In the real estate realm, the “BRRRR method” simplifies the path to success: buy, rehab, rent, refinance, and repeat. This approach involves acquiring distressed properties, revamping them, generating rental income, and then refinancing to bankroll more real estate investments. Unlike traditional methods, BRRRR prioritizes flipping these properties before refinancing for future acquisitions.
In the cash-out refinance phase, investors leverage their property’s increased equity to secure larger mortgages, providing extra capital for various investment opportunities, like acquiring additional rental properties. It’s a potentially profitable strategy, but one that isn’t without its risks – a journey worth embarking on with careful consideration. Explore the potential pitfalls of the BRRRR method before diving into the world of real estate investment.
What is a BRRR?
The BRRRR Method, an acronym for “buy, refurbish, rent, refinance, repeat,” is a systematic approach for investors seeking passive income. This method involves a precise sequence of steps. Firstly, investors acquire a property, which is then meticulously renovated. Subsequently, the refurbished property is leased to tenants for an extended duration. The rental income covers the mortgage, generates profits, and builds equity. As equity accumulates, it can be leveraged to purchase more properties through refinancing, repeating the process.
The ‘B’ in the BRRRR method stands for “buy,” and it’s the critical starting point for the entire investment journey. This phase involves a multifaceted evaluation, determining the property’s potential as a lucrative rental. Factors such as renovation costs, projected monthly rental expenses, and ensuring a profitable rental income are meticulously analyzed. Investors often adhere to the 70 percent rule, which considers repair expenses and post-renovation value to establish the maximum property offer. This rule safeguards a viable profit margin post-renovation.
The next step in the BRRRR method is “refurbish.” Here, landlords must ensure their rental properties meet basic living standards and functionality requirements. Once these prerequisites are met, investors can explore value-adding renovations that justify higher rental rates. Striking a balance is crucial, avoiding excessive upgrades that surpass potential rental income.
In the BRRRR strategy, the first ‘R’ stands for “rehab,” and it involves a thorough cost-benefit analysis at each step. Investors should focus on home improvement projects known for their favorable return on investment (ROI). Here are some rehab projects with high ROI:
- Roof Repairs: Repairing or replacing a roof often adds property value equal to the investment.
- Updated Kitchen: Even outdated kitchens can have salvageable features. Houses with demoed kitchens, typically purchased with cash, offer a high ROI rehab opportunity.
- Drywall Repair: Fixing drywall damage is relatively inexpensive and 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.
After completing the property’s rehab phase, the investor progresses to the “rental” stage. This phase includes tasks such as tenant screening, managing turnover, and addressing maintenance requests. Over time, investors evaluate the effectiveness of their due diligence. Challenges may arise, including vacancies, troublesome tenants, or rental costs surpassing income. These issues can strain property finances, increasing the risk of foreclosure. Therefore, it’s crucial for investors to carefully analyze the numbers and make informed decisions when implementing the BRRRR strategy or venturing into the realm of landlords.
After completing the rehabilitation and rental stages, it’s time to consider refinancing. Some banks offer cash-out refinance options, while others focus on covering the outstanding debt. Opting for a cash-out refinance is generally more favorable. However, be aware of the ‘seasoning period,’ which indicates how long you must own the property before refinancing based on its appraised value. Although some banks may hesitate to refinance single-family rentals, investors can usually find suitable lenders through their networks.
Following the cash-out refinance of the initial rental property, investors can proceed to finance the purchase and rehabilitation of their second property. Cash-out refinancing offers advantages such as favorable interest rates, tax benefits, 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 delve into the BRRRR real estate strategy using an example. Meet Johnny Crushit, a resident of Austin, TX, keen on tapping into the growing rental market. He discovers a property priced at $200,000 and crunches the numbers. Johnny puts down $40,000 and secures 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 increases to $250,000, and Johnny rents it for $2,500 per month. Approximately a year later, Johnny undergoes a cash-out refinance, obtaining a loan for 75% of the appraised value, which amounts to $187,500. This clears the original $160,000 loan, leaving Johnny with $27,500 (in addition to ongoing rental income) to invest in another property. Johnny can replicate this process, amassing more investment properties over time. While these figures are simplified, they provide an overview of how the BRRRR strategy operates in practice.
How The BRRRR Method Works
When executed correctly, the BRRRR Method can generate passive income and establish a continuous cycle of property acquisition and ownership. This method comprises the following steps:
- Purchase a property: Identify distressed properties that require renovations to meet rental standards. These properties are typically more affordable due to their condition.
- Rehabilitate the property: Conduct extensive renovations to address structural, safety, and aesthetic issues, preparing the property for rental.
- Rent out the property: Determine the rental rate and secure tenants to occupy the property.
- Perform a cash-out refinance: Utilize a cash-out refinance to convert your property’s equity into cash. This is achieved by obtaining a larger mortgage that exceeds your current loan balance. The cash can be allocated for various purposes, including the acquisition of additional properties.
- Time to Rent: The ability to rent out your property depends on the timely completion of the renovation work. Delays in the renovation process can significantly affect your schedule, particularly if you plan to have tenants in place before refinancing. In the BRRRR strategy, the refinancing process often hinges on having tenants, and your cash flow won’t kick in until occupants move in. Therefore, any delays in the renovation work translate to a lengthier wait for returns on your investment. While having financial reserves to handle delays mitigates this concern, it remains a critical aspect to consider, especially for a BRRRR property.
- Rental Income: The anticipated rental income is a central component of your BRRRR analysis. It directly influences whether the property can generate positive cash flow. If the numbers don’t align for a positive cash flow scenario, it may necessitate 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 foresee positive cash flow with tenants in place, you might contemplate flipping the property instead. Your decision is contingent on your BRRRR objectives, but rental income stands as a pivotal factor.
- Refinancing Timing: Typically, lenders impose a seasoning period of approximately six months after tenants are in place before you can initiate the refinancing process. This means your capital will be tied up for a minimum of six to twelve months, taking into account the timeline for renovations. For instance, if you possess $100,000 for a BRRRR deal, it might be a year before you can reinvest that capital. In contrast, traditional rental property investing with the same $100,000 could secure five properties with a 20% down payment. This raises the question: which portfolio will yield more cash flow—five properties or two?
- Refinancing Limits: The strength of a BRRRR deal hinges on your ability to recover your initial investment and reinvest it. While achieving this in every BRRRR deal is ideal, it’s not always feasible. After the six-month seasoning period, you might still retain $5,000 to $10,000 in the deal due to lender restrictions on the refinancing amount. This outcome is reasonable, but it necessitates a six-month wait for refinancing. In contrast, traditional rental property investing requires saving up for a 20% to 25% down payment, which can be more challenging depending on market conditions and your available liquid capital. If there are cost-saving opportunities that enable you to invest more in traditional rental properties, it’s a path worth considering.