Welcome to the first chapter of the big book of real estate strategy an on-going series where I’ll be covering all the popular, unpopular, proven, and experimental strategies and tactics that reside in the real estate landscape.
I’ll be explaining the strategy, breaking down how they are supposed to work, the formulas and principles involved in the strategies, considerations you need to think about, the pros and cons of the strategy, how to start the strategy if you like it and my concluding thoughts on the strategy.
To start of this series, I’m going to be coming out of the gates with one of the most popular real-estate strategies out there. So does it hold up?
What Is The BRRRR Strategy?
The BRRRR method is a real estate investment strategy that continuously combines and uses multiple real estate tactics (buying, renovating, renting and refinancing) to create an on-going cycle that is meant to quickly develop a position where a BRRRR invested property allows for the purchase of another property with BRRRR strategy potential.
Breaking Down The BRRR Method.
To apply the BRRRR strategy, it requires an investor to strictly and to execute the following actions:
The first step of applying the BRRRR strategy as your real estate plan is to (wait for it) … Buy a property! But don’t just rush to say “well duh.”
There’s more to buying a BRRRR strategy viable property than just having the disposable income to pay for the down payment on a property and to viable for credit.
When you’re buying a “Ready-For-BRRRR” property, there are 4 vital considerations that need to be made to evaluate whether or not the property is viable for the strategy. These considerations include the following:
a. How is the property valued?
As with almost every real estate strategy out there (that I will discuss in later chapters); the biggest factor of success is the wedge. The wedge, in real estate, is the space range between how much the property is bought for and how much the property is worth.
The bigger the wedge, the more likely it is that the BRRR strategy will work because there is a larger buffer for risk management as well as giving you more leverage and potential to sell the property at a premium.
A wedge is affected by many factors such as negotiation and seller status and if you want to know more about wedge deals, you can find a dedicated post on it (HERE).
b. What is the renovation potential of the property?
As part of the BRRRR strategy, you are going to have to renovate (Rehabilitate) the property. Though you will only rehabilitate the home in the next step, you have to ensure that it is rehab ready in the buying stage.
A rehab ready property is more than just a fixer-upper, it’s a property that has renovation opportunities that you know; will be profitable and capable of raising the value of the property – not just for you and potential tenants but for the lending facility who will refinance your home in step 3 (see how everything depends on this stage?)
You will need to know the cost of renovations and their ROI on value for your property. If you want to learn about which renovations are worth their weight in gold and which renovations will sink you; go to my post on just that (HERE).
c. What is the renting potential of the property?
The BRRRR strategy is particularly demanding and nit-picky when it comes to what is BRRRR strategy viable. In terms of renting out, the rental revenue should be able to cover all or the majority of the following:
– Mortgage on the property.
– Property insurance.
– Property repairs and maintenance.
– Enough cash-flow for renovation savings.
The above should all be financeable as soon as the property is rehabilitated in stage 2 and listed on the market. As you can see, this is very demanding. This is why you need to become familiar with the rent range and potential of the property in the initial Buy stage of BRRRR before you invest too heavily where it is not viable.
Renting out the property will later assist in the refinancing stage of BRRRR.
d. What is the refinancing potential of the property?
The final crucial consideration for successfully running a BRRRR strategy is understanding how the refinancing process works in your state and for the specific type of property you own and are renting out.
Some lenders (banks and mortgage brokers) have what is called a seasoning period where they will not refinance a property within the first 6 months of its purchase. This changes from state to state as well as potentially changing from property type to property type.
Practitioners and debaters can strongly are that the refinancing stage is the most important stage of raising your chances of success with the BRRRR method because it is the single-stage that determines whether or not you can refinance you home for enough value to repeat the BRRRR strategy.
I would argue that by stating that the success or failure of the refinancing stage is already decided by the groundwork done in the buying stage; as I’ve covered above.
A property that is viable for the BRRRR strategy needs to positively affirm the above considerations. The buying stage of BRRRR is the foundation that determines every other step of strategy and the overall success potential of the entire strategy.
Rehabilitation in the BRRRR strategy is more than just fixing the flaws in a home to make it as good as new. To get the most out of rehabilitating a home, you are aiming to make it more valuable than it would be; even if it was new.
This is done through appropriate renovations and remodels of the property and there is a fine line when doing this.
Rehab a home too little and you not only risk jeopardizing the rental potential of the property through how much you can charge and how quickly you can get your home off the market but you also risk not getting the most out of refinancing or even not being able to refinance enough to complete the last stage of the BRRRR method.
Rehab too much and you might sink your investment by overspending to the point where you cannot rent out the property at a price that would be needed to cover the costs as well as having your rehabs go above the value cap of your neighborhood – where the property value can’t rise any more regardless of what you do to the home.
You need to be able to separate the worthwhile areas of rehab and the areas that are not justifiable to invest in. You can learn more about the most profitable and least profitable avenues to renovate a residential property (HERE).
Once the property is purchased and the rehabilitation process has been completed, the next phase to executing BRRRR is to rent out the property. Renting out the property has a support role in the BRRRR model that is both short-term and long-term.
In the short-term, renting out your BRRRR property will support you in the next stage of refinancing by assisting in showing the lending facility (bank or broker) that the property is generating income. This makes you less of a risk to lend money too; thus increasing your chances of getting a loan in the first place.
In the long term, renting out the property is going to provide you with rental income that will not only contribute to covering all the expenses of owning the home – paying your mortgage and for property repairs but will also provide you with net income for personal use.
As mentioned above, you need to be aware of the rental range for properties like yours in that specific area to ensure that the property can realistically afford to fund most, if not all of the costs of owning and running the property.
Refinancing is a process of replacing an existing mortgage with a new one. There are 2 potential refinancing avenues to take; a “cash-out” refinance and an “outstanding-debt” refinance.
In the context of the BRRRR model, you will want to take out the “cash-out” refinance which will have the bank appraise your property and higher value because of the relevant and profitable renovations you would have made as well as because the property is already generating income.
When appraised, the bank provides you with a new loan that is over and above what you owe on your previous mortgage + cash at closing. This is a formula to refinancing a property which can be projected beforehand to evaluate the viability of BRRRR. It goes like this:
The BRRRR Strategy Refinancing Formula:
Step 1 – Identify the total Property Purchase Price, Down Payment Amount, and Outstanding Loan Amount (before refinancing).
Step 2 – Identify the amount used to rehabilitate the property.
Step 3 – Identify your total cash investment at the time of refinancing.
step 5 – Get the property re-evaluated for refinancing and identify the value.
step 6 – Get a new loan for the re-evaluated property.
step 7 – If viable, pay off the old loan with the new one and claim the remainder as cash at closing for the last step of a phase of BRRRR.
By this, the final stage of a single phase of the BRRRR model you should have on hand; enough income from what you received at “cash at closing” to completely or significantly fund the down payment and rehabilitation of another BRRRR viable property to restart the BRRRR modal indefinitely – again and again.
Thought Process Behind The BRRR Strategy.
The BRRRR method is hailed by many as the holy grail of real estate investment strategies and for good reason. When everything lines up and goes smoothly; the BRRRR strategy allows a practitioner to do the following:
1. Raise their wealth and capital from property acquisition.
As with the majority of real estate investment avenues, The BRRRR method involves the acquisition and retention of property which is a fixed asset that contributes to increase an individuals’ net worth and has a high likelihood of appreciating over time.
2. Generate a continuous stream of income from renting out the property.
BRRRR viable properties are rented out at large pricing leverage which should not only cover the majority if not all the expenses of running the property but will also generate enough net income (after expenses) for personal use.
3. Rapidly repay their original mortgage loans.
The refinancing of the property, when carried out successfully will allow a BRRRR practitioner to apply for a second loan at a value that is over and above the total value of the previous loan. This allows the practitioner to repay their original mortgage, as well as have income leftover.
4. Use the cash-at-closing to fund the down payment of another property.
The undeniable greatest benefit of the BRRRR strategy is that it allows a practitioner to quickly leverage renovating, renting out, and refinancing a property enough to purchase another property.
The fact that this can be done in a relatively short period (under a year) is a phenomenal feat. In theory, the BRRRR method can be repeated indefinitely to continuously purchase and reap the above perks of multiple rental properties.
Considerations – What You Should Know About The BRRRR Strategy
The following is a detailed list of what a potential practitioner needs to be conscious of when considering applying the BRRRR strategy:
- Do you know your figures?
- Can you survive the time horizons?
- Do you know which renovations are worth it?
- Do you know your rental market?
- Do you know how the property will be appraised?
- Are you prepared to be all-hands-on-deck?
1. Do you know your figures?
Successfully implementing a BRRRR model strategy is a numbers game. As a practitioner you need to plan and operate within a tight budget:
- Did you purchase the property at a worthwhile wedge?
- Is your budget for rehabilitating the property within a reasonable range to produce results without taking you under?
- Will you be able to rent out the property consistently to a tenant at a price that is sufficient to cover the running expenses of the property?
- Will you be able to refinance the property to the minimum viable value to repeat the cycle?
Each point of the above needs to work for the BRRRR strategy to work and as such, a practitioner needs to be conscious of every dollar they spend and be sure that it is going to the right place in the right amount.
2. Can you survive the time horizons?
Time horizons in real estate are the periods between the purchase of a property and the moment the property begins to generate income. The BRRRR strategy has a significantly long time horizon because of the following:
- The time is taken to design, fund, and execute the rehabilitation process of the property and…
- The time needed to list the property and acquire a tenant who brings in income in the property.
Because BRRRR works better when more value can be added into the property, an ideal property will have multiple areas needing rehabilitating which can take 3-6 months+
During that time, a BRRRR practitioner will have to pay mortgage bills, insurance, repair, renovation, and remodeling costs – all before the property brings in a single penny. As such, a practitioner needs to be able to survive that period through sufficient financing.
3. Do you know which renovations are worth it?
The first phase of the BRRRR model after acquiring a property is to rehabilitate the property through renovations. But not all renovations are made equal; a BRRRR practitioner needs to be aware of which renovations will be worth their investment to bring in tenants and add value to the property.
A practitioner who is not aware of this; risks the complete failure of the BRRRR strategy as they may not make the appropriate renovations to bring in a good tenant or that will revalue the property to the minimum viable amount.
4. Do you know your rental market?
Are you certain that you will be able to rent out the property at an amount that covers all or the majority of the running costs of the property? If not, you risk acquiring a loan and being in a stable enough situation to run a second property if you still manage to effectively refinance the property to afford the purchase of another one.
5. Do you know how the property will be appraised?
Do you know how they refinancing is done in your state? If you don’t, just know this; as stated above, refinancing can come in two forms: “cash-out” and “outstanding-debt” and if you can only refinance through “outstanding-debt;” you cannot implement the BRRRR strategy at all.
Aside from that, are you aware of how the bank refinances the property in the first place to make sure you are making the appropriate renovations?
6. Are you prepared to be all-hands-on-deck?
You’ve probably seen, the BRRRR strategy involves a lot of planning and action. It’s a never-ending cycle that when each phase is started, it needs everything to be watched over and run perfectly either by you or by a prepped and ready property manager.
Evaluating The BRRR Strategy – Pros and Cons.
|Pros Of The BRRRR Strategy.||Cons Of The BRRRR Strategy.|
|Build equity quickly.||High-interest rates or fees or early loan repayments.|
|Generates income from tenants.||Longer time horizons and seasoning on the properties.|
|Scalable + economies of scale.||Many avenues for failure.|
|High ROI potential.||Appraising a property is a risky business.|
|Potential for no money down.|
Pros Of The BRRRR Strategy.
1. Builds equity.
The BRRRR strategy is focused on around a continuous cycle of repeated purchases of property which you can acquire multiples of through relatively small down payments from your end. This is because you’re leveraging refinancing of one property to purchase the next.
2. Generates income from tenants.
After rehabilitating the property, you have access to a high-end property that you can charge premium rent on; the rent not only gives you personal income, but sufficient enough cash flow to cover the costs of running the property (mortgage payments, repairs, and insurance).
3. Scalable + economies of scale.
When done effectively, refinancing provides you with more capital to scale and purchase more properties. When you purchase more properties you can leverage economies of scale for rental income, loan leverage, tax benefits, property appreciation, and income diversification.
4. High ROI potential.
Because you are leveraging purchasing properties via wedge deals that are financed through small short term loans as well through rehabilitating the property to charge more rent for it; you stand to earn a large return because you earning income with relatively little of your capital invested in the property.
5. Potential for no money down.
A common agreed upon principle of economics is this “money now is more valuable than money tomorrow;” economically, this is because tomorrows’ money is influenced by inflation (things cost more), and today’s money benefits from compound interest (gives you more money).
The BRRRR model works in this sphere because it allows you to save more of your own personal by making use of the money you get from lenders to acquire the property.
Cons Of The BRRRR Strategy.
1. High-interest rates or prepayment penalties.
In theory, you will only need to take out short term loans that will be able to finance payment of the down payment on BRRRR property, the cost of rehabilitating the property, and a few mortgage payments.
These short term loans are easier and more convenient to repay but at the cost of usually having significantly higher interest rates. And if you decided to go through a long term loan, when you refinance your property and pay it back, you may be subject to prepayment penalties for paying it back too early.
2. Longer time horizons and seasoning on the properties.
Traditional rental properties will not usually require long periods for renovation or may even be purchased ready to rent out. BRRRR properties on the other hand; are purchased because they have great and often time-consuming renovation potential – this leads to long periods before the property can be rented out to generate income.
As well seasoning periods; the time before a property can be refinanced – slow down the BRRRR process to only being viable a few times in a year as well as forcing you to repay more payments from the original loan.
In cases where the seasoning period is up to a year or longer; short term loans may no longer be viable, which puts you at risk for prepayment penalties.
3. Many avenues for failure.
The BRRRR model is made up of 5 different stages of handling a property that each require their specific factors for success and failure and should one factor fail, the entire BRRRR strategy is compromised.
4. Appraising a property is a risky business.
Despite the seasoning period, when you finally get your property appraised, the value by which the property is appraised to is in the final hands of the bank and though the risk can be minimized by doing the math and knowing what you are doing – Your property may not be valued high enough for what you would need to repay your previous loan and finance another property.
This is a big problem and immediately halts the progress of the BRRRR strategy.
Conclusion – Do I Recommend BRRRR.
When you look at through a narrow lens, you could easily say “BRRRR” is perfect for everyone. After all, it can build a practitioner a large real estate investment portfolio in a relatively short time but as I said, this is a narrow and obscured view of the model that ignores certain nuances.
The BRRRR strategy is undeniably successful and it is not a matter of fixed decision like do I or don’t I recommend it. The more accurate questions for the more accurate answers would be these:
Who Would I Recommend BRRRR For?
I would recommend BRRRR for the active practitioner who loves the thought of leveraged income more than the thought of passive income – the BRRRR model is anything but passive and needs a lot of work that involves paying meticulous attention to multiple variables and details.
A BRRRR ready property is a dime a dozen and you need to keep your eyes and ears on the market day in and day out to make sure you get it before someone who doesn’t realize it’s value does.
An individual needs to learn and read up on being well versed in almost every form of real estate investment – buying, renovating, renting, and refinancing. You have to be prepared to love and put in the work.
Many avenues can cause the strategy to fail and you need to be prepared to be in the trenches to conduct market research because if you do, the potential rewards are immense.
Who Would I Not Recommend BRRRR For?
In short, I would not recommend the BRRRR strategy to anyone who isn’t ready to do what I mentioned above. BRRRR is very demanding and if you aren’t prepared for the work needed to successfully implement it; it will not be worth its required effort.
That said, an individual who isn’t ready for BRRRR can still successfully partake in BRRRR by assembling a strong and knowledgeable team to make implementing the strategy more manageable for them.
Aside from that, there are also many other real estate strategies that could be just as lucrative as BRRRR for someone else. Just remember this, “most strategies work, but very few will work for you.” Make sure you do your due diligence in finding the strategy that works for you.
For chapter 2 in The Big Book Of Real Estate Strategy; go (HERE).