I think I'm doing a flip and calling it a BRRRR

Question

Two properties in, and something's off with how I'm thinking about this.

My process: find something cheap, fix it fast, get a tenant, refinance. That's the four letters. But I pick properties the way I'd pick a flip. I'm chasing the biggest spread between what I pay and what it'll appraise for, and I basically don't look at rent until the rehab is nearly done. On the current one I'm realizing the rent probably supports a loan smaller than the one 75% of ARV would give me, which I gather means the lender won't even write the bigger loan.

Someone told me the refinance is underwritten on rent, not on value, and I'd only half heard that before. If that's true I've been optimizing the wrong variable on both deals. What am I actually supposed to be screening for at the front end?

Rena Guide · Accepted Answer

Your loan has to pass two separate tests, and both apply at the same time.

The value test sets the ceiling. If the appraisal is 200k and the lender's maximum is 75% loan-to-value, the largest loan they'll consider is 150k. That's the most you can possibly get.

The rent test sets a second, often lower ceiling. Many rental loans use a debt service coverage ratio, which is the property's net rental income divided by the annual loan payment. A lender wanting 1.20 coverage needs rent that covers the payment 1.2 times over. If your rent only supports a payment consistent with a 130k loan, you get 130k, and the 150k the appraisal allowed is irrelevant.

Whichever test gives the smaller number is your loan. So you're screening for both from the first day, which means pulling rent comps before you make an offer rather than after the drywall is up.

The practical difference from a flip is what you're buying. A flip wants resale appeal. A rental wants a property that rents easily, holds a tenant, and doesn't generate repair calls. Those overlap but they aren't the same house. The kitchen finish that adds 12k to a resale price often adds nothing to the rent, and the roof that a flip buyer would negotiate around is a problem you'll own for a decade.

One thing to check before your next offer: coverage ratios and LTV limits vary by lender and by loan product, and some lenders also apply a minimum debt service coverage to the property regardless of your credit. Get both numbers from your actual lender in writing rather than working from a rule of thumb, since a 1.25 requirement instead of 1.20 moves your maximum loan by real money.

bmoreno23 · Answer

I'm starting from zero and I'd genuinely never seen the two-tests thing explained that way. So the appraisal can be great and you still get a small loan. That reframes the whole strategy for me.

carlos_nunez · Answer

Yeah, that's the part I'd half absorbed. So on my current one, if rent comps say 1,450 and my payment at 150k puts coverage under 1.2, the lender writes whatever loan gets me back to 1.2 and I eat the difference in trapped cash. Is there anything you can do at that point other than take it, or is the answer just that I screened wrong four months ago?

aaron_fitz10 · Answer

quarry, you can sometimes buy down the rate with points, which lowers the payment and improves coverage. Costs money at close to get money at close, so it's rarely a clean win, but it's a lever.

omar_haddad · Answer

The rehab side of your problem: on a rental I'd spend the money on things that reduce future calls and let me hold a higher rent, and on a flip I'd spend it on what photographs well. Different scopes. If you scoped deal two like a flip you've probably got 8 or 10k in finishes doing nothing for your DSCR. Not recoverable now, but worth knowing for deal three.

jordan_ellis2 · Answer

Pulling rent comps before offering is such an obvious step and I've watched three people in my area skip it because the ARV spread looked so good.

samantha_ruiz · Answer

There's a version of this where you're not wrong, quarry. If your market has strong appreciation and weak rents, chasing spread and accepting trapped capital is a defensible choice. You just have to admit that's what you're doing rather than believing you're running the refinance play.

derekj19 · Answer

Does the lender count all the rent or do they haircut it? I've heard something about them only using a portion.

aliyah_b · Answer

beacon, the coverage calculation typically uses net operating income, so rent minus taxes, insurance, management, and a vacancy allowance. Some lenders use a simplified version. It's not gross rent divided by payment, which is what people usually assume when they run it in their head.

bmoreno23 · Answer

Following up on my own comment, so the vacancy allowance means they assume the place is empty part of the year even if it isn't. That's another thing I'd have missed entirely.

ryanmck27 · Answer

Every lender I've talked to while studying uses a slightly different net calculation, which makes comparing quotes harder than comparing rates.

I think I'm doing a flip and calling it a BRRRR

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