Things to Consider Before Investing in BRRRR. In real estate, the “BRRRR method” stands for buy, rehab, rent, refinance, and repeat. In this strategy, investors acquire distressed properties, renovate them, generate rental income, and then refinance to fund more investments. Unlike traditional approaches, the BRRRR method emphasizes flipping distressed properties before refinancing to finance further real estate acquisitions.
During the cash-out refinance stage, investors convert their equity into cash by obtaining larger mortgages than their property’s initial value. This extra capital can be invested in various ways, including purchasing additional rental properties. While this strategy can be lucrative, it comes with inherent risks that investors should understand.
Explore the potential BRRRR risks before embarking on this real estate investment journey.
What is a BRRRR Method?
The BRRRR Method, short for “buy, refurbish, rent, refinance, repeat,” is a systematic strategy for investors aiming to create a stream of passive income. This approach involves a sequence of steps that must be followed precisely. Initially, the investor acquires a property, which is subsequently renovated. The renovated property is then leased to tenants for an extended period, with the rental income covering the mortgage, generating profits, and accumulating equity. As equity in the property grows, the investor can use it to finance the purchase of additional properties through refinancing, and this process can be repeated.
BuyÂ
The first step in the BRRRR method is the ‘B,’ which stands for buy. During this phase, it’s crucial to remember that it’s the linchpin of the entire investment and can dictate the outcome. It involves a complex interplay of ensuring the property is a sound investment and has the potential to perform well as a rental.
This necessitates thorough deal analysis, encompassing renovation costs, monthly rental expenses estimation, and confirming that the rental income will yield a satisfactory profit margin. Ensuring the property’s strong rental performance may involve researching robust rental markets and ensuring the purchase price includes a buffer for renovation expenses. Many investors follow the 70 percent rule, which considers repair costs and after-repair value to determine the maximum offer for a property. This rule helps ensure a viable profit margin after renovations.
RefurbishÂ
At its core, landlords must ensure their rental properties meet basic livability and functionality standards. Once these prerequisites are met, investors can consider value-adding updates or renovations that justify higher rental rates. However, it’s vital to strike a balance, avoiding excessive upgrades that exceed potential rental income.
In the BRRRR strategy, the first ‘R’ stands for rehab, and it involves a meticulous cost-benefit analysis at every stage. Investors should focus on home improvement projects with a high return on investment (ROI). Here are some rehab projects known for their favorable ROI:
- Roof Repairs: Repairing or replacing a roof often adds property value equivalent to the investment made.
- Updated Kitchen: Even outdated kitchens can have salvageable features. Houses with demoed kitchens, typically purchased with cash, present an opportunity for high ROI rehab.
- Drywall Repair: Fixing drywall damage is relatively inexpensive, and it can make a property eligible for financing.
- Landscaping: Simple landscaping, like clearing overgrown vegetation, can be cost-effective and doesn’t always require professional help, making it a high ROI project.
- Bathroom Updates: Bathrooms are relatively small, and material and labor costs are manageable. Updating bathrooms enhances the property’s competitiveness with higher-end homes in the area.
- Additional Bedrooms: Homes with ample square footage but lacking enough bedrooms can be upgraded to increase value without significant costs. Adding 3 or 4 bedrooms can enhance competitiveness with upscale properties in the vicinity.
RentÂ
Once the property’s rehab phase is complete, the investor moves on to the rental phase. This involves tasks like tenant screening, managing turnover, and addressing maintenance requests. Over time, investors assess the effectiveness of their due diligence. Potential challenges may include vacancies, problem tenants, or rental costs exceeding income. These issues can strain property finances, raising the risk of foreclosure. It’s crucial for investors to diligently analyze the numbers and make informed decisions when adopting the BRRRR strategy or becoming landlords.
Refinance
Once your property is rehabbed and rented, it’s time to plan for refinancing. Some banks offer cash-out refinance, while others only cover outstanding debt; choosing the former is preferable. Be aware of the ‘seasoning period,’ indicating how long you must own the property before refinancing based on its appraised value. While some banks may be reluctant to refinance single-family rentals, investors can usually find a suitable lender through their networks.
Repeat
After the cash-out refinance of the first rental property, investors can finance the purchase and rehab of their second one. Cash-out refinance comes with benefits like favorable interest rates, tax advantages, and financial control. Despite the initial learning curve and inevitable mistakes, investors can apply their experience and newfound knowledge to subsequent BRRRR cycles with confidence.
BRRRR Method Example
Let’s break down the BRRRR real estate strategy with an example. Meet Johnny Crushit, an Austin, TX resident looking to tap into the growing rental market. He spots a property for $200,000 and crunches the numbers. Johnny puts down $40,000 and takes out a $160,000 loan. He decides to invest $10,000 in renovations.
Here are the key figures:
- Property Price: $200,000
- Down Payment: $40,000
- Loan Amount: $160,000
- Rehab Costs: $10,000
After the renovations, the property’s value rises to $250,000, and Johnny rents it for $2,500 per month. About a year later, Johnny refinances, securing a loan for 75% of the appraised value, which is $187,500. This pays off the original $160,000 loan, leaving Johnny with $27,500 (plus ongoing rental income) to fund another property. Johnny can repeat this process, accumulating more investment properties over time. While these numbers are simplified, they illustrate how the BRRRR strategy works in practice.
How The BRRRR Method Works
If executed correctly, the BRRRR Method can generate passive income and create a continuous cycle of acquiring and owning rental properties. This method involves the following steps:
1. Purchase a property: Seek out distressed properties that require renovations to bring them up to standard for renting. These properties are often more affordable due to their condition.
2. Rehabilitate the property: Extensively renovate the property to address structural, safety, and aesthetic issues, preparing it for rental.
3. Rent out the property: Determine the rental rate and find tenants to occupy the property.
4. Perform a cash-out refinance: Through a cash-out refinance, convert your property’s equity into cash. This is achieved by obtaining a larger mortgage, exceeding your current loan balance. The cash can be used for various purposes, including acquiring another property.
5. Utilize refinance funds to purchase another property: With the funds obtained from the cash-out refinance, repeat the process by acquiring another distressed property, rehabilitating it, renting it out, and eventually refinancing it.
Things to Consider Before Investing in BRRRR
Let’s discuss things you need to be aware of before attempting the BRRRR method of property investments.
1. Renovation Delays
If you’ve ever hired a handy person or contractor for a significant repair or improvement, you’ve likely experienced projects running longer than expected. It happens, and it’s not always someone’s fault. Weather can disrupt renovations – you can’t replace roofs or paint exteriors during snowstorms or icy conditions.
2. Unforeseen Renovation Expenses
Unexpected major expenses can be a nightmare for real estate investors, jeopardizing their projected rehab costs. These expenses can turn a profitable investment into an unprofitable one. Even when buying a supposedly rent-ready property, it’s essential to hire an independent property inspector to assess its condition and uncover potential major repair costs. Anything hidden before purchase may surface later as an unexpected financial burden.
3. Managing Renovations
One challenge with the BRRRR strategy is overseeing property renovations. Contractors are often considered the trickiest partners in real estate, and finding reliable ones can be as difficult as striking gold. As a new investor, consider this: Would you prefer to work with a seasoned investor who knows the ropes or a newbie with many questions, planning only a couple of deals this year? While not impossible, finding a top-notch contractor as a beginner is improbable, and the management of the entire renovation process is no small feat.
4. Appraisal Concerns
In the BRRRR or flip strategy, the property’s post-renovation value, determined by appraisal, is a critical factor, if not the most crucial. The entire effort is aimed at increasing the property’s worth. Therefore, it’s essential to crunch the numbers carefully. If the property’s appraisal falls short of expectations, it can spell trouble for your profit margin. While this can be manageable in a BRRRR strategy, provided the property generates rental income, it assumes you haven’t employed unconventional financing methods or made unrealistic promises to investors regarding returns.
5. Time to Rent
Renting out the property hinges on the completion of the rehab. Delays in the renovation process can significantly impact your timeline, especially if you plan to rent it before refinancing. In the BRRRR strategy, refinancing often depends on having tenants, and your cash flow won’t commence until occupants move in. Therefore, any delay in rehab work translates to a longer wait for returns on your investment. If you have the financial cushion to handle delays, it’s less critical, but for a BRRRR property, it’s a key consideration.
6. Rental Income
The anticipated rental income plays a pivotal role in your BRRRR analysis. It directly impacts whether the property will generate positive cash flow. If the numbers don’t add up for positive cash flow, it might prompt a reevaluation of your strategy. The essence of BRRRR is to refinance the property after renovation and hold it as a rental. If you don’t anticipate cash flow with tenants in place, you might consider flipping the property instead. Your decision hinges on your BRRRR goals, but rental income is a critical factor.
7. Refinancing Timing
Typically, lenders require a seasoning period of around six months after acquiring tenants before you can refinance. This means your capital will be tied up for at least six to twelve months, factoring in the rehab timeline. For instance, if you have $100,000 for a BRRRR deal, it could be a year before you can reinvest that money. In contrast, with traditional rental property investing, the same $100,000 could secure five properties with a 20% down payment. The question then becomes: which portfolio will yield more cash flow—five properties or two?
8. Refinancing Limits
The strength of a BRRRR deal lies in the ability to pull out your initial investment and reinvest it. While it’s ideal to achieve this in every BRRRR deal, it’s not always feasible. After the six-month seasoning period, you may still leave $5,000 to $10,000 in the deal due to lender restrictions on the refinancing amount. It’s a decent outcome, but it requires waiting six months for refinancing. In contrast, traditional rental property investing involves saving up for a 20% to 25% down payment, which can be more challenging based on market conditions and your available liquid capital. If there are cost-saving opportunities that allow you to invest more in traditional rental properties, it’s a route worth considering.
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