How To Boost Your Passive Income With The BRRRR Method

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Imagine yourself attending a real estate investing networking event, and you overhear someone saying “BRRRR.” Chances are, your colleague is not commenting on the temperature of the room, but rather, is discussing a popular investing strategy known as the BRRRR method. Those wondering how to build wealth in real estate should consider this unique framework that represents a hybrid between active and passive income. Read on to find out more about the BRRRR strategy.

BRRRR Meaning

The BRRRR Method means “buy, rehab, rent, refinance, repeat,” and describes a strategy and framework used by investors who wish to build passive income over time. This acronym represents steps that should be implemented in the exact order they appear. First, an investor purchases a property that they proceed to rehabilitate. The newly revitalized property is then rented out to tenants for an extended period, through which the rental income can enable the owner to pay the mortgage, earn profits, and build up equity over time. Once a sizable amount of equity in the property is built up, the investor can then purchase a second property by refinancing the first, and so on.


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brrrr

Buy

The first letter in the BRRRR method is ‘B,’ which stands for buy. When searching through listings, keep in mind that this phase serves as the critical point and will determine the outcome of an investment. There exists a complicated intersection between making sure a property represents a sound investment deal, while also promising to perform well as a rental property.

This will require an intensive deal analysis, which includes calculating the cost of renovations, estimating monthly rental expenses, and confirming that the resulting rental income will provide a sufficient profit margin. Ensuring the strong performance of a rental property may include researching the best rental markets, as well as making sure that the purchase price provides enough of a buffer zone to allow for renovation costs. Many investors rely on the 70 percent rule, which estimates for the cost of repairs and after repair value, which helps to determine a maximum offer to be made on a property. By using this rule of thumb, they can better ensure that a profit margin will remain after renovating a property.

Rehab

At the most basic level, landlords must identify how to make their rental properties both livable and functional for their tenants. Once these requirements are satisfied, updates or renovations that will add value to a property (and thus justifying increased rental rates) may be considered. On the other hand, however, investors must be careful not to make any excessive upgrades that will end up costing more than what can be produced through rental income. Representing the first ‘R’ out of four, the rehab phase of BRRRR requires an in-depth cost-benefit analysis every step of the way. Investors are advised to only select home improvement projects that will provide a high return on investment.

Rent

Once the rehabilitation phase of the property is complete, the investor can then execute the rental phase of the process. This might entail screening and selecting tenants, managing turnover, and responding to maintenance and repair requests. After a certain amount of time, an investor will typically figure out whether or not their practice of minding due diligence was satisfactory. Possible things that can go wrong include vacancies, bad tenants, or rental expenses that exceed income produced. All these possible outcomes can quickly drive a property underwater, increasing the risk of foreclosure. This is not intended to scare investors away from becoming a landlord, or from exercising the BRRRR strategy, but merely to emphasize the importance of properly running the numbers before making any investment decision.

Refinance

Once your property has been effectively rehabbed and rented, you can start devising a plan on how to refinance it. Some banks will offer a cash-out refinance, while others will only offer to pay off outstanding debt; of these two options, you will want to select the former. You will also want to make note of the required ‘seasoning period,’ which indicates how long you must own a property before the lender will consider refinancing against the appraised value of the property. Although you may encounter some banks that are not willing to refinance single-family rental properties, investors can generally tap into their networks to find a lender that fits their refinancing needs.

Repeat

Finally, the investor can use the cash out refinance from their first rental property to fund the acquisition and rehabilitation of their second. A cash-out refinance offers additional advantages, such as interest rates that are often favorable when compared to other sources of capital, tax benefits, and having control over your financial timeline. Facing quite the learning curve, an investor is sure to encounter some difficulties and mistakes from their very first BRRRR cycle. However, they can apply their experience and newly-acquired wisdom when tackling their second, third, or fourth property, and so on.

BRRRR Method Example

Reviewing an example of the BRRRR real estate strategy can help illustrate how to accomplish each of the steps. Read through the following example to better understand how to buy, rehab, rent, refinance, and repeat.

Let’s say Johnny Crushit lives in Austin, TX and is interested in purchasing a house to capitalize on this emerging rental market. He finds a property for $200,000 and runs the numbers on the deal. Johnny is able to make a down payment of $40,000 and takes out a loan for the remaining $160,000. After walking through the house with a contractor, Johnny decides to spend $10,000 rehabbing the property. So far we have these numbers:

  • Sale Price: $200,000

  • Down Payment: $40,000

  • Loan Amount: $160,000

  • Rehab Costs: $10,000

After the renovations are complete, the property is appraised at $250,000 and Johnny is able to rent it for $2,500. About a year down the line Johnny refinances and takes out a loan for 75 percent of the appraised value: $187,500. He then uses this amount to pay off the original loan of $160,000, leaving him with $27,500 (plus the ongoing monthly rental income) to purchase and rehab another property. The more Johnny follows this process, the more investment properties he can accumulate over time. While this example does use simplified numbers, it should help to illustrate the BRRRR process in action.

How To Finance BRRRR Properties

One of the most difficult obstacles for starting investors is figuring out how to finance BRRRR properties. Commonly, you will have to finance the property more than once. First, when you purchase the property and second for any repairs or improvements. Most beginning investors don’t have the funds to finance the property without a loan. If you are purchasing a property for the first time, here are a few options open to you:

  • Conventional Bank Loans: As a down payment, you will need about 20% – 25%. However, the interest rate should be similar to that of an owner occupant loan. It is important to note that if the property is in poor enough conditions, the bank may not offer you a loan to purchase it.

  • Local Bank Loans: Local banks offer a more significant amount of flexibility when lending for rental properties. While they will most likely require the same down payment as conventional bank loans, they may also overlook any expenses for repairs. They also offer flexibility on mortgage limits and debt-to-income ratio problems.

  • Private Lenders: Private money is acquired by people you know personally whether it be family, friends, business partners, or other investors. In this case, the rates can vary depending on the property and your relationship with the lender. It is common for private lenders to also finance any repairs the property needs.

  • Hard Money Lenders: These lenders specialize in lending to house flipping and rental investors. The cost and rates of hard money lenders commonly exceed bank loans, however, they will most likely cover repairs and improvements.

BRRRR Strategy Pros

Any type of investing strategy will promise certain advantages while bearing some level of risk, and the BRRRR method is no exception. Before executing any type of strategy, make sure to review the pros and cons, and determine for yourself whether or not BRRRR is the right strategy for you:

  • Potential for returns: One of the main benefits is the possibility of a high return on investment. When done right, investors can purchase a distressed property for a relatively low cash investment, fix it up, and rent it out for strong cash flow.

  • Building equity: One should also account for the amount of equity that is built up during the rehabilitation phase. When pursuing a passive income strategy, many investors are merely creating cash flow off a property worth the price it was paid for.

  • Top-grade tenants: If a property has been properly rehabbed to meet consumer standards in a specific market, it will most likely attract great tenants. Tenants who are willing to pay top-dollar for their rental property in exchange for certain features and amenities are more likely to take better care of the property, and thus help to reduce your expenses. Better tenants often translate directly into improved cash flow.

  • Economies of scale: Once you hit your BRRRR stride, you can achieve something called economies of scale, where owning and operating multiple rental properties at once can help you lower your costs overall, by lowering your average cost per property and spreading out your risk.

BRRRR Strategy Cons

The following list helps to shed some light on potential risks associated with the BRRRR strategy. However, it should be noted that these points are not necessarily cons or disadvantages, rather, they warn investors of what can happen if they are not careful and have not minded their due diligence:

  • Expensive loans: When opting to use a short-term or hard money loan to finance the purchase of a property, high-interest rates can prove to be expensive, especially during the rehabilitation phase. Investors should make sure they know how they will make mortgage payments during the time that the property is not producing any income.

  • Rehabilitation: Taking on a large rehabilitation project can prove to be expensive, with many headaches along the way. Rehabbing means dealing with project timelines, managing contractors and sub-contractors, and dealing with unexpected issues. Make sure that you have the right resources and contingency plans in place before tackling a project.

  • Waiting period: BRRRR is a strategy associated with a longer time horizon, which includes at least two waiting periods. The first is during the rehab phase, where the investor must make improvements to a property before they can place tenants and start earning income. The second waiting period is seasoning, a term that describes the period an investor must wait before a lender will allow a cash-out refinance.

  • Appraisal Risk: Investors typically refinance a property based on the appraisal of the property, rather than how much money they have paid into it. There is always a risk that the property will not be appraised for as much as expected. This should serve as a warning that running the numbers correctly in advance is crucial.

brrr strategy

Who Should Use The BRRRR Method

The BRRRR method is perfect for investors interested in building a passive income portfolio from start to finish. The process is more much demanding than purchasing a turnkey rental unit, though it can be highly rewarding. Investors who are comfortable with a certain level of risk, have capital available for an initial down payment, and who are ready to roll up their sleeves for some in-depth market research will be well suited for this real estate strategy.

Who Shouldn’t Use The BRRRR Method

One of the biggest determinants in deciding if the BRRR method will be the right fit is whether or not you are willing to take on a rehab project. Arguably, this is the most intensive step required by the BRRRR method; and those without the time or dedication required to see a renovation through will not find success. To those who are intimidated at the thought of managing a rehab, but still want to implement the BRRRR strategy, I recommend building a strong real estate team. This could mean a business partner who is willing to be more hands-on if you provide the capital. Or, it could mean finding a trustworthy contractor who can handle the bulk of the rehab process.

Summary

To review, the BRRRR method describes a strategy that involves buying, rehabbing, renting, and refinancing an investment property—before repeating the process over again. By building equity in a property through renovations, investors can leverage the after repair value to improve the property’s cash flow and invest in additional real estate by refinancing.

Although a certain degree of risk exists, potential downfalls can be mitigated through proper research and due diligence. It is crucial to identify an optimal rehab project, within an optimal rental market. This strategy is perfect for investors prepared to double down on their planning to build a successful real estate portfolio.

Which phase of the BRRRR phase would you find the most challenging? The most rewarding? Share your thoughts in the comments below.

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Real Estate Investing Strategies
Real Estate Investing Strategies
Real Estate Investing Strategies
Real Estate Investing Strategies
Real Estate Investing Strategies
Real Estate Investing Strategies