These simple examples show you the power of leverage in real estate investing.
Real estate investors know they need loans to buy properties. But few real estate beginners understand exactly how big of a difference leverage makes.
Leverage turns property-buying into a real estate investment career. It builds real money, and a portfolio of net worth that can create generational wealth.
In this article, we’ll use simple examples to break down the power of leverage in real estate – and how maximizing leverage skyrockets your real estate career.
What Is Leverage?
In short, leverage means buying with money that isn’t yours in order to make a profit.
Leverage takes the form of loans from lenders: banks, credit unions, hard money lenders, people you know.
The greatest tool for a real estate investor is leverage.
How to Find the Power of Leverage
Let’s look at some simple numbers to show the power of leverage.
We’ll look for two things:
1) How much income can you get from a rental?
2) How much equity will a property generate over time?
Note: We’re going to use $100,000 as our base number. That might be a lot more money than you have to start with. It’s also likely a lot less money than you’ll spend for your properties.
Regardless, it’s a simple number to show the power of leverage. These same principles will apply despite your starting number or your property costs.
Now, let’s dive in.
Income without Leverage vs with Leverage
Rent is the income you get from tenants. Net rent is that income after you’ve made any loan payments for the month on that property.
Net rent is the number that’s true cash flow for you. We’ll use this number to analyze real estate income with and without the power of leverage.
Income No Leverage
Say you have $100,000 to invest in real estate.
You could take this money and buy one rental property valued at $100,000. You can invest the full $100,000 and receive $1,200 of net rent income per month, or $14,400 per year.
Income With Leverage
Now let’s see how it plays out when you involve a lender rather than buying outright.
You could talk to a lender who might offer to loan you $75,000 if you put in the other $25,000. Now, instead of pouring all of your money into one rental property, you’ll only have to use $25,000. The $75,000 covered by the lender is considered leverage.
Using lenders like this, you could buy four properties, each with a $25,000 down payment. Because you’re paying a mortgage, however, your net rent per month goes down. Your net rent is now $750 per property. This brings in $3,000 per month, or $36,000 per year.
With leverage, you have the potential to make $1,800 per month more, or an additional $21,600 per year – just from using leverage.
Net Worth without Leverage vs with Leverage
Rent income isn’t the only financial outcome of buying and renting real estate. There’s also appreciation.
According to the stats over the last 20 years, real estate goes up an average of 5.3% per year. Using this 5.3% number, one home increases value by an average of $5,000 per year.
This isn’t a straight line (ie, exactly $5,000 per year). Some years may appreciate more, some less. But over the long-term, that’s the average yearly appreciation, so we’ll use this number.
Net Worth No Leverage
Let’s see how appreciation would impact our real estate portfolio had we bought the one home outright, with no leverage.
Our single rental would have $5,000 in equity after one year, $25,000 after five years, and $150,000 after 30 years.
Net Worth with Leverage
Now let’s see the equity of the four properties purchased with leverage.
Each of the four homes increases in value by $5,000 every year. Multiply that by four, and your portfolio appreciates $20,000 per year.
Over a 30-year span, your four properties would add $650,000 to your net worth (compared to $150,000 with the single property).
Total Power of Leverage
Let’s put all these numbers together now.
Using leverage brought in an extra $21,600 of income per year, plus a total net worth increase of $600,000 over 30 years.
This is the power of leverage: bringing in extra income and raising your net worth through equity.
By using other people’s money, you can take advantage of the true wealth in real estate.
Now, we’ll take this example one step further. Simply using leverage unlocks a lot of money. What happens when you maximize leverage?
We looked at an example of a lender giving you 75% ($75,000 on a $100,000 property). “Maximizing” that leverage would look like getting a bigger loan. Instead of 75%, another lender might give you 80-85%.
Let’s go back to the original example, but say a bank gives you 5% more. Now, you get $80,000 per $100,000 transaction.
Income with Maximized Leverage
Your down payment per property is now only $20,000, so you can buy 5 properties. But since you borrowed more money, the mortgage payment is higher, and the net rent goes down.
At this point, it may seem like you’re set up to make less money since you’re paying more on your loan. But let’s see how it plays out.
Five properties with an income of $700 per month is $3,500 per month. This works out to be $42,000 per year. Annually, that’s $6,000 more than using a 75% loan, and $27,600 more than using no leverage at all.
Equity with Maximized Leverage
For five properties, after 30 years, equity appreciates by $750,000. All that money is added to your net worth.
Maximizing your leverage in this scenario would give you $42,000 in yearly income, plus $750,000 added to the value of your properties over time.
That’s the road to generational wealth.
How to Maximize Leverage
To maximize your leverage, focus on becoming the sort of investor that attracts lenders.
Having all the right pieces in place will help your leverage take you further. The more leverage you use, the better returns you’ll see – both in the short-term income and long-term equity.
Harnessing the Power of Leverage
Now you can see how leverage impacts your real estate career.
What are your next steps?
If you need an entry point into real estate investment, email Mike@HardMoneyMike.com. Ask about our 30-day fuel up challenge to learn how to maximize your leverage.
You can also join our weekly Leverage Up chat, on Thursdays from 1:15pm – 2:15pm MST at this link.
https://hardmoneymike.com/wp-content/uploads/2022/09/Sept-22-Leverage-Up-YT-Thumbnail.png7201280Jenna Weldonhttps://hardmoneymike.com/wp-content/uploads/2019/06/hard-money-mike-logo.pngJenna Weldon2022-09-22 16:35:432022-09-22 16:35:43The Power of Leverage: Are You Losing Money?
For a successful investment career, start with these 7 real estate loan fundamentals.
Are you “money wise”? It’s not hard to get there. And it will save you a lot of cash down the line.
It’s like when a person who knows about cars goes to a mechanic – they have peace of mind because they understand what’s going on. If you’re not a “car person,” at the mechanic’s it’s harder to figure out if they’re telling you the truth, or just trying to sell you more than you need.
As a real estate investor, leverage is at the center of what you do. It’s like a foreign language when you first start out. But when you become money wise, the leverage in your real estate investment career is fully in your hands.
Here are 7 real estate loan fundamentals that will make you money wise.
Fundamentals of a Real Estate Deal
There’s certain information you’ll need to bring to your lender when you need a loan. If you know the answers to their questions, the time with your lender will be much more productive.
At the end of the day, lenders want to know: Do you have a good deal? (And you should want to know the answer, too!)
We’re going to dive into 7 main concepts to answer that question:
Purchase Price / Contract
Scope of Work
Estimated Profit / Equity
Comps / ARV
1. Strategy – What Is a Real Estate Strategy?
When your lender asks about your strategy, they want to know whether you’ll use the property as a
or if you’re not sure yet.
What is a real estate strategy dependent on? 1) your goals, and 2) the property.
You’ll have to know the numbers to know if the property will make a good flip with carry costs you can afford, or if it would cash flow well as a BRRRR-style rental.
But how do you “know the numbers”? Let’s start with the cost of the property.
2. Purchase Price / Contract – What Are the Fundamental Numbers of a Real Estate Loan?
Your lender could refer to this as purchase price, contract, or as-is value.
In real estate investment, there’s a distinction between what you’re paying for a property and what it’s worth. The purchase price isn’t necessarily what the value of the home is.
This is the number on the contract, the number you’ve agreed to buy the property for. And this number is foundational to whether or not your project will turn a profit.
3. Scope of Work – How Do You Fix Up a Real Estate Investment?
Many beginner investors mistake “scope of work” for the budget. Scope of work is what you’re going to do to the property, not the number of what that work will cost.
Will you add a bedroom? Re-do the garage? Are you going to convert the porch to additional square footage? Or add egress windows to the basement?
Scope of work is your rehab plan. Lenders need this info to find out what kinds of properties they should compare to yours to estimate an after repair value.
4. Budget – What Is a Real Estate Budget?
During the conversation with your lender, have a high overview of your construction budget. You don’t necessarily need all the details ironed out quite yet.
For example, you can estimate that the kitchen will cost $10,000, siding $6,000, windows $4,000, and new paint $2,000. At this point, you don’t need to share a breakdown of the cost of each new appliance, labor and materials, etc.
You just need a realistic estimate of how much it will cost to get into the property. Having your scope of work lined out helps you with an estimated budget. When you know the purchase price an your budget, then you know how much the entire project will cost.
5. Estimated Profit (Flips) / Estimated Equity (Rentals) – How Much Will a Deal Make?
Estimated profit is what you expect to make on the transaction, between buying the property, fixing it up, and selling it again.
Equity is the difference between the amount you owe and what the property is worth. You build equity on your rentals by successfully refinancing after a flip and paying down the mortgage with rent income.
The number one reason to be in real estate investment is to make money and create wealth – it’s true for lenders, and it’s true for you. So, it’s important to both you and your lender that your properties make profit or build equity.
You’ll need your estimated profit / equity when you bring a deal to your lender.
6. Comps / ARV – What Does ARV Mean in Real Estate Investing?
ARV is the after repair value. It’s what the property will appraise for, or sell for, on the current market once the scope of work is completed.
You estimate a property’s ARV by looking at the prices of similar homes in the current market.
Comps (comparables) are those similar homes you look at. It’s important that your comps have the same value as your property.
For example, if your deal is for a 950 square-foot home, you’ll compare it to other 900 to 1,000 square-foot homes on the market, not a 2,000 square-foot one. A 2-bedroom, 1-bath house will be compared to houses of the same specifications, and not compared with 4-bedroom, 2-bath homes.
For your ARV to be accurate, you need to stay true to your scope of work. If you only repaint and re-carpet a house that needed much more work, you won’t get top-of-the-market value when you try to sell or refinance.
On the other hand, if your scope of work is a full remodel, your comparables should be homes that are fully remodeled, so you don’t miss out on any profit.
The money you put into fixing up a house isn’t a direct indicator of how much the house will be worth. What the property looks like when it’s finished has nothing to do with how much it cost to get it there.
To find the true profitability of a deal, your ARV and comparables help:
ARV – (Purchase Price + Budget) = Profit Amount
7. Exit Strategy – How Will You Pay Your Real Estate Loans?
When a lender asks for your exit strategy, they want to know your plan for paying off the loan. For hard money loans, your exit should be fast.
If it’s a flip, your exit strategy is to sell the property, then pay off the loan.
If it’s a rental, your exit strategy is to refinance into a long-term loan, which will pay off the hard money loan.
The Why Behind Money Wise – Real Estate Investing Definitions
When you come to the table prepared, with strategies, numbers, and knowledge, you can speak the same language as your lender.
This is key to ensuring you have a safe transaction with a lender that is working in your best interest.
Curious About Other Real Estate Loan Fundamentals?
If you have any questions, or want coaching through a deal, we’re happy to help. Reach out at HardMoneyMike.com.
For more info on real estate loan fundamentals, keep up with our Hard Money 101 series on our blog, or visit our YouTube channel here.
https://hardmoneymike.com/wp-content/uploads/2022/09/Sept-22-Money-Wise-Blog-Thumbnail.png6001800Jenna Weldonhttps://hardmoneymike.com/wp-content/uploads/2019/06/hard-money-mike-logo.pngJenna Weldon2022-09-20 08:00:242022-09-15 10:43:097 Real Estate Loan Fundamentals – Hard Money 101
As a real estate investor, if a property costs $100,000 as it sits, you know you’re going to put work into it and make it worth more. But that as-is value, the $100,000, is what lenders base their loan amount on.
Know the Basics: After Repair Value
After Repair Value (ARV) is used more by hard money lenders and the real estate investment world. Banks and traditional lenders more often use LTV.
Because in real estate investing, we’re basing our numbers on what you can do to the property. What can the value be once you fix it up? That’s the number that determines profit, so that number is more important for hard money lenders.
ARV is the target value of what the house will be worth after all your renovations. This ARV should always be higher than the current price of the house when you buy it.
Calculating ARV and LTV
Let’s say you found an undermarket property that’s selling for $100,000. If a lender says, “We’ll loan you 75%,” that could mean two things, and you’ll want to know the difference.
First, if they’re a bank, they’re likely talking about 75% of the value. In this example, that would be:
$100,000 × 75% = $75,000 loan
Hard money lenders will care more about the value of the home after repairs, so they go off ARV. If they loan you 75%, that would be:
$150,000 × 75% = $112,500 loan
If a loan is based on ARV, lenders might want to know – what are you doing to the property? Different renovations will affect the value of the property in different ways. What you will do and the quality of the work will affect the ARV.
Know the basics about LTV and ARV, and your hard money experience will be much smoother.
Hard Money Loan Requirements
What are the requirements for a hard money loan?
What will hard money lenders lend you, and what does it take to get it? Knowing these numbers in advance will help you stay on track to getting profitable deals.
The majority of hard money lenders will lend up to 75% of the ARV.
So, let’s say a property will be worth $100,000 after all repairs, and a lender offers you 75% of that ARV. You’ll receive a loan for $75,000.
Is that enough? Now it’s up to you to crunch the numbers and see if you meet these hard money loan requirements. Will that $75,000 cover everything – the purchase, the rehab, etc.? And if it doesn’t – how much do you need to bring in? Can you make that work?
What Expenses Does a Hard Money Loan Cover?
A hard money loan covers:
The purchase of a property.
The rehab of that property.
100% financing is possible with a hard money loan, but it’s dependent on a lot of things – your credit score, investing experience, relationship with the lender, and more.
Let’s see an example of how the numbers on that $75,000 loan could work out to cover the flip 100%:
Purchase Price: $50,000
If it’s possible to keep rehab costs at $25,000, you could get this $50,000 property 100% financed by a hard money loan, if the ARV is $100,000.
But let’s say rehab ends up costing $35,000. The total cost of the project would be $85,000, but your loan only covers $75,000. You’d have to come up with that extra $10,000 somewhere else – either from an alternative lender or from your own pocket.
Know the numbers to help you plan ahead with your hard money loan. If you know up-front that rehab will cost $35,000 on this property, you’ll know to only go through with the deal if you’re able to bring in that additional $10,000.
The 75% Rule Hard Money Loan Requirement
You can learn ahead of time whether your project can be 100% covered by a hard money loan. Just follow the 75% rule: make sure the costs of your project are under 75% of the property’s ARV.
Hard Money Loans Calculations
We’ve gone over some of the basics, but there are a few more hard money loans calculations to know.
Hard money lenders – especially national lenders – have two important numbers they go by.
First, 75% of the ARV is the maximum they’ll lend you.
Second is a more specific breakdown of how that money will be used, usually referred to as 90/100 or 80/100.
Know the Numbers: What Is the 90/100 Number in a Hard Money Loan?
This number is usually around 90/100, but lenders can tighten down to 80/100 or lower. But what does this number mean?
The first number is the percentage of the loan that goes toward the purchase. The second number is the percentage that goes toward rehab. The higher the numbers, the less of your own money you have to put down.
In the case of 90/100, that means your loan will cover 90% of the purchase and 100% of the rehab.
But whatever that calculation is, it still has to be less than 75% of the ARV. Here’s an example
90/100 Calculation Example
Let’s use the numbers from our last example to look at a 90/100 loan. We’ll take 90% of the purchase price.
Purchase Price: $50,000
50,000 × 90% = $45,000
So, $45,000 of your loan must go toward the purchase of the property. But since it costs $50,000 total, you’d have to bring in the additional $5,000.
25,000 × 100% = $25,000
So, $25,000 of the loan will go toward rehab. That covers all of it, so you wouldn’t need to put any of your own cash into repairs.
So what would this 90/100 loan cover total?
$45,000 + $25,000 = $70,000
90/100 vs 75% Rule
But wait, that 90/100 loan example only gave you $70,000. The 75% rule on the same property said you could get a $75,000 loan. So which is it?
The 75% rule (hard money lenders loaning 75% of the ARV of a property) isn’t a guaranteed loan amount. It’s the maximum loan amount.
This maximum rule becomes more relevant as the deals get riskier.
Lenders don’t like risky deals because there’s a good chance you’ll lose money or only breakeven.
Here’s how our previous example could become much riskier and the 75% rule would become more important:
Let’s say we have that same property with an ARV of $100,000. But this time, the purchase price is bigger.
Purchase Price: $60,000
Now, let’s apply the 90/100 principle:
60,000 × 90% = $54,000 loan for purchase
25,000 × 100% = $25,000 loan for rehab
Total loan amount = $79,000
So if a loan covered 90% of this purchase price plus all of the repair costs, the total loan would need to be $79,000.
But the 75% rule says your max loan for this property with a $100,000 ARV can only be $75,000. So, in this case, you’d get the loan for $75,000, and be stuck bringing in that extra $4,000 the loan didn’t cover.
Why the 75% Rule?
The 75% rule protects you from the other costs from your project. You’ll still have to pay for selling costs, overhead, and loan fees. Yet you’ll still want at least 10% – 15% profit.
If your loan by itself is any more than 75% of your ARV, you’d be set up to make little to no money.
Lenders want to stop you before you get started if they can see there’s a good chance you won’t make a profit. They want to encourage good deals, and discourage deals people won’t be able to follow through on.
The bottom line: remember there are two numbers. The 75% rule is the maximum amount they’ll lend you overall. The 90/100 (or 80/100, etc) tells you the amount of the loan they’ll allocate to purchase and rehab.
What If I’m Still Confused?
These hard money calculations, numbers, and requirements can be overwhelming if you’re not used to them. Luckily, you don’t have to memorize all this stuff right off the bat.
Download our deal analyzer here. With this spreadsheet, all you have to do is enter the numbers. It does the math for you to help you decide whether to pursue your deal, and how much money you’ll have to bring in if you do.
A tool like this can help you know the numbers before you go to your hard money lender. Life is easier for everyone, and more profitable for you, when you know the numbers of a hard money loan.
Calculating Hard Money Loans for BRRRR
If you’re looking at the rental side of real estate investing with BRRRR, what are the numbers you need for a hard money loan? What do you look for in a profitable flip?
BRRRR was designed to let investors get into rental flips with almost no money down. How do you do it? The 75% rule.
What does that mean, and how do we calculate it?
With BRRRR, there’s two loans involved. The first (hard money) loan is to purchase and fix up the property. And the second (bank) loan is to refinance for the long term.
To make the BRRRR process happen with no money down, you have to know ahead of time that you can keep costs under 75% of the ARV.
The Math on a BRRRR Hard Money Loan Using the 75% Rule
75% of what your property will be worth (ARV) is your cap for costs.
Let’s say you’re buying a property, and based on the neighborhood, comps, and all other appraisal considerations, the ARV is $200,000.
Using the 75% rule would give us:
200,000 × 75% = $150,000
Your hard money loan could be up to $150,000. This means if all your costs for the project stay under $150,000, you don’t have to bring any money in.
With this example, it would be doable:
Purchase Price: $125,000
Total cost: $150,000
If you could keep rehab costs at $25,000 for the project, all costs would be equal to the 75% ($150,000) loan we’d receive.
If we take the same example, but the purchase price was $140,000 with $25,000 of rehab costs, you’d end up putting in $15,000 of your own money. Still doable, but more expensive.
100% BRRRR Financing in the Future
As the economy turns and we begin to see more foreclosures, BRRRRs will be a great opportunity to build up a bigger real estate portfolio with no money down.
The opportunities are out there, but to do it, your costs have to be at 75% or lower. This number might tighten in the near future to 70%, but all the same rules still apply.
If you know your numbers before you buy, you can use a BRRRR hard money loan to your full advantage with zero money down.
Hard Money Calculator
A hard money calculator is another important tool to help investors know the numbers of a hard money loan.
Beginner and experienced investors alike need to know the difference between loans offered by different hard money lenders.
How Does a Hard Money Calculator Work?
Some lenders will charge higher interest rates with no points. Some will charge higher points, which are percentage points taken out for fees, but have a lower interest rate.
The numbers get complicated fast. How can you compare all this for your specific deal?
The best way to figure out these numbers is to use our loan optimizer, with a free download here.
It’s a simple way to compare lenders in your area and find the best price.
Example of a Hard Money Loan Calculator
Finding the cheapest loan for your deal can save you thousands of dollars on your project.
(Note: It’s good to shop around to find the best numbers, but don’t shop around forever! Or else you’ll never get to know a lender well enough to get preferential treatment.)
Here’s a walkthrough of how a loan optimizer might compare two lenders:
Let’s say for a potential deal, you need a loan for $150,000. Both lenders we’re comparing are going to give you that full amount:
Interest Rates, Points, and Their Costs
But let’s say Lender A and Lender B have different rates (interest rate) and points (percentage taken out for fees).
Many beginner investors look at this and think, “Well, I don’t want a lender with so many points. I don’t want to just be paying fees.” But they fail to actually do the calculations. You’ll be surprised which loan will save you the most money.
A loan optimizer will calculate the cost based on these rates and points:
As we can see, the daily interest combined with the cost of the points makes Lender B look like the cheaper option so far.
But there’s one more crucial cost we still need to take into consideration.
Often, lenders who charge zero points up-front end up charging a lot of “junk fees” later. Here’s the example of Lender A and Lender B with all the extra fees highlighted:
The various fees charged by Lender B add up quickly, making Lender A suddenly look a lot better.
But let’s check with a final calculation which lender would be the cheaper choice:
Here’s our final calculation by our loan optimizer. By the end of the six months, we’d be paying $12,352 to Lender A, or $13,408 to Lender B.
So, Lender A, who had more points up-front, is the cheaper option – by over a thousand dollars!
Yet, if we’d judged these lenders based on our first impression of interest rate and points, we might not have gone with Lender A.
Some people just win at the BRRRR method. How can beginners do it?
Cash-flowing rental properties… With little-to-no money down… That passively run themselves after fix-up… This is the stuff beginner real estate investors dream about. And it’s possible with BRRRR.
But there are a lot of ways to do BRRRR wrong that’ll wreck this beautiful dream.
How do successful investors make it work? Here are 5 ways beginners can win at BRRRR:
1. Understand the Meaning of BRRRR
BRRRR winners understand what BRRRR is – and just as importantly – what it’s not.
We aren’t just talking about the literal meaning: Buy, Rehab, Rent, Refinance, Repeat. We’re talking about understanding the strategy behind the BRRRR method. Successful investors understand the money side of these investments.
Types of Properties that Win at BRRRR
Foundationally, BRRRR means buying undervalued properties.
These properties have a lot of rehab needed, causing them to be valued much lower than other homes in the area. These houses are problems for someone else but opportunities for you. You can fix them up and get them in your rental pool.
We often see people who want to use the BRRRR strategy, but they buy their properties at 90% or 95% of the ARV. They buy close to retail price, and once they put the time, money, and effort into fixing up the property… They can’t even really use BRRRR.
BRRRR’s Two-Loan Strategy
BRRRR means using a two-loan strategy. At the beginning of the project, closing with a hard money bridge loan. At the end of the project, refinancing a traditional loan.
Using this strategy on an undermarket purchase captures the equity of the home to use to your advantage. If you buy a property too close to its ARV, the whole system falls apart and you lose your refinancing power.
To be successful with this two-loan plan, you have to search for undermarket properties you can get for 75% or less of the ARV. With this 75% rule, you can complete a BRRRR project with little or no money out-of-pocket.
Buying undermarket and using two strategic loans is the meaning behind BRRRR that winners fully grasp. But there’s much more to it.
What should you really look for when you buy for BRRRR?
2. Set Yourself Up for the BRRRR Method
There are two ways beginners can set themselves up for success using the BRRRR method: focusing on the numbers and putting together a team.
Numbers for Beginners
The BRRRR method is all about numbers. Beginners sometimes fail because they make a deal emotional and bid the property up. When buying properties, you have to stick to the math.
Your North Star for BRRRR investments is the 75% rule – the best properties only cost 75% of the after repair value.
The reason for the 75% rule is because that’s the number banks will rate-and-term refinance a conventional loan for. When you can do this type of refinance, you can finish up the deal without putting any of your own money in.
It’s smart to shop around for banks for your refinance loan, though. Some banks may allow you to buy up to 85% of the ARV, under certain conditions.
Get a Team Together
So you need good, low-priced properties. And the best way to find them is to build a good team. Especially as a beginner, you’ll need to know several of these kinds of people:
Realtors and Wholesalers
Knowing wholesalers and realtors can help you locate better properties and close with better deals.
You’ll need private lenders for bridge loans and another lender for the long-term refinanced loan. Having relationships with lenders ahead of time speeds up a closing and can earn you a lower price.
Ideally, from closing to refinance, BRRRRs are completed in 90 days. This means you’ll need contractors at-the-ready who can work efficiently and reliably to fix up your properties.
If you want your BRRRRs to be passive after the refinance, find a good property manager. A common beginner’s mistake is to take the first tenant who shows an interest – without any background checks or other renting requirements.
A good property manager can both find you better tenants and manage them for you. Many investors overlook this member of their team, but it can truly make or break your BRRRR experience.
Knowing several people from each of these categories gives you options to customize for each of your deals. Putting together a good and broad team will make the BRRRR method much easier and smoother — especially for a beginner.
3. Know What Makes a Good BRRRR Property
A good BRRRR property follows the 75% rule. But that’s not the only criteria you should follow. What else makes a good BRRRR property?
What to Look for in a BRRRR Property
Here are the factors successful BRRRR investors consider in their properties.
For multi-family or commercial tenants, lenders have different requirements. They often need you to hold your loan for 12 months after purchase (or even 12 after tenants move in). That timeline doesn’t work well with the BRRRR method. You’ll have a much easier time with single-family homes.
“Knowing your numbers” also means knowing the rent prices in the area of a property. Cash won’t flow on your investment if you’re unable to charge enough rent.
Find properties people want to live in. If you wouldn’t want to spend time there, good renters probably won’t either.
If you’re doing vacation rentals, do the research on:
What areas people want to visit
What the rates are in the area
What third-party booking sites would be most profitable
What fix up levels you’ll need
Whether there are good hosts or property managers in the area.
Don’t Rush into Bad BRRRR Properties
Beginners fail at BRRRR when they don’t choose properties wisely. Don’t just buy property to buy property. You can own ten bad rentals and make no money. BRRRR should be a system that builds cash flow.
We see people do one or two BRRRRs then stop because it’s not what they expected. They put too much money in, or the area isn’t good, or their renters aren’t paying, or the rent isn’t enough to generate cash flow.
Those issues aren’t BRRRR’s fault. A prepared investor, beginner or experienced, can always succeed with BRRRR properties.
4. Know the Numbers of a BRRRR Deal – An Example
We always talk about “knowing your numbers.” But what exactly do we mean? Here’s an example of an ideal BRRRR property using the 75% rule.
Example Breakdown of a BRRRR Deal
After repair value (ARV) is the number the house should sell for once it’s all fixed up and on the market. This number is often dictated by what similar properties in the area are going for.
To get the best long-term rates, you refinance your second, permanent loan. In order for it to cover everything (i.e., you don’t have to put any money down), all your costs must be 75% or less of the ARV.
PURCHASE PRICE + REHAB + CARRY COSTS + LOAN CLOSING COSTS = 75% of ARV
Let’s say, for example, other properties in the area are selling for $200,000, so that’s your ARV. You want to spend 75% less than that, so we’ll do:
$200,000 X .75 = $150,000
When the ARV is $200,000, all costs of the job should only be $150,000 or less. This includes the closing price, carry costs, rehab costs, and any loan costs.
5. Know Good Lenders for BRRRR
People who win at BRRRR understand the two most important aspects of the process: getting properties undermarket, and organizing their lenders early on.
Lenders are an important member of your investment team. Here’s how to get them ready for your BRRRR investments.
BRRRR Lender Options
You’ll have a hard money or private money lender up-front. Then, in the second half of the project, you’ll have a more conventional lender with a traditional loan.
This traditional loan is usually 30-year with fixed rates, but comes with some constraints. You’re limited to ten properties with this kind of loan (including your own home). There’s also usually a limit on loan-to-value ratio, and conventional loans won’t let you put a loan in an LLC’s name.
Another option for this second loan is DSCR no-income loans. DSCR loans come in a variety of options: five- or seven-year ARMs, standard 30-year fixed mortgages, and more. Successful BRRRR investors know all their options for refinancing.
Set Your Lenders Up Ahead of Time
People who win at BRRRR set up all their lenders before they jump into a deal.
The amount loaned for the purchase and for rehab can very a lot from lender to lender. Good investors will always know how much their hard money lenders will give them.
Hard Money Mike, for example, does a lot of 100% loans if the cost is 75% less than ARV because we know the investor can easily refinance out. We know we can set them up with a rate-and-term refinance, and they’ll have no money out-of-pocket.
BRRRR winners don’t get into a property, get it fixed up, and then figure out the long-term loan. Winners figure out first whether they can get the cash out they need, and how.
Smart BRRRR investors have a pool of lenders they work with. They know what each lender can offer, and which will best fit their current strategy, ability, and deal.
You Can Win at BRRRR
Winners start as beginners.
This is a business. This is a way for you to make a living in real estate. Those who take the time to learn and get their team set up – those are the winners.
For help in setting up your team, going over your numbers, and getting your financing in order, reach out to us at HardMoneyMike.com.
What do hard money lenders look at? There are two main factors you need to know.
Becoming hard money proficient will put you miles ahead as an investor.
Before you run to any lender with a deal, you’ll need to know… How does a hard money loan work? There are two key terms you’ll need to understand: loan-to-value ratio and, more importantly for fix-and-flips, after repair value.
The first important number a lender takes into account is the cost of the property. The second is the amount of the loan. Loan-to-value ratio is the ratio of the loan and the cost.
Let’s say you have a property with a current appraisal of $200,000. Then you get a loan for $100,000. The loan is half of the value of the home, so your loan-to-value is 50%.
After Repair Value (ARV)
ARV, after repair value, is another important factor hard money lenders consider. The properties targeted by real estate investors are undervalued. They need repair-work done to be brought up to the standards of the surrounding community.
So, lenders look at not only the current value of the house, but also the future value of the house, after it’s all fixed up.
Many hard money loans are based on after repair value rather than loan-to-value. Your lender might offer you up to 75% – not of what you’re buying it for, but what you could sell it for by the end.
What Does A Hard Money Loan Using ARV Cover?
A key factor to ARV is that lenders will lend not only for the initial purchase, but for the fix-up costs too.
Many lenders will put money aside in escrows to use throughout the project to pay contractors and cover other renovation costs.
If your loan considers ARV, it’s possible for you, with ZERO money down, to:
Buy a property.
Fix it up.
Either sell it (fix-and-flip) or refinance it (BRRRR).
After selling or refinancing, you use that money to pay the loan back.
Hard money is designed to build value into real estate. Understanding the role of the after repair value will help you immensely in your hard money investments.
https://hardmoneymike.com/wp-content/uploads/2022/07/how-a-hard-money-loan-works.png6991048Jenna Weldonhttps://hardmoneymike.com/wp-content/uploads/2019/06/hard-money-mike-logo.pngJenna Weldon2022-07-21 10:48:252022-07-21 10:48:25How Does A Hard Money Loan Work?
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