Maximizing Profits: 11 Steps to Estimating Monthly Costs for Rental Investments
So you know BRRRR is an investment strategy to pursue. But how does it really stand up against the alternatives out there for real estate investing?
Experienced real estate investors weigh up the long-term returns on their various options. Accurately estimating your cash distributions on a BRRRR investment is crucial to making the smart decision and maximizing your profits—and it’s easy to do once you know how. In this post, we walk through the steps of quickly estimating the profits of a property investment, using real numbers.
Step 1: Determine the Home Price and Down Payment
Imagine you found a property you like in foreclosure for $100,000. Assuming your down payment is 20%, common for investment properties, your initial investment is $20,000 (20% of $100,000), plus closing costs of around $3,000. So, $23,000 total. The outstanding $80,000 will come from a lender (we’ll get to that in Step 3).
Step 2: Account for Rehab Costs
Now you factor in the rehab costs it will take to get this property back to beautiful. Assume that you’ve estimated the rehab costs for this property to be around $30,000, an amount you can borrow in full.
Step 3: Get your Initial Loan
Next, you apply for a loan that fits with your BRRRR strategy, which here would be for $80,000 + $30,000 rehab draw (and since the loan in this case is $80,000, you’ll want to look for a lender such as Backflip, that does not exclude small loans), for a total loan value of $110,000.
Step 4. Rehab
Congratulations: you managed to renovate the house in 6 months with your rehab funds and stayed on budget! Let’s say the After Repair Value of your house is now $200K. You want to refinance at a low interest rate to pay back the initial $110K loan.
Step 5: Refinance
You come to Backflip for a long-term, low-interest DSCR cash loan of 75% of the new value of the property: $150K (75% of $200K). You immediately pay back your $110K loan, leaving you $40K in your pocket. (Factoring the $6K you paid in interest these last six months, plus the $23K you invested at the start, you’ve made $11K cash profit, plus 25% equity on a 200K home: or $50K. In total, you’ve returned $66K on your $23K investment—almost tripling your money.
Step 6: Calculate the Monthly Loan Payment
Let’s assume the interest on your new DSCR loan is 7%, in the zone for an investment property. Using a loan calculator, you can calculate the monthly loan payment based on your loan and interest rate. In this case, the estimated payment is approximately $800.
Step 7: Estimate Potential Rental Income
Next, consider the potential rental income from the property. Based on research from a reliable source, you find that the average monthly rent for similar properties in the area is $1,800.
Step 8: Account for Expenses
As a landlord, you’ll also need to account for various expenses associated with managing a rental property, including vacancy, maintenance, and property management fees. Let’s be safe and set these expenses at 30% of the rental income. This would be $540 (30% of $1,800).
Step 9: Calculate Net Cash Flow
Subtracting the estimated expenses from the estimated rental income, you would have a net cash flow of $1,260 ($1,800 – $540) per month.
Step 10: Subtract Loan Payment
Next, subtract the estimated monthly loan payment of $800 from the net cash flow to get the final cash flow after loan payment. In this case, the estimated monthly cash flow comes to $460.
Step 11: Calculate Cash Distributions
To determine your cash distributions, you need to calculate annual cash flow. Multiply estimated monthly cash flow by 12 to get an annual cash flow of $5,520 ($460 x 12). Divide this by your initial investment of $23,000. Your annual cash distributions are equal to 24% of your initial investment. You will set your own investment benchmarks. Most investors agree that a projected return above 12% is good for rental property acquisitions, so 24% is appealingly high!
In short, by choosing to refi instead of sell, you are choosing to keep $50K invested as equity in the deal instead of pulling that $50K out and reinvesting it elsewhere–because the perpetual passive income looks good. Of course, be accurate with your estimations, and only invest what you can afford to lose, but you can see BRRRR is one path to early retirement.