Many new investors think the best way to begin developing a rental portfolio is to buy a rent ready property. It seems to make sense to avoid buying a distressed asset that would require work. You seemingly eliminate the extra expense of renovation and move right into a long-term, low-interest rate loan. Seems like immediate cash flow, right? Well, you may be missing some upside.
What if you could buy a property that needs work, use less money than a large down payment would require, and increase your equity position significantly without paying for rehab out of pocket? This “too good to be true” scenario is actually possible by utilizing a hard money loan within the BRRR (buy, renovate, rent, and refinance) strategy. Below we explore utilizing hard money within this methodology and how it helps investors.
Overall Process
Utilizing hard money for a rental property is a two-step process. The hard money loan provides capital to buy and renovate the property. Once complete, the investor simply refinances into a long-term loan in order to cash flow. It is important for any investor to have long-term financing lined up before starting a new project. The requirements are typically more arduous and delays in refinancing can be costly.
The Math
Now we can take a look at how utilizing hard money can actually help you minimize out of pocket expense and maximize ROI. We will work with the following assumptions:
Purchase Price – $50,000
Rehab Required – $25,000
After Repair Value (ARV) – $100,000
Lender financing up to 75% of ARV (Longhorn’s Guidelines for rental disposition)
In this example the borrower is financing 100% of cost. The hard money loan is providing capital for both the purchase price and renovation expense.
$50,000 + $25,000 = $75,000
$100,000 * .75 = $75,000 loan amount (100% of cost)
We typically assume about 6% for closing costs on any transaction, so the borrower would be bringing a minimal amount of money to close
$75,000 * .06 = $4,500 (total out of pocket)
In summary, the borrower is closing on a property with $4,500 out of pocket and will immediately benefit from a 25% equity position on the asset by using hard money and buying a distressed property. Take-out financing will typically roll in closing costs, so there may be a slight reduction in equity once refinanced. Buying a rent ready property may allow investors to avoid rehab, but can certainly cost them more in the end. Consider using a hard money loan for your next rental acquisition!
