With a house flip, calculating profits is fairly straightforward. Deduct your purchase, rehab, and associated holding costs from the net sales proceeds of the flip, and you have your profit. But how Do you Calculate the BRRR profits?Figuring out your profit of a BRRR project, gets a little trickier with a buy, renovate, rent, and refinance.
Instead of looking at a single number – as with a flip – calculating profit with a BRRR deal entails looking at a few different metrics, all of which we’ll discuss in detail in the following sections:
- BRRR deal overview
- Ways you make money in a BRRR deal
- Monthly cash flow
- Tax benefits
- Loan amortization
- Long-term appreciation
- Unrealized equity from renovation
- Closing thoughts
BRRR Deal Overview
What is BRRR in real estate investment? Unlike the short-term nature of a flip deal, BRRR projects have a longer investment horizon. Here are more information about BRRR vs Flip which one works better for you. Specifically, these deals break down into the following four parts:
Buy: Find and purchase an undervalued property, typically in need of improvements.
Renovate: While staying within the constraints of the BRRR budget, renovate the property (i.e. add value) to make it attractive to high-quality tenants.
Rent: Having added value to the property, find, screen, and place a high-quality, long-term tenant to cover the monthly expenses (e.g. mortgage/interest, insurance, property taxes, etc).
Refinance: With a tenant in place and property value increased due to the rehab, refinance the property to remove the original cash (and potentially more) that you put into the deal. This cash can then be used to repeat the process again and again.
Ways You Make Money in a BRRR Deal
As stated, investors need to take a more holistic approach to successfully analyze the BRRR profits. Each of the following metrics needs to be reviewed and cross-referenced against an investor’s unique preferences to determine the overall profitability of a deal:
- Monthly cash flow
- Tax benefits
- Loan amortization
- Long-term appreciation
- Unrealized earnings related to renovation
In other words, there’s no “magic number” in a BRRR deal. Rather, when calculating BRRR profits, investors look at each of the above as a piece to the broader puzzle of a deal’s inherent profitability.
For an investor seeking financial independence, monthly cash flow may take priority. On the other hand, for someone looking to build long-term wealth, projecting the 10-year appreciation of the property may be of more importance.
Monthly Cash Flow
This is a straightforward profitability metric to most investors. You simply take the cash coming in every month and deduct the cash going out to determine your monthly cash flow. For example, assume someone rents a single-family home, here’s how you can determine monthly cash flow:
- $1,500 – monthly rent
- ($1,200) – minus total of monthly expenses (loan principal/interest, property taxes, insurance, landscaping, etc)
- $300 – equals monthly cash flow
As a result of this basic math, an investor can plan for cash flow of $300/month from this property.
The tax benefits of a BRRR deal also need to be considered, and, while they relate to the above monthly cash flow considerations, there are some key differences between the two profitability metrics.
First, investors need to consider the positive tax benefits of depreciation, a non-cash expense.
With most necessary business expenses (e.g. buying goods to sell), the IRS lets you fully deduct costs immediately. However, with large items like real estate, you are required to deduct a portion of the total cost of a property over the IRS’s determined lifetime of that property via a process known as depreciation.
For residential real estate investors, this means that every year, you take the total purchase price of a home (minus the cost allocated to land, which is not depreciable), divide it by 27.5 (the IRS’s depreciable life of residential real estate), and offset your rental income for the property by that amount.
While this is a non-cash expense, it directly increases your cash flow by reducing your tax burden.
NOTE: Investors need to also consider the depreciation recapture effects on an investment property sale, though this is beyond the scope of this article.
Second, while there is a profitability benefit to the principal (as opposed to interest) portion of your monthly mortgage payments (discussed in the below loan amortization section), these portions of your loan payments are not tax deductible expenses. Rather, they are benefits to an investor’s balance sheet, with each principal payment increasing your net worth.
On the other hand, the portion of a loan payment applied to interest is a tax-deductible expense, which is important to remember when calculating BRRR profits.
While the term amortization can seem overwhelming to non-accountants, most property investors inherently understand the concept.
What dose amortization mean in real estate? An amortizing loan is simply one that requires the borrower to make regularly scheduled payments, with a portion of the payment applied to principal (i.e. paying down the outstanding loan) and a portion applied to interest (i.e. tax-deductible borrowing costs).
In the beginning of a 30-year loan term, the interest portion of a monthly payment will be very high while the principal portion will be low. As the loan progresses (and more of the loan is paid off), this will reverse, with a smaller portion of your payment applied to interest and a greater to principal.
For an investor, every time a principal payment is applied to a loan, ownership in the associated property increases. For example, assume someone purchased a property valued at $100,000 with a $20,000 down payment and $80,000 loan.
That investor would have equity, or ownership interest, in the property of $20,000 ($100,000 value minus $80,000 outstanding loan balance, or principal).
With the principal portion of each mortgage payment, that $80,000 loan balance would get slightly smaller while the investor’s equity would get proportionately larger.
As the above section outlines, one way an investor increases ownership in a property is by paying down the outstanding loan balance on that property.
Additionally, equity in a property builds as a result of long-term property appreciation. Put simply, over time and on average, the value of a property grows (even accounting for the short-term fluctuations in local housing markets).
Let’s use the same example of the above investor who purchased the property for $100,000. Now assume that same investor held the property for 10 years, and it increased in value by an average of 3% per year (a fairly conservative estimate given national, long-term trends).
Value at purchase: $100,000
Value after 10 years: $134,000
This means that, excluding the loan amortization effects, the investor’s ownership stake in this property would’ve increased by $34,000 after holding the property for 10 years.
Unrealized Equity from Renovation
Property value is not only increased via long-term appreciation. The renovation of a property (the first “R” in BRRR) will also benefit an investor by increasing property value.
For example, assume an owner bought a run-down property for $60,000 cash and put $50,000 of rehab costs into it for a $110,000 total outlay. Following the renovation, assume that same property appraised at $130,000.
This means that, as a result of the innovation, the investor has increased equity by $20,000 ($130,000 appraised value minus $110,000 cash outlay). And, this $20,000 bump in the investor’s net worth is tax deferred, as associated taxes on that growth will not need to be paid until property sale.
While there isn’t a single number investors can look at with a BRRR deal to assess its profitability, the above metrics offer a variety of options that, when viewed holistically, can tell you how profitable a deal will be.
The best part of BRRR strategy is, you can utilize the BRRR strategy with little of your own money.
So what’s next? You’ve done your research and made a decision – what now?
In any deal, financing is king. Without financing, a great opportunity cannot be pursued. As such, it’s critical to establish solid relationships with lenders.
The Do Hard Money team would love to help with your financing needs for real estate investment. Regardless of your situation and experience as a real estate investor, we can help you meet your goals. Drop us a note, and we’ll figure out the best way to support you on your real estate investing journey.
We look forward to working with you!