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.
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.
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!