Karen Lin
How to Increase ROI on Your Real Estate Investment

Based on my review of David Greene’s “Buy, Rehab, Rent, Refinance, Repeat”

There are many reasons why I have always been intrigued by real estate. I have seen the field’s incredible potential for generating passive income through my own family’s investments. It’s a brilliant vehicle toward financial freedom and generating wealth disproportionate to the input of time and resources. My goal behind this book review — and a series of more to come on the topic of real estate investments — is to give my readers useful, relevant ideas and tidbits that will hopefully contribute to the overarching goal of helping them make better real estate investment decisions.

The author, David Green, is a real estate investor with experience in buying, selling, and rehabbing properties. In his book, “Buy, Rehab, Rent, Refinance, Repeat,” coined “BRRRR” for short, Greene explains how BRRRR works and his approach that helped him rapidly expand his investment portfolio.

Greene argues that one can maximize return on investment (ROI) by rehabbing the property first then refinancing versus the traditional route of financing the property then rehabbing. He’s a strong proponent of playing the long-term game of keeping positive cashflow properties rather than flipping and paying the associated costs of selling (such as closing costs and capital gain taxes). From a financial perspective, it makes sense to keep positive cash flow properties for the purposes of cost avoidance. If there is a concern about access to capital, the investor can always pull equity from capital appreciation to finance the next buy. Lender fees from refinancing are significantly lower than selling, as mentioned above.

Why do we care about ROI? It’s a universal metric used to measure and compare the performance of portfolios across all investment vehicles, allowing a buyer to make an objective decision about whether the investment is a wise leverage of his/her capital.

ROI is calculated by taking the yearly profit and dividing it by the amount of money invested (down payment, closing costs, rehab costs, holding costs, etc.). There are two ways to increase ROI: increase profit or decrease invested capital.

To illustrate this concept, compare the respective ROIs in the two examples below between a purchase using BRRRR and a traditional purchase of financing the property first, then rehabbing.

Example 1 using the BRRRR method: A property is purchased with cash at $52,000, then rehabbed for $32,000 to add value. The total investment is $84,000, since the seller paid the closing costs.

Property purchase price = $52,000

Rehab cost = $32,000

Closing costs = seller paid

Total cost for the buyer = $84,000

After being rehabbed, the property is valued at $110,000, and the bank agrees to refinance at 75% of the after repair value (ARV). With the net capital ($77,500) recovered, the remaining $6,500 is left in the investment.

ARV = $110,000

Amount financed = $82,500

Closing costs = $5,000

Net capital recovered = $77,500

Down payment/money left in the investment = $6,500

The total monthly expenses to maintain this property as a rental are $617. Expenses include mortgage ($443), tax ($54), insurance ($40), and property management ($80) (see breakdown below). This positive cash flow property generates $1,000 per month in rent. With monthly expenses of $617, monthly profit is $383; annual profit is $4,596.

Rent = $1,000

Total monthly expenses = $617 includes the following breakdown:

Mortgage payment ($82,500 at 5% over 30 years) = $443

Tax (1.25% of purchase price, $52,000) = $54

Insurance = $40

Property management (8% of $1,000 rent) = $80

Finally, to calculate ROI, divide the profit into the investment: $4,596/$6,500.

ROI is a whopping 70.7%!!

I’d say that’s a pretty good number.

When a buyer uses a bank to finance a property, there are more restrictions enforced, such as those on the condition of the home. As such, the opportunity to add value by rehabbing a property significantly decreases compared to an all-cash purchase. Remember the two methods of increasing ROI? One can either boost profit (i.e., rental income) or minimize cost (i.e., rehabbing cost). Both factors are fairly fixed, meaning there is only so much an investor can demand in rent, as defined by supply and demand in the market. The same goes for rehab costs: one may have only minimal control over labor and material costs. Ultimately, the highest potential for influence that a buyer has on ROI is the amount of value added to the investment property — the key to generating higher ROI is by adding value to a property.

In Example 2, let’s look at another scenario using the traditional method of purchasing a property: finance then rehab.

A property with a sales price of $100,000 is purchased with a 25% down payment. After rehab costs of $10,000, closing costs of $5,000, and a down payment of $25,000, the total investment is $40,000. An appraised ARV of the home is assessed at $115,000.

Purchase price = $100,000

Rehab cost = $10,000

Closing costs = $5,000

ARV = $115,000

Down payment = $25,000

Total investment (down payment plus rehab and closing costs) = $40,000

The total monthly expenses to maintain this property as a rental are $635. Expenses include mortgage ($403), tax ($104), insurance ($40), and property management ($88) (see breakdown below). This positive cash flow property generates $1,100 per month in rent. With monthly expenses of $635, monthly profit is $465; annual profit is $5,580.

Rent = $1,100

Mortgage payment ($75,000 at 5% over 30 years) = $403

Tax (1.25% of purchase price, $100,000) = $104

Insurance = $40

Property management (8% of $1,100 rent) = $88

Total Expenses = $635

Total monthly profit (for simplicity, this does not include maintenance, CAPEX, etc.) = $465

Finally, to calculate ROI in Example 2, divide the profit into the investment: $5,580/$40,000. ROI is pretty good at 13.95%, but nowhere near the figure achieved using the BRRRR method in Example 1.

With $77,500 in equity pulled from the property in Example 1, the investor was able to reutilize 92.3% of the initial capital to reinvest in a second property, whereas using the traditional method, the capital was only used once. It is apparent that the BRRRR method allows an investor to accumulate more in properties and passive income at an exponentially rapid rate.

I believe the concept of BRRRR is the most core shaking idea from David Greene’s book. When the two different investment strategies (Examples 1 and 2) are applied over the course of 15 years, the numbers present an unsurprisingly stark contrast. Here are the two portfolio values in 15 years:

Example 1: BRRRR Method
Number of properties acquired: 84 | Gross cash flow: $71,736 | Total equity in properties: $1,764,000

Example 2: Traditional Method
Number of properties acquired: 15 | Gross cash flow: $14,775 | Total equity in properties: $0

By financing the properties after rehabbing, the investor in Example 1 was able to leave significantly less money in each deal. Therefore, the investor in the first example was able to pull money out of the house to use again toward the next purchase. In the second example, the investor left money in the property and had to save up in order to buy another.

I hope the wealth-building potential of BRRRR as indicated in these math illustrations hit home as drastically for you as it did for me.

Greene’s book contains many other useful bits of advice on relationship and team building, finding deals, rehabbing strategy, and more. It’s a useful guide for the novice buyer just starting out in residential real estate investment. Coincidentally, Greene himself started out as a part-time investor while working his full-time job in law reinforcement. I surmise that this is the advice he wishes he had when starting out as a rookie.

There are other key takeaways from Greene’s book, which I’ll highlight here on a macro level. Though this list isn’t comprehensive, they are curated to include my favorites:

  1. Build a core team of experts who have experience as investors or have worked with investors in every market. This core team — consisting of lenders, property managers, agents, and contractors — can bring value, as they will look at a deal from an investor’s perspective. Work with the best talent you can find, as the strength of your team will directly affect your performance.
  2. Add value to others, even if they are your service providers or suppliers. Bringing value in a relationship, especially to the people who work for you, will incentivize them to bring you the best deals.
  3. Build a system that allows work to be delegated to members of your team. This can be applied to any aspect of your operations, from selecting deals to managing repairs in rental properties. An example would be building a funnel system of criteria for selecting deals. If this were communicated to members of your team, it would allow your agent to bring in prospective leads that are truly worth your time.
  4. Understand how buyers and appraisers value properties in your market before starting the rehabbing process. Know which features and aesthetics bring in top dollar in the area. This may seem like an obvious statement, but it can easily be overlooked when novice investors work on their first property. Consult the advice of your core team, especially contractors. If they are good at what they do, they will know what buyers value in their market.

This book is a fast read at slightly over 300 pages. Much of the information is intuitive and useful for first-time property buyers because it introduces fundamental/basic concepts in the world of real estate investing. I love that the table of contents clearly delineates each topic of discussion so the reader can jump to topics of interest. It’s an easy read. I recommend it to anyone who’s looking to maximize their portfolio value.

Source link