The BRRRR strategy for real estate investing looks like the traditional rental property investment method and seems pretty straightforward. Investors buy a flip property, fix it up, rent it out, go to a bank, get a refinance, and rinse and repeat. But, of course, it isn’t quite so simple. Let’s do a quick BRRRR analysis to see if this strategy might be right for you.
What does BRRRR mean?
The BRRRR method is an acronym for buy, rehab, rent, refinance, repeat, and it is a break from the traditional way of finding properties and running a rental business. With BRRRR, an investor uses a short-term loan to buy a distressed property, fixes it up, builds equity (by doing the rehab), rents it out (and builds cash flow), refinances the property loan, and repeats the process. It is an investment cycle that can quickly build an investor’s portfolio.
Pros of the BRRRR strategy
Potentially no money down
BRRRR investing can be a strategy for investing with very little money out of pocket. Some investors can avoid putting down any of their own money. If the investor works the numbers, they could get a rental property for very little cash.
High return on investment (ROI)
This strategy works with minimal out-of-pocket cash from the investor, so the ROI can be huge. If an investor can work out $10,000 in the deal and the property’s cash flow is $2,500, that equals 25% cash-on-cash return. And that doesn’t include the equity built when you rehabbed the property.
Equity
Since the property is rehabbed, it automatically gains equity, so the investor immediately owns a property worth more than what they paid for it. And it’s always better to own property that is worth more than what you purchased it for!
Renting a rehabbed property
A rental property that is freshly renovated is easier to rent out, can attract better tenants, and lowers the maintenance budget. All of these factors contribute to making landlording easier.
More on BRRRR from BiggerPockets
Cons of the BRRRR strategy
Short-term loan
Short-term loans usually have a higher interest rate—and these are the types of loans that investors use to fund a BRRRR property. To avoid negative cash flow at any point in the project, many investors use cash or a home equity loan for the first half of the project. Then, once they refinance, they use the money to purchase another property.
Potential for a low appraisal
There is always the possibility that the property will not appraise well. This is why the investor needs to study the numbers and ensure that their budget is on point.
Seasoning
There is a period of time that rentals need to have tenants before a bank even considers refinancing the loan. This is known as “seasoning,” and it can take anywhere from six months to a year.
The timing of the loans has to be right. For a short-term loan that will cover the cost to purchase and rehab the property, it is recommended that its length is 18 months at a minimum. This allows for enough time in case the refinance doesn’t work at month 12 and gives a six-month leeway to sell the property or find another lender.
Dealing with a rehab
Finally, any rehab is a big project that is unpredictable. Many moving parts and complications can easily jack up rehab costs and become a major problem. It isn’t easy and shouldn’t be taken lightly!
BRRRR analysis by the numbers
Here is a very simple way to illustrate BRRRR calculations.
Let’s say the purchase price for a property is $200,000, and the investor budgets $40,000 for the rehab. That brings it to $240,000, plus $10,000 in closing and holding costs, for a total of $250,000. This means that the property’s after repair value (ARV) should be around $350,000 for it to work.
The investor then takes out a short-term loan for $250,000. This can be with a hard money lender, borrowing from a line of credit, or money from a 401(k). That money is used to purchase and rehab the property.
After the rehab, the property is rented out, and the rental income is $2,500 a month. But the investor is paying a lot in interest. Hard money lenders typically charge a higher interest rate, around 12%. And who wants to pay that much in interest?
After the seasoning period, anywhere from six to 12 months, the investor can apply to refinance the property. Appraisers look at the property, and because the investors’ calculations were correct, the property is set at $350,000. (There is appreciation since you rehabbed the property.) And the investor found a bank willing to do 80%, which amounts to a $280,000 loan. Even if the investor found a new lender that would do 70% to 75%, that would still be good!
At this point, the hard money loan ($250,000) can be paid off, and there is an extra $30,000 left over. The beauty of this is the new loan is for a 30-year mortgage at 4% interest, which makes monthly mortgage payments really manageable. The property is basically brand new and will need little to no maintenance. Since the property is nice, it attracts good tenants. And property values and rents usually go up over time. A good bonus is that the investor doesn’t have any money in it and can go out and do it all over again. So it is a win-win-win-win-win for the investor!
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Analyzing a real-life BRRRR deal
I found a flipped property that I was very excited about because it was basically turnkey and move-in ready.
I renovated the kitchen, and most of the appliances were new. That meant that the electricity bill would be lower, and the home wouldn’t need that much maintenance. It didn’t have a refrigerator, but I could easily work that into the budget.
The house had two renovated rooms and one full bathroom on the second floor. The only issue was that I like to purchase three-bedroom homes because they have a better cash flow, and I do not usually buy flips.
I went to check out the house anyway and could see that there was potential to divide the home and rent out the second floor to a family. The first floor had a full bathroom, and I could convert the garage into a bedroom for another tenant. And because it would be a converted garage, it would have its own private entrance. I figured we could get $1,000 for the first floor and $1,200 for the second floor.
When I did the math, though, my estimation didn’t look so good. The asking price was $209,000, which was workable, especially since the property had potential. I figured it would cost $15,000 to convert the garage into a bedroom.
We definitely needed to get the numbers right so that it would be worth it. Here is what happened.
- Asking price: $209,000
- Offer: $189,000
- Counteroffer: $200,000
- Remodel: $15,000
- Proposed equity: $4,000
If we had gotten the property for $189,000, we would have had $10,000 to $15,000 in equity. That would have been enough to cover the cost of converting the garage into an additional room.
Instead, with the $200,000 counteroffer, it meant that I would be out $15,000 to cover the renovation and only have $4,000 in equity. I would have to pay out of pocket to do the renovation, which just didn’t work for me.
There wasn’t enough reason to purchase the property, and ultimately we passed on it.
Who should use the BRRRR investment strategy?
Realistically, anybody could use the BRRRR method. But it’s more attractive to certain types of investors. If the investor is OK with using expensive hard or private money, and they are systematic, good at budgeting, good at dealing with rehabs, and want to use little out-of-pocket cash, then the BRRRR investment strategy is for them.
But if the investor’s long-term goal is to use their own money to attain financial independence through cash-flowing rental properties, then sticking to traditional rental property investing is the way to build passive income. All they need to do is find a property that they can purchase with a 5% to 25% down payment and find a tenant, and they will be earning money.
If the investor has $100,000 to do a BRRRR deal, they wouldn’t see their money until after the seasoning period. That could be six months to a year.
Traditional investors could use that $100,000 as a down payment to buy five houses. These investors immediately have five houses in their rental business that they don’t need to rehab, wait for it to be “seasoned,” and then refinanced. It will have cash flow as soon as there are tenants in place. And a portfolio with five houses has a higher cash flow than one BRRRR property.
BRRRR really is a different way of thinking and doing business, so it all depends on what the investor is willing to do.
You may still be asking, is the BRRRR method legit? The quick and dirty answer is yes, it is. It takes an investor with a certain skill set or years of experience to be a true master of it. BRRRR is definitely a good way to use other people’s money to build personal wealth. There are things to watch out for. However—the property has to have the potential to gain equity in the rehab, it has to be rented out and “seasoned” before you can refinance it, and the math has to be right.
2021-09-14 15:30:00
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