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 representing a hybrid between active and passive income. Read on to find out more about the BRRRR strategy.
[ Thinking about investing in real estate? Register to attend a FREE online real estate class and learn how to get started investing in real estate. ]
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.
Matt Woodley from Mover Focus states that “the BRRRR Method is a real estate investing strategy that helps investors identify, research, and purchase properties at a discount. The BRRRR method involves three steps: brainstorming, researching, and reselling. By brainstorming ideas for potential properties to invest in, investors can gain an understanding of the market and find undervalued properties. Once researched, investors can determine whether or not the property is worth purchasing and make the necessary repairs or upgrades. Finally, once purchased and renovated, the property can be resold at a profit”.
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 determines the investment outcome. There is a complicated intersection between making sure a property represents a sound investment deal and 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 and ensuring 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. Using this rule of thumb, they can better ensure that a profit margin will remain after renovating a property.
At the most basic level, landlords must identify how to make their rental properties livable and functional. Once these requirements are satisfied, updates or renovations that add value to a property (and thus justifying increased rental rates) may be considered. On the other hand, investors must be careful not to make any excessive upgrades that will cost more than what can be produced through rental income.
Representing the first ‘R’ out of four, the rehab phase of the BRRRR strategy 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. Here are a few rehab projects with high ROI to look out for:
Roof Repairs: It is common for appraisers to return the money you spent in property value when adding a new roof.
Updated Kitchen: Outed kitchens are often unappealing, but many of its features may still be usable. Also, houses with demoed kitchens are ineligible for financing, making them frequently bought with cash. Rehabbing a house with a kitchen in one of these states has proven to have a high ROI.
Drywall Repair: Drywall damage also makes a house ineligible for financing. While this may be a red flag for most homebuyers, this can be an opportunity for rehabbers as drywall is actually very inexpensive to repair.
Landscaping: Simple landscaping projects, such as removing overgrown vegetation, can be done with little cost to you. This type of landscaping also doesn’t require a professional to complete, making it a high ROI rehab project.
Updating Bathrooms: Bathrooms are usually not very large and their material and labor costs are inexpensive. Updating bathrooms will allow your home to compete with higher quality homes in the area for little cost to you.
Additional Bedrooms: Homes with an exceptional amount of square feet but lack enough bedrooms offer rehabbers an opportunity to increase value at little cost to them. Increasing a home’s bedroom total to 3 or 4 will allow it to be more competitive with higher-end properties in the area.
Once the property’s rehabilitation phase 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 their practice of minding due diligence was satisfactory. Possible things that can go wrong include vacancies, bad tenants, or rental expenses that exceed the 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 exercising the BRRRR strategy, but merely to emphasize the importance of properly running the numbers before making any investment decision.
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; you will want to select the former of these two options. You will also want to note the required ‘seasoning period,’ which indicates how long you must own a property before the lender considers refinancing against the appraised value of the property. Although you may encounter some banks that are unwilling to refinance single-family rental properties, investors can generally tap into their networks to find a lender that fits their refinancing needs.
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 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 step. 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 can 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 can 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.
[ Learning how to invest in real estate doesn’t have to be hard! Our online real estate investing class has everything you need to shorten the learning curve and start investing in real estate in your area. ]
BRRRR Method Pros & Cons
There are numerous factors to consider before tackling the BRRRR strategy ranging from your schedule to financing, tax incentives to holding periods. Read through the following pros and cons to learn more about what you’re diving into.
BRRRR Strategy Pros
Any investing strategy will promise certain advantages while bearing some level of risk, and the BRRRR method is no exception. Before executing any strategy, make sure to review the pros and determine for yourself whether or not BRRRR is appealing 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 bought 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 reduce their 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, investors can find themselves over-leveraged, especially during the rehabilitation phase. According to Brian, a real estate investor and founder at SparkRental.com, “Far too many new investors underestimate expenses such as repairs, maintenance, vacancy rate, and other irregular but inevitable expenses that don’t hit you every single month.” 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 improve 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 allows 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.
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.
Refinancing A BRRR Property
There are two main ways to refinance your BRRR property. One of the options available is through conventional financing. This option is the most popular and comes with the lowest interest rates available. Another option to refinance can be found in commercial finance, although they come with higher interest rates.
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 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.
How Much Can You Make With The BRRRR Method?
Investors can make significant returns with the BRRRR method, if they are able to secure the right purchase price for each property. Investors also need to pay careful attention to the market, as this will determine how well they are able to find consistent tenants and generate rental income. Essentially, the amount of money you can make with the BRRRR method comes down to how well you can find great leads at all stages of the process. As you can imagine, the results can vary depending on a number of factors from financing methods to the sheer size of a portfolio. Always mind your due diligence and be sure to develop a reliable system for analyzing potential investments.
BRRR Method Alternatives
If you decide the BRRRR Method isn’t the right real estate investment strategy for you, there are other strategies you can pursue. One option is to purchase a property and rent it out, collecting the monthly rent paid on the property. Another option is to crowdfund real estate. This involves the process of utilizing funding from a wide range of investors who pool their money to purchase real estate, allowing for investments made with less money and work.
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.
Ready to start taking advantage of the current opportunities in the real estate market?
Click the banner below to take a 90-minute online training class and get started learning how to invest in today’s real estate market!