657
  • Cash ROI: 65,70%
  • Equity accrued: € 3.373
  • Total return: € 4.030
  • Total ROI: 403,30%

When you look at this deal through a cash-on-cash analysis the yield looks insanely high but what I’m concern about is cash flow leaving just € 657/year on the table, exposing me to any missing payments from tenants or market correction.

What do you think about the numbers?

Thank you in advance for any and all replies.

@Fabio Busatto Hi Fabio, I'm admittedly a beginner, but a few things stick out to me:

1) 8 Year lease??? what are the terms of this - are there rent increases, or any optionality included?

2) 212/mo for expenses seems a bit low - what is your breakdown on this? Its around 25% of GSI which seems off.

Thank you for your reply @Thomas DiMeo :)

About your question:

1)Terms for contract: 4+4 years, rent increase after the first four year based on the ISTAT (Italian National Institute of Statistics) index 

2)Expenses breakdown:

  • Local Tax: € 112.50 monthly
  • Assumption for small repair: € 50/month
  • Assumption capex for extraordinary maintenance: € 50/month

Am I missing something? Everyone talks about BRRRR as the best possible thing to run but these numbers do not follow...

Also I just found the amount of tax I will need to pay on the income: 21% which brings my annual cashflow to negative  (€ 1520)

@Brandon Turner pls help :)

@Fabio Busatto Not sure the standard expense list in Europe, but my understanding was that in addition to property tax, maintenance, and capex, you should account for insurance, utilities (those that the tenant does not pay), and potentially property management (even if you want to self-manage, to see if the deal works from a passive investment standpoint).

Originally posted by @Thomas DiMeo :

@Fabio Busatto Not sure the standard expense list in Europe, but my understanding was that in addition to property tax, maintenance, and capex, you should account for insurance, utilities (those that the tenant does not pay), and potentially property management (even if you want to self-manage, to see if the deal works from a passive investment standpoint).

Thanks Thomas. Insurance as utilities will be paid by tenant's. Yes I should have counted for property management. What I dont realize is what should be change for this deal to work throught. Is it income too low? Is it mortgage rate too high?

I don't know much about the Italian market. In the US, we'd generally look for a property that with a monthly rent of 1% of its value. This is usually enough gross income to cover your costs while making a reasonable profit. This varies from market to market and it depends on where you are in the market cycle. In the worst parts of the recession, it wasn't difficult to find properties that rented for 2%+ of their value. 

In the US, a property renting for .4% of its value would be an indication that the value of that individual property is too high. If that value is consistent with the market, then it would indicate the market is too hot to invest in. in the best case scenario, you will only have 657 euros left over every year. Thats simply not enough profit to justify your time, let alone the capital expenses you might have to make down the road. If you're buying it because you think the value will go up over time, then pull the trigger. You shouldn't be buying it for cashflow though.

Originally posted by @Alex Jones :

I don't know much about the Italian market. In the US, we'd generally look for a property that with a monthly rent of 1% of its value. This is usually enough gross income to cover your costs while making a reasonable profit. This varies from market to market and it depends on where you are in the market cycle. In the worst parts of the recession, it wasn't difficult to find properties that rented for 2%+ of their value. 

In the US, a property renting for .4% of its value would be an indication that the value of that individual property is too high. If that value is consistent with the market, then it would indicate the market is too hot to invest in. in the best case scenario, you will only have 657 euros left over every year. Thats simply not enough profit to justify your time, let alone the capital expenses you might have to make down the road. If you're buying it because you think the value will go up over time, then pull the trigger. You shouldn't be buying it for cashflow though.

Thanks Alex. Does it mean that in your market property value $ 200K would be rented for $ 2000/months?!?! That's gorgeous! 

Do you think rent it's the only reason why this BRRRR doesn't look attractive or the may be another reason?

Originally posted by @Fabio Busatto :
Thanks Alex. Does it mean that in your market property value $ 200K would be rented for $ 2000/months?!?! That's gorgeous! 

Do you think rent it's the only reason why this BRRRR doesn't look attractive or the may be another reason?

Either the rent would have to increase or the price would have to come down for it to make any sense for me. BRRRR is a great strategy, but the fundamentals still have to be there.

There must be something I'm missing because this property scares the hell out of me. Is it normal for a 220k property to only rent for 900 euros a month? The scariest part to me is that you're only financing 70% of the value, have an incredibly generous interest rate at 2.55% and the property is still barely covering your expenses. Values will have to fall alot when central banks begin increasing interest rates in the next 2-4 years. I'm not sure this is the right environment to be buying rental properties. Again, I don't know anything about the Italian market though. Maybe I'm missing something fundamental here.

@Fabio Busatto it’s very interesting to hear about a deal from Italy! Your cash flow looks small but I think there’s more to a good deal than just cash flow. 

My first question would be is there a really good chance of appreciation on the property in the future? What are the fundamentals of the town/city where the property is located...population growth, unemployment, job growth, etc. Is the property in a great area that attracts the best kinds of tenants or in a not so good area? Have properties in the area gone up consistently in the past? What about rent growth? Is there a good chance of rent increasing? 

Are eight year rent agreements normal in Italy? In the US many assume rent will grow each year by at least a little (depending on the area). 

You may consider just flipping the property and using the profits to find one that has better cash flow numbers if that is your goal. If you can afford to leave more of your money in and it’s a great area that has an excellent chance to go up in value/rents then you could possibly do that as well...leave more of your money in to keep the monthly payment down. 

Cash flow is one of five wealth generators in real estate...cash flow, equity growth from renter paying down mortgage, appreciation, ability to leverage using other people’s money at low interest (the banks), and tax benefits (tax benefits are probably a lot different in Italy). 

Really the only way you’d probably want to hold is if you are very sure that value and rent will go up and you are in a personal financial position to cover any “negative” cash flow in the mean time. 

@Fabio Busatto If the lease term is fixed for 4 years, perhaps you don’t need a 4% a year vacancy reserve. Also the taxes sound very high, 2k on 10k gross income. Are you sure you have accounted for all deductions, if so is there a way to mitigate taxes by changing up ownership structure? Owning in a trust / limited liability company for example .
Originally posted by @Alex Jones :
Originally posted by @Fabio Busatto:
Thanks Alex. Does it mean that in your market property value $ 200K would be rented for $ 2000/months?!?! That's gorgeous! 

Do you think rent it's the only reason why this BRRRR doesn't look attractive or the may be another reason?

Either the rent would have to increase or the price would have to come down for it to make any sense for me. BRRRR is a great strategy, but the fundamentals still have to be there.

There must be something I'm missing because this property scares the hell out of me. Is it normal for a 220k property to only rent for 900 euros a month? The scariest part to me is that you're only financing 70% of the value, have an incredibly generous interest rate at 2.55% and the property is still barely covering your expenses. Values will have to fall alot when central banks begin increasing interest rates in the next 2-4 years. I'm not sure this is the right environment to be buying rental properties. Again, I don't know anything about the Italian market though. Maybe I'm missing something fundamental here.

 Thanks @Alex

Unfortunately yes, in my city it is normal for a 220K property to only rent 900 euro a month. 

What do you mean for "Values will have to fall a lot when central banks begin increasing interest rate in the next 2-4 years" . Is it just relative to my mortgage rate or in general? As in my case I will have fixed rate for 30 years

Originally posted by @Satha Palani :
@Fabio Busatto If the lease term is fixed for 4 years, perhaps you don’t need a 4% a year vacancy reserve. Also the taxes sound very high, 2k on 10k gross income. Are you sure you have accounted for all deductions, if so is there a way to mitigate taxes by changing up ownership structure? Owning in a trust / limited liability company for example .

Thanks Satha :)

I counted for 4% year a vacancy reserve in case of any missing payments from the tenant's which is not that rare in my city. Also, it count for cost of recovering this money. 

I'm checking with my accountant if there are any deductions, thanks for the suggestion.

I will also ask my accountant if there is any changing up ownership which may help me on that, thanks again for the suggestione

Originally posted by @Ryan E. :

@Fabio Busatto it’s very interesting to hear about a deal from Italy! Your cash flow looks small but I think there’s more to a good deal than just cash flow. 

My first question would be is there a really good chance of appreciation on the property in the future? What are the fundamentals of the town/city where the property is located...population growth, unemployment, job growth, etc. Is the property in a great area that attracts the best kinds of tenants or in a not so good area? Have properties in the area gone up consistently in the past? What about rent growth? Is there a good chance of rent increasing? 

Are eight year rent agreements normal in Italy? In the US many assume rent will grow each year by at least a little (depending on the area). 

You may consider just flipping the property and using the profits to find one that has better cash flow numbers if that is your goal. If you can afford to leave more of your money in and it’s a great area that has an excellent chance to go up in value/rents then you could possibly do that as well...leave more of your money in to keep the monthly payment down. 

Cash flow is one of five wealth generators in real estate...cash flow, equity growth from renter paying down mortgage, appreciation, ability to leverage using other people’s money at low interest (the banks), and tax benefits (tax benefits are probably a lot different in Italy). 

Really the only way you’d probably want to hold is if you are very sure that value and rent will go up and you are in a personal financial position to cover any “negative” cash flow in the mean time. 

 Thanks Ryan :)

I will check all of this data (population growth, market appreciation, job growth...), to be honest I do not have any exact number at the moment. 

Rent increase after the first 4

Quote:"If you can afford to leave more of your money in and it’s a great area that has an excellent chance to go up in value/rents then you could possibly do that as well...leave more of your money in to keep the monthly payment down"

Very interesting. I have tried to run some numbers lowering the finance amount to € 100 K (in stand of 150K) and yes indeed my cashflow is now positive. Is there any other downside a part from leaving more money on the table?

Originally posted by @Fabio Busatto :
Originally posted by @Ryan E.:

@Fabio Busatto it’s very interesting to hear about a deal from Italy! Your cash flow looks small but I think there’s more to a good deal than just cash flow. 

My first question would be is there a really good chance of appreciation on the property in the future? What are the fundamentals of the town/city where the property is located...population growth, unemployment, job growth, etc. Is the property in a great area that attracts the best kinds of tenants or in a not so good area? Have properties in the area gone up consistently in the past? What about rent growth? Is there a good chance of rent increasing? 

Are eight year rent agreements normal in Italy? In the US many assume rent will grow each year by at least a little (depending on the area). 

You may consider just flipping the property and using the profits to find one that has better cash flow numbers if that is your goal. If you can afford to leave more of your money in and it’s a great area that has an excellent chance to go up in value/rents then you could possibly do that as well...leave more of your money in to keep the monthly payment down. 

Cash flow is one of five wealth generators in real estate...cash flow, equity growth from renter paying down mortgage, appreciation, ability to leverage using other people’s money at low interest (the banks), and tax benefits (tax benefits are probably a lot different in Italy). 

Really the only way you’d probably want to hold is if you are very sure that value and rent will go up and you are in a personal financial position to cover any “negative” cash flow in the mean time. 

 Thanks Ryan :)

I will check all of this data (population growth, market appreciation, job growth...), to be honest I do not have any exact number at the moment. 

Rent increase after the first 4

Quote:"If you can afford to leave more of your money in and it’s a great area that has an excellent chance to go up in value/rents then you could possibly do that as well...leave more of your money in to keep the monthly payment down"

Very interesting. I have tried to run some numbers lowering the finance amount to € 100 K (in stand of 150K) and yes indeed my cashflow is now positive. Is there any other downside a part from leaving more money on the table?

Well the downside is mostly not having that extra money available for more deals or as an emergency fund. Your cash on cash return will go way down. Not sure what your new cash flow numbers are if you leave 55k in it as opposed to just 1k as before but it will be way lower than the 65% you have listed above. 

Above you also say you accounted for a 4% vacancy because of any missed payments. This will be a weird concept to investors in the US. If you are worrried about tenants missing payments then I would recommend doing a more thorough screening and background check. If tenants miss payments here it usually means they get evicted and those evictions will usually show up on background checks. Also, if rents are going up in your area each year can you perhaps  find a different tenant that will sign a shorter lease. Even better would be building in rent increases each year into the lease agreement for this current prospective tenant. If you can increase the rent each year, even by a somewhat small amount, it will really add up over those 8 years. If you have 50 euro per month increase each year, your monthly rent would be 1250/month by year 8. 

Are 8 year leases normal there? I ask because that is something I’ve never heard of here in the US. Besides a rent to own situation anyway. 

@Fabio Busatto

Firstly, good to see some international input with regards to different markets around the world!

What we've adopted for numerous reason (mainly it's conservative and covers us, and that it's simple to calculate) is to build in a 15% of RENT allowance for deferred maintenance and vacancy.  So far, so good.  I don't know how your 212 number compares with that but that's what we do and it's worked thus far.

Good luck!