8 BRRRR Risks to Know Before Investing in Rentals

In the world of real estate, the “BRRRR method” refers to the process of buy, rehab, rent, refinance, and repeat (hence the acronym!). In this investment strategy, a real estate investor will buy and then flip a distressed property, collect rental income by renting it out to a tenant, and then cash-out refinancing the investment property to continue purchasing additional rental properties for investment.

A key difference between traditional investment property strategies and the BRRRR method—and the reason for many of the BRRRR risks—is the focus on flipping distressed properties before refinancing them to fund additional real estate purchases.

As a real estate investor conducting the cash-out refinance step in the BRRRR method, you essentially convert your equity into dollars. When you take out bigger mortgages on your rental properties, you borrow more money than what you owe on these investments, which grants you access to your equity. The left-over funds can be used for other purchases such as (but not limited to) additional rental properties.

While this is an excellent investment method for the right person, there are risks associated with this type of real estate investment strategy.

Let’s discuss the BRRRR risks you need to be aware of before attempting the BRRRR method of real estate investments.

1. Renovation period

If you’ve ever hired a handy person or a contractor for a bigger-ticket repair or improvement to your own home or an investment property, at some point, you’ve most likely experienced the job taking significantly longer than was originally anticipated.

It can happen easily, and it’s not always anyone’s fault. Sometimes, property renovations get put on hold because of winter storms, for example. It’s not possible to replace roofs or siding or do outdoor painting when snow is swirling or ice is forming.

2. Renovation cost

One of the most frustrating things that can happen to any investor who owns real estate is an unexpected major expense mucking up their expected rehab costs.

Major expenses can make the difference between a profitable real estate investment and an unprofitable one. Even as an investor buying a rent-ready rental property, meaning no repairs are assumed to be needed, you should always hire an independent property inspector to thoroughly confirm the condition of the property so that you can be aware of any specific impending major repair costs.

Anything unknown before you buy a property can pop up later as a major or unexpected repair cost.

3. Rehab management

A downside to a BRRRR is that you need to manage a rehab. You hear that contractors are the hardest people to work with in this business. Finding them is tough, too, and good ones are like gold.

As a new investor, what makes you think you will find a great contractor?

If you were a contractor, who would you rather work with a seasoned investor who knows exactly what they are doing or a new investor who will ask a lot of questions and do one or two deals this year?

It’s not impossible, as a newbie, to find a good contractor, but it is unlikely. Additionally, you’ll need to manage this entire process, which is a lot of work.

4. Appraisal

One factor in a BRRRR or flip, if not the primary factor, is what the property will be worth after you put the work into it: the appraisal.

Improving the property to increase the appreciation is the whole point of putting in the work. So, back to the numbers. If your property doesn’t appraise at what you expect, you could be looking at a heap of trouble regarding your profit margin. You can probably handle this easier in a BRRRR strategy, as long as the property has cash flow as a rental.

This assumes you didn’t do any “creative” financing and/or didn’t make promises to investors about a return.

5. Time to rent

You obviously won’t be able to rent out the property until that rehab is completed. For BRRRR properties, if you plan to rent it out and then refinance it, a rehab delay of any sort will prolong the time before you can place tenants.

This timing matters because the refinance depends on having tenants (in most cases), and you won’t start having cash flow until you have tenants living in the property. That means the longer the rehab is delayed, the longer before you start getting your money back out of the project.

If you have the financial means to handle a delay, then the time to rent isn’t as critical. But it must be considered for a BRRRR property. Along with time being a crucial factor, keep in mind that so is how much you’ll be able to rent the property for.

6. Rental amount

Yes, the rental amount matters. If you are BRRRRing, your initial numbers analysis should include the anticipated rent amount you expect to receive once tenants are in place.

This matters because you’ll know whether or not the property will have positive cash flow. If you can’t expect cash flow, reconsider your strategy.

The point of a BRRRR is to refinance the property after it’s been fixed up. But if you won’t have cash flow after you have tenants, you can flip it rather than hold it. Your decisions will depend on why you are doing a BRRRR, but the idea is to rent the property out rather than sell it as a flip. Cash flow is a big part of that equation.

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7. Time to refinance

If you ask a lender how quickly you can refinance after a tenant is obtained, the answer will most likely be six months.

With this six-month seasoning period, your money is now tied up for—you guessed it—at least six months. In fact, it is likely going to be longer than that because it is six months after the tenant moves in. When you include time for the rehab, we are now talking nine to twelve months before you can move onto the next property.

For example, let’s say you have $100,000 to invest in a BRRRR deal. You will not be able to reinvest that money for at least six to twelve months. The maximum amount of properties you could obtain in one year is two because of that six-month seasoning period.

However, with traditional rental property investing, if you have that same $100,000, you could buy five $100,000 properties with 20% down.

Whose portfolio will have more cash flow? One with five properties or one with two?

8. Limits to the refinancing amount

What makes a BRRRR investing deal so powerful is the ability to pull your money out and reinvest it. In a perfect world, you’ll be able to do this on every BRRRR deal.

Unfortunately, we do not live in a perfect world.

Pulling all of your money out on a BRRRR is a home run of a deal. You can’t reasonably expect every deal you do to be a home run.

In most cases, after that six-month seasoning period, you will likely leave $5,000 to $10,000 in the deal due to the amount the lenders will allow you to refinance.

Not bad, but you still have to wait six months for refinancing.

With traditional rental properties, you need to save up that 20% to 25% down payment. This may be more difficult depending on the market (say, a high down payment is needed) or the amount of liquid capital you have (low savings rate).

If there are ways you can spend less money and make more of it, do it—and then invest that difference into traditional rental properties.

Who shouldn’t use the BRRRR strategy?

Are you looking to attain financial independence as quickly as possible through cash-flowing rental properties? If so, BRRRR is not the best real estate investment option for you.

Do you know what the best strategy is?

Believe it or not, it isn’t house hacking (although house hacking is a subset of this category).

If you guessed “good old-fashioned rental property investing,” that’s correct. Find a property that you can purchase with 5% to 25% down and that you can immediately place a tenant in to start generating passive income.

You could be better off putting your time, effort, energy, and finances into traditional rental property investing. What’s more, the more rentals you can invest in, the better.

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Systemize your investing with BRRRR

Through the BRRRR method, you’ll buy homes quickly, add value through rehab, build cash flow by renting, refinance into a better financial position—and then do the whole thing again. Over time, you’ll build a real estate portfolio that’s the envy of your fellow investors.

Who should use the BRRRR method?

The BRRRR strategy is right for you if you are looking for deals with a hard money loan or private money and looking to refinance after the seasoning period for cheaper debt.

Keep in mind that you have to invest the time to rehab a home, vet tenant applicants, and allow for seasoning before you get to the cash-out refinance step.

If you can afford to be patient in your investment opportunities, then give the BRRRR method a try.

Evaluating BRRRR risks and alternative solutions

If you’ve determined that BRRRR risks outweigh the rewards for you, look at some alternative investment strategies.

For example, you could consider crowdfunding. Real estate investors use this method to pool their money, which allows them individually to invest less money, effort, and work while still reaping and enjoying the benefits.

Another strategy, which we discussed above, is to simply purchase a ready-to-live-in-home and collect traditional rental income.

A traditional rental property that is turnkey might only need some minor improvements. You can get a handyperson to complete minor repairs in a single day.

After the repairs are completed, you turn the unit over to a property manager who helps find tenants to occupy the rental. That starts the cash flow process practically from Day One.

Don’t worry if the BRRRR risks are not for you. There are plenty of other real estate investment options out there.

2021-09-21 19:30:00

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