In all our BRRR examples, we will make the numbers easy. The example is a house that you purchase for $50k, rehab for $20k, has an after-repair value of 100k, and will rent for $1k/month. Once it is rehabbed and rented you will refinance with a traditional lender (to pay off the hard money lender and potentially recoup some of your costs).
One quick reminder: I'm sharing models and systems that have worked for me. They may work for you as well, but you should take the time to understand your own comfort level when it comes to your investments. I'll share that things could have impacts on tax or legal work (or that they did for me), but I'm not an accountant or an attorney - and sharing an idea or telling you about my experience shouldn't be taken as legal or tax advice.
A BRRR deal can go sideways and cause you to leak money in a handful of ways. Here are a few things that could turn your BRRR deal into a leaky BRRR.
- Your numbers were off on value, and the lender can’t do 100% leaving you to cover some of the loan. Don’t expect the hard money lender to give you the 70% ARV and just assume you’ll make up the difference by lowering the rehab budget. The ARV is typically dependent on you doing all of the work that is in your rehab budget. Think it from their perspective. If you don’t complete a full rehab, it’s fair to expect that the value of the property goes down.
- You cannot find a property that works for BRRR but you want to try anyway. The numbers unfortunately don’t change much. In some markets you won’t find these deals easily. Finding deals is a topic for a future post - check back here soon.
- Lender fees snuck in and your three to five points has become a lot more than that. One lender insisted on an expensive termite inspection for a property in Minnesota. Some lenders have legal fees which require you to set up an LLC for that transaction. These fees can cut into your loan and cause you leak money.
- Your lender doesn’t allow for any costs outside of purchase and rehab to be rolled into the loan. Some lenders will allow you to finance the closing costs. And if a property has back taxes, these can be rolled into loans with some lenders. But some won't, leaving you to cover these with cash at closing.
- You picked a lender that will lend 70% of the ARV but only a percent - let’s say 90% - of the cost. Terms like that you could help you lower the points or the interest rate, which seem like a win. This kind of a loan structure could work well for an investor who is flipping (buying, rehabbing, and selling) because they would see lowered carrying costs and get that money back when the property sells. But for investors looking to acquire rentals, terms like 85% LTC (loan-to-cost) means you’re putting in your own money and not getting it back at the end.
- You went over budget with the rehab, either by bad estimates or over-rehabilitating the property. Knowing how to keep contractors working within a budget is important and a key to keep you from having a leaky BRRR.
- The appraisal value went down during the rehab period. In volatile markets you can expect values to change over the course of a few months. It is one of the reasons that you should complete rehab and start the refinance quickly.
- Your hard money lender asked you to purchase the property in an LLC and your lender can only rehab into a personal loan. Depending on your comfort (talk with your attorney and accountant), this can be an easy solution. Your lender may be willing to allow your LLC to quit claim the deed into your name (hold it personally).
- Your refinance lender requires seasoning. What is seasoning? Lenders often require you to own the property for a certain amount of time before refinancing. Typical seasoning periods are six months and up to one year. Seasoning is poisonous to a good BRRR deal so make sure you check your lender before launching into the deal.
- Some lenders will require a certain rental period before they count this as income. The worst scenario - a lender that will only document income if it appears on your tax return. Not all lenders will have this long of a requirement, but some may require some period (1-2 months) of you receiving rental income (usually deposited rent checks). Be mindful of this before you begin.
- Your refinance lender is taking forever. Once you’ve found a lender that will refinance your rental, you’re not out of the woods yet. Adding a month of holding costs, or worse, needing to refinance your hard money loan can cost you thousands. Unfortunately, as an investor your loan is going to seem less urgent to a mortgage broker, especially during busy periods where the broker is rushing to help owner-occupants get into new homes.
- You’re close on income, but a little shy. This could happen if your personal income situation changes - a likelihood if you are purchasing more than one property at a time or if you’re needing to accumulate other debt (ex. credit card debt) to help finish your rehab costs. Here are some ways that could happen: your quick analyses on rental income missed key factors, like taxes or high insurance.
Next up! How to make sure your BRRR deal doesn’t spring a leak….