If you are a real estate investor, you must have overheard the term BRRRR by your colleagues and peers. It is a popular method used by investors to build wealth along with their real estate portfolio.
With over 43 million housing units occupied by renters in the US, the scope for investors to start a passive income through rental properties can be possible through this method.
The BRRRR method acts as a step-by-step guideline towards effective and convenient real estate investing for beginners. Let’s dive in to get a better understanding of what the BRRRR method is? What are its important components? and how does it actually work?
What is the BRRRR method of real estate investment?
The acronym ‘BRRRR‘ simply means – Buy, Rehab, Rent, Refinance, and Repeat
At first, an investor initially buys a property followed by the ‘rehabilitation’ process. After that, the renewed property is ‘rented’ out to tenants providing an opportunity for the investor to earn profits and build equity over time.
The investor can now ‘refinance’ the property to purchase another one and keep ‘repeating’ the BRRRR cycle to achieve success in real estate investment. Most of the investors use the BRRRR strategy to build a passive income but if done right, it can be profitable enough to consider it as an active income source.
Components of the BRRRR method
1. Buy
The ‘B’ in BRRRR represents the ‘buy’ or the buying process. This is a crucial part that defines the potential of a property to get the best outcome of the investment. Buying a distressed property through a traditional mortgage can be difficult.
It is mainly because of the appraisal and guidelines to be followed for a property to qualify for it. Opting for alternate financing options like ‘hard money loans’ can be more convenient to buy a distressed property.
An investor should be able to find a house that can perform well as a rental property, after the necessary rehab. Investors must estimate the repair and renovation costs required for the property to be able to put on rent.
In this case, the 70% rule can be very helpful. Investors use this rule of thumb to estimate the repair costs and the after repair value (ARV), which allows you to get the maximum offer price for a property you are interested in purchasing.
2. Rehab
The next step is to rehabilitate the newly bought distressed property. The first ‘R’ in the BRRRR method denotes the ‘rehabilitation’ process of the property. As a future landlord, you must be able to upgrade the rental property enough to make it livable and functional. The next step is to evaluate the repairs and renovation that can add value to the property.
Here is a list of renovations an investor can make to get the best returns on investment (ROI).
Roof repairs
The most common way to get back the money you put on the property value from the appraisers is to add a new roof.
Functional Kitchen
An outdated kitchen may seem unattractive but still can be useful. Also, this type of property with a partially demoed kitchen is ineligible for financing.
Drywall repairs
Inexpensive to repair, drywall can often be the deciding factor when most homebuyers purchase a property. Damaged drywall also makes the house ineligible for finance, an investor must look out for it.
Landscaping
When looking for landscaping, the biggest concern can be overgrown vegetation. It costs less to remove and doesn’t need a professional landscaper. A simple landscaping project like this can add up to the value.
Bedrooms
A house of more than 1200 square feet with three or fewer bedrooms provides the opportunity to add some more value to the property. To get an increased after repair value (ARV), investors can add 1 or 2 bedrooms to make it compatible with the other expensive properties of the area.
Bathrooms
Bathrooms are smaller in size and can be easily renovated, the labor and material costs are inexpensive. Updating the bathroom increases the after repair value (ARV) of the property and allows it to be compared with other expensive properties in the neighborhood.
Other improvements that can add value to the property include essential appliances, windows, curb appeal, and other important features.
3. Rent
The second ‘R’ and next step in the BRRRR method is to ‘rent’ the property to the right tenants. Some of the things you should consider while finding good tenants can be as follows,
- A solid reference
- Consistent record of on-time payment
- A stable income
- Good credit report
- No criminal history
Renting a property is important because banks prefer refinancing a property that is occupied. This part of the BRRRR strategy is essential to maintain a stable cash flow and planning for refinancing.
At the time of appraisal, you should notify the tenants in advance. Make sure to request interior appraisal rather than drive-bys, there’s a possibility that the appraisers may downgrade your property with drive-bys. It is recommended that you should run rental comps to determine the average rent you can expect from the property you are purchasing.
4. Refinance
The third ‘R’ in the BRRRR method stands for refinancing. Once you are done with essential rehab and put the property on rent, it is time to plan for the refinance. There are three primary things you should consider while refinancing,
- Will the bank offer cash-out refinance? or
- Will they only pay off the debt?
- The required seasoning period
So the best option here is to go for a bank that offers a cash out refinance.
Cash out refinancing takes advantage of the equity you’ve built over time and provides you cash in exchange for a new home loan. You can borrow more than the amount you owe in the existing loan.
For example, if the property is worth $200000 and you owe $100000. This means you have a $100000 equity in the property. You can refinance on the equity for $150000 and receive the difference of $50000 in cash at closing.
Now your new home loan is worth $150000 after the cash out refinancing. You can spend this cash on house renovations, purchasing an investment property, pay off your credit card debt, or paying off any other expenses.
The main part here is the ‘seasoning period’ required to qualify for the refinance. A seasoning period can be defined as the duration you need to own the property before the bank will lend on the appraised value. You must borrow on the appraised value of the property.
While some banks may not be willing to refinance a single-family rental property. In this situation, you must find a lender who better understands your refinancing needs and offers convenient rental loans that will turn your equity into cash.
5. Repeat
The last but equally important (fourth) ‘R’ in the BRRRR method refers to the repetition of the whole process. It is important to learn from your mistakes to better implement the strategy in the next BRRRR cycle. It becomes a little easier to repeat the BRRRR method when you have gained the required knowledge and experience.
Pros of the BRRRR Method
Like every strategy, the BRRRR method also has its advantages and disadvantages. An investor should review both before investing in real estate.
1. No need to pay any money
If you have insufficient cash to finance your first deal, the trick is to work with a private lender who will provide hard money loans for the initial down payment.
2. High return on investment (ROI)
When done right, the BRRRR method can provide a significantly high return on investment. Allowing investors to purchase a distressed property with a low cash investment, rehab it, and rent it for a consistent cash flow.
3. Building equity
While you are investing in properties with a greater potential for rehab, that instantly builds up the equity.
4. Renting a pristine property
The property was distressed when you bought it. Then you put effort into making it livable and functional. After all the renovations, you now have a pristine property. That means a greater opportunity to attract better tenants for it. Tenants that take good care of your property reduce your maintenance expenses.
Cons of the BRRRR Method
There are some risks involved with the BRRRR method. An investor should assess those before getting into the cycle.
1. Costly Loans
Using a short-term loan or hard money loan to finance your purchase comes with its risks. A private lender can charge higher interest rates and closing costs that can affect your cash flow.
2. Rehabilitation
The amount of money and efforts to rehabilitate a distressed property can prove to be inconvenient for an investor. Dealing with contracts to make sure the repairs and renovations are well executed is an exhausting task. Make sure you have all the resources and contingencies planned out before handling a project.
3. Waiting Period
Banks or private lenders will require you to wait for the property to ‘season’ when refinancing it. That means you will need to own the property for a period of at least 6 to 12 months in order to refinance on it.
4. Risk of Appraisal
There’s always the risk of a property not being appraised as expected. Most investors primarily consider the appraised value of a property when refinancing, rather than the sum they initially paid for the property. Make sure to calculate the accurate after repair value (ARV).
Financing BRRRR Properties
1. Conventional loans
Conventional loans through direct lenders (banks) offer a low rate of interest but require an investor to go through a lengthy underwriting process. You must also be required to put 15 to 20 percent of down payment to avail a conventional loan. The house also needs to be in a good condition to qualify for a loan.
2. Private Money Loans
Private money loans are much like hard money loans, but private lenders control their own money and do not depend on a third party for loan approvals. Private lenders usually include the people you know like your friends, family members, colleagues, or other private investors interested in your investment project. The interest rates depend upon your relations with the lender and the terms of the loan can be custom made for the deal to better work out for both the lender and the borrower.
3. Hard money loans
Asset-based hard money loans are perfect for this kind of real estate investment project. Though the rate of interest charged here can be on the higher side, the terms of the loan can be negotiated with a lender. It’s a hassle-free way to finance your initial purchase and in some cases, the lender will also finance the repairs. Hard money lenders also provide custom hard money loans for landlords to purchase, renovate or refinance on the property.
Takeaways
The BRRRR method is a great way to build a real estate portfolio and create wealth alongside. However, one needs to go through the whole process of buying, rehabbing, renting, refinancing, and be able to repeat the process to be a successful real estate investor.
The initial step in the BRRRR cycle starts from buying a property, this requires an investor to build capital for investment. 14th Street Capital provides great financing options for investors to build capital in no time. Investors can avail of hassle-free loans with minimum paperwork and underwriting. We take care of your finances so you can focus on your real estate investment project.