3 Critical Keys to a Successful Refinance (for the BRRRR Strategy!)

by | BiggerPockets.com

One of the best ways to build your rental portfolio is through the BRRRR strategy (buy, renovate, rent, refinance, repeat). Many factors are important to be successful at this. A source of capital is needed to fund the purchase and renovations, a reliable contractor is needed to do your renovations, and a banking relationship is needed to provide the take out financing.

Along with all those things, the refinance phase can be a deal maker or breaker. The key to that phase is getting the right valuation so that you can recoup your capital and repeat. Without a good value at the refinance phase, you will be left with some of your capital tied up in the deal, which will prohibit your buying power on the next deal. That’s not sustainable. At some point, you will run out of capital if you have to leave some behind on each deal.

I always look for sustainability in my business, which means doing profitable activity that I can do over and over again. I came up with three keys to getting a good value at your refinance so that you can have sustainability in your business, repeating the process over and over again with the same capital.

Once you have a banking relationship in place with a lender that will fund your deal, the pivotal point in the refinance is the appraisal. To ensure you get the right value, consider the following three tips.

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Related: The BRRRR (Buy, Rehab, Rent, Refinance, Repeat) Strategy: A Primer for Investors

3 Tips for a Successful Refinance

1. Make sure the income approach is used.

Most appraisers use what’s called the “market approach” on an appraisal. This is looking at the local real estate market for completed sales within a specific timeframe to determine value. Real estate slang for this is “running comps” or comparable sales. Things like distressed sales and bank auctions can pull down the market value unfairly. The sales they are comparing your property to may also not be as profitable. The income approach factors in the profitability of the deal, looking at the net operating income (NOI) and applying a cap rate to come up with the value. If you deal is a good one, the income approach will typically show a higher value than the market approach.

2. Break out your construction costs.

You want to make sure the bank and appraiser see that you did significant work on the property to increase its value. The best way to convey that is to show them a detailed scope of work for your renovations. A bid from a general contractor with pricing and lots of details included is a good start. If you did any work on the property yourself, be sure to show some value for that. We also include a construction management fee on our deals to compensate us for our oversight. This fee could be taken as a payment or contributed as equity in the deal, but we make sure to show the dollar value in our budget.

Related: How I Bought, Rehabbed, Rented and Refinanced 14 Properties at Once

3. Make sure to attend the appraisal.

You know where the value is in your deal. You know the key points that should be considered in a refinance, and you know all the work that was performed better than anyone else. It makes sense for you to attend the appraisal to ensure that the deal is presented in the best light.

In today’s video, I go deeper into these three tips and teach how to make sure you get the best value on your refinance so you can have a sustainable business model moving forward.

I hope you enjoyed! If you have some tips on refinances or the BRRRR strategy overall leave them below!

It would be great to have a discussion with you on the topic. Have a great and profitable week!

About Author

Matt Faircloth

In 2005, Matt founded The DeRosa Group along with his wife, Elizabeth. At the time, the two person company owned and managed two assets – a single family home and a duplex. Over the last nine years, they have grown the company to a 12 person team owning and managing over five million dollars in residential and commercial assets throughout the central NJ and Philadelphia area. One of DeRosa’s mantras is “to make money while making a difference.”

24 Comments

  1. Jared Garfield

    Matt, this is an excellent post, very well written with some excellent points! Clearly you know what you are doing, and have used this strategy to perfection multiple times. This is very helpful for new and even seasoned investors. I would add these tips:

    Make sure you take a proforma to the banker showing cash on cash return, cap rate, cost per square foot related to comps, your rehab scope, and comparable sales (if the appraisal comes in lower than expected it will help with disputing the lower value, and if the banker agrees that it was low it’s easier to get an adjustment). Make sure that your proforma page includes the debt service coverage ratio, and that should be at least 1.2. Get to 1.7 or 1.8 and you are golden!

    It’s important to keep rehab costs for material and labor as low as you can, it must be good quality, but if you can get access to a large investor who does 10 or more homes per month and has a nationally managed account, and buy materials using your cash and their account you can save up to 30% on materials and 50% on paint. See if they will let you use their crews, giving their crews extra work helps them keep their pricing low, and if you are only doing one house at a time it doesn’t strain their resources. These steps will help you get more equity.

    Consider a construction loan from a local bank that will loan you the rehab money and make you only put 25% down, and then refinance with that bank. If they are willing to go off of the after repair value, you will be able to start with much less cash, and may easily refinance with no cash out of pocket! (Many banks will love that this also doubles your loan volume).

    • Matt Faircloth

      Hey Jared,
      Good to hear from you. Happy New Year! Great points! I learned a few things also – didn’t think to find a larger developer / investor and use their buying power. That’s a good one!
      Other points are good also!
      I appreciate the input!
      Matt

  2. Dan White

    I love the BRRRR strategy, my whole business with built with a combination of this and some flipping to gain more capital. The problem I have run into is the lack of lending opportunities after ten financed properties. in the “old” days mid-90’s to early 2000’s this was not a problem and I was able to get over 20 loans with a a single lender, refi with cash out, no seasoning and other great tools. Now I cannot get cash out refinancing, I often pay cash, rehap then refi, the refi part is very hard now, the pool of portfolio lenders in Washington State is very very limited. Most of my properties are SF or small multi 2-3 units. Any solutions? I have maxed out of WA Fed. Can only buy so many all cash properties and want normal interest rates.

    • Matt Faircloth

      Hey Dan,
      Are you financing in your own name or in an LLC? I have only seen the 10 deal limit for ownership in personal names, not in LLC’s. Small community banks (those with less than 10 branches and a very small geography of focus) will typically LLC refinance deals and only require a personal guarantee, not that the real estate be held in or show on your personal return. Some of the nation wide portfolio lenders will do it but they are more expensive. They lend on the value of the asset, without much regard for the borrower at all. You can try someone like B2R Finance if you are OK with a higher rate, but they will do the deal.
      I hope that helps!
      Matt

  3. chris kane

    Great post Matt. An issue I just ran into with the BRRRR strategy is finding a lender that will do a cash out refinance on the appraised value of the rehabbed property prior to Fannie May’s 6 month seasoning period. My appraisal came in high enough to pull out most of my initial investment but the lender will only loan on the purchase price. Like you said, leaving your capital tied up in a property limits your ability to scale and repeat the process. Now I’m patiently waiting a few more months to refinance so that I hit the 6 month mark…

    • Matt Faircloth

      Hey Chris,
      You are probably not dealing with the right lender. If your banker is going off Fannie May guidelines then they are going to sell the loan to Fannie May after closing. Small Community Banks don’t sell those loans, they hold them in house so they are not governed or concerned with FM’s regulations. You should be able to find a bank that will do the deal and refinance out your equity inside of the 6 month seasoning period if you look around a bit. Try and find a bank that has just a few branches and is local to your investment.
      Good luck!
      Matt

  4. Timothy Hamilton

    Fantastic article Matt. Another thing to consider is thoroughly tracking and documenting your cash flow from your properties in those months before you go for the refi. The more documentation, the better your case will be with the bank/lender and appraiser.

  5. Kyle Davis

    Hey Matt! This post is really intriguing to me as I’m both a real estate appraiser and a real estate investor. A few things I would clarify in the article to speak to a wider range of prospective fellow investors: 1) Regarding the Income Approach. In many markets (but not all!) using the income approach would be terrible. As a real estate appraiser, one of our very first jobs is to determine the “Highest And Best Use” of a property. If the value is higher as an “owner occupied” property vs. a rental, that is what any good appraiser is going to appraise it as. In my market, I own several SFR properties that are worth substantially higher as a owner-occupied property vs. a “rental” property and as such the market approach is worth higher than the income approach. (Please note, this is my market, and not all).

    2nd) Regarding the construction costs: Again, in my market, cost does not equal value. And HGTV programs are not helping some people in my area wrap their brains around that fact as countless TV shows have the investor say “We’re going to spend $10,000 on this bathroom remodel and it will increase the overall value by $15,000!” I hear it all the time. They are hoping that since they spent “x” amount of dollars it should increase the value by at least the same “x” value. And I have to break the bad news to them that in our market, your cost to improve something does not increase the overall value by the same amount. So I would caution people to ask around with other real estate professionals in your market area first before you start demolition on your kitchen. As I say to many people that break out their construction costs, “It doesn’t matter if you spent $1 or $1,000,000 on your improvements, it is only worth what somebody is willing to pay for it.” That being said, it is helpful from an appraisal perspective to get a grasp for all the work done.

    3) Being present at the appraisal inspection. I couldn’t agree more. Giving the appraiser the overall scope of the project is very helpful, and being available to answer questions right away helps expedite the process. I would only advise to not be too “pushy” with the appraiser. They have the right to decline appraising any property if they feel undo pressure from anyone. Now that has only happened to me once in my 10 years of appraising, but that one time came from a real estate investor that constantly pushed his idea of value, how his life would be ruined if it didn’t sell and how that would be on my hands! So be polite, feel free to give your best “pitch” and be honest and truthful about everything!

    • Matt Faircloth

      Hey Kyle,
      Good point on the income approach. I would agree that it won’t work as well in B or A class areas where there are many home sales to end buyers / home owners. The market approach would work better in those areas. In C class areas with higher cash flow due to lower sell prices it will be harder to find the right market comps because there aren’t that many purchases by homeowners.

      I document construction costs can be deceptive. A 50k kitchen up grade will not add 50k in most areas. I think that HGTV has ruined society’s perception of real estate forever, LOL!

      Glad to get an appraiser’s input! Thanks for jumping in!
      Matt

  6. Jimmy Davis

    Matt, once again another great informative post & awesome video. Thanks.

    The most difficult phase for us has always been the refinance phase and more specifically in qualifying for the refinance due to our dti (debt-to-income) after quitting my day job to become a full time investor & real estate agent. However 2016 is going to be the year that I am not going to write off ALL of my expenses and pay the IRS (way too much) so my dti will be inline with the lender’s cash out refi qualifications…

    Do you (or anyone else for that matter) have any advice, or a general rule of thumb on dti and/or tax structures for a successful cash out refi on an investment property for small business owners??

    • Matt Faircloth

      Hey Jimmy,
      I’m glad you brought this up. It’s always a balancing act in showing enough income on a tax return to get a loan but not so much that you get hammered with high taxes. I can’t tell you the exact DTI to aim for but I can say that the banks I work with do understand this business and know to add back things like depreciation to show a higher income. I would speak to your CPA about it, and make sure your CPA has done tax returns for successful real estate investors like yourself!
      Matt

  7. Connie Keslar

    Matt,
    Thank you for sharing your knowledge! I am a new investor and trying to learn about the BRRRRR strategy. I am still in the rehab process which is being managed by my partner. Your video was very helpful and the comments as well. I am trying to be proactive so that I can make this a successful cash out refi!

    Our contractor gave us a lump price for a list of items.
    Now that I know it will be helpful to have these itemized I can walk through the list with him and get the list as itemized as I can. I am dealing with a contractor that doesn’t even have an email address so I am certain he does not have an official invoice that he gives his customers. lol

    Connie

    • Matt Faircloth

      Hey Connie,
      You are welcome, and thanks for the comment. I am not surprised that your contractor does not have a price breakdown of the work, or an email address for that matter. Some of them are behind the times lol. You should be able to get him to help you out by breaking the job down into hypothetical prices for each phase of the project even if he gives you the numbers and you type it up. It’s just more detail for your bank to show them that you made major investments into the property.
      Another tip I forgot in the video / write up – take some before and after pictures and give those to your lender also. Those pictures tell a good story also.
      Good luck!
      Matt

    • Matt Faircloth

      Hey Joshua,
      Get a new bank! There are others that will play ball and make sure that you propose the income approach as a second means to determine value, along with the market approach. Also make sure you are prepared to challenge the market appraisal if they try and compare you to short sales and distressed properties.
      Matt

  8. John Murray

    I manage and leverage $3M in SFH and do exactly like you suggest. Not the construction cost bullet point because I do my own work. It is about $100 per day on renovation and this holds true for my 8 complete projects. 90 Day is $9K, 60 day is $6K and so on. Rent profit return is at least 10% of my initial investment in the first year and refinance to clear $50K. When you get BRRR wired I think it is the best way to wealth building.

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