I began discussing the BRRR approach to acquire investment property in general terms in a recent post. In that post I described an interplay between the buy, rehab, rent and refinance and how each aspect can effect how other aspects of the plan perform and overall determine the outcome of a given BRRR cycle. In this article I will take a closer look at the final piece of the puzzle, the refinance step and how the steps before help shape the refinance effort.
A typical refinance in order to cash out equity gained over a period of time will involve either a new mortgage or an equity line of credit. Either option allows for the availability of liquid assets that you can use to finance that next investment property. Keep in mind that typically the equity is built over time and is shaped by a decrease in principle owed on the property, (you have paid down the debt of the purchase price) and hopefully an increase in market value over time, (your investment is worth more than the purchase price). Lets look at some of the effects each of the BRR steps will have on this crucial refinance:
Aspects Of The Buy That Will Effect The Refinance
Purchase Price— This is without a doubt the single most influential aspect of the future refinance. Simply, if you purchase above the market value at the time of sale, it will take longer to recoup the equity needed during the refinance. Its a double edged issue; it will take longer to pay down the principal and it will take longer for the market to grow past the purchase price. This can add years to the point of being able to refinance. Keep that in mind when a realtor attempts to convince you the property is still a good buy at $15,000.00 over fair market value, (I will get into what is fair market value in a future post).
Debt terms— Almost all investment property is purchased using a mortgage lender and the terms of the mortgage will affect future refinance plans. The less debt you roll into the mortgage the less you will need to pay in debt service and the quicker your principal will be paid off. Keep in mind a no money down approach assumes that you will have mortgaged 100% of the investment, which will take longer to pay down then financing 80%. The interest rate on the loan is an important factor as well. You will not have much say in a given lenders interest rate but shop around and you may be able to shave a few points off of the overall finance of the investment property.
Current Market Status— When you buy can also dictate future refinance outcome. Buy low and sell/refinance high sounds easy but timing issues invariably get in the way. What if your all set to buy but the market is at a historic high. The other side is that you are not liquid (no cash on hand) and the market has hit rock bottom. There are no easy answers to how to ride the real estate market trends. Sitting on a good amount of cash reserve or even selling an investment property when you note the sale would net you double the purchase price might be the best case scenarios, but it does set you slightly off course in the BRRR model. Just remember what goes up must come down and market corrections in the positive after a ‘meaningful downturn’ can take a decade…
Market Area—Future value of a given property has a lot to do with its location. Some geographic areas or locations within a given state are simply more desirable than others. This fact means the properties in desired areas will hold there values and usually increase in value quicker, compared to ‘softer’ market areas. Equity build up in sought after markets is a good reason to invest a little more capital on investment properties in these prime real estate market areas. That is not to say that investing in a non-hot market area is a bad idea. Sale prices are typically much lower, renters are still interested in renting in these areas and an upmarket will still mean these properties will increase in value.
It is beyond obvious that the way we buy will have a great impact on the outcome of a future refinance. The above are just a few examples to illustrate the point that the BRRR model is not as simple or straight forward as it first appears. I will devote part 2 of this discussion on the other aspect of the BRRR, (rehab and renting) and how these factors also influence the refinance plans down the road.