In times of economic uncertainty like we are in today, many Americans feel less anxiety over their investments when they are in the driver’s seat. One of the best ways to do this without taking up too much of your free time is through real estate investing.
Home prices and interest rates remain elevated, causing homeownership to remain an elusive dream. Because of this, many young Americans are in desperate need of homes to rent. This and other economic factors have led to higher rents and significant profits for landlords.
One of the best strategies to employ as a real estate investor to take advantage of the current market is BRRRR, which stands for Buy, Rehab, Rent, Refinance, and Repeat. There are many advantages to the BRRRR method over regular rental or house flipping strategies. Read on to see if this method might be for you.
BRRRR Introduction
Before we get into each of the five steps, let’s go over a quick introduction into this system. Unlike house flipping, where you immediately sell a house after renovating and then go to the next one, the BRRRR method requires you to hold onto the home and rent it out. You still renovate the homes, but instead of realizing profits by selling the home for an increased value, you get your equity back by refinancing the home after renovations and taking out the cash difference between your original loan and your new one.
You can then take this money and your net income from renting the property and use it to buy a new home. This method allows you to build up your real estate portfolio without requiring you to consistently invest your own funds outside of the income you are generating from your rental properties. We’ll go over each step below to give you a detailed understanding of the process.
Step 1: Buy
The most important part of the BRRRR method is finding good real estate. Your goal should be to find a home in need of improvements in a great location where people want to live. There are a few questions you need to ask yourself to help you find the right home to purchase.
How much can I borrow?
Homes in need of drastic repairs may not be up to the standards conventional lenders require for them to provide a loan. As a result, you may have to put in more equity than you would for a typical home purchase. You can get conventional loans for properties that just require minor renovations, but keep in mind that you want your renovations to add a greater value to the home than the cost of the renovations.
How much will renovations be?
It is up to you to determine if you want to buy a home in need of many repairs, or just some minor renovations. If you want to make major renovations and repairs, it would be best to talk with a contractor and determine a budget to renovate the home to your standards. If you are just doing some minor renovations, you can go online and research material and labor costs for common projects.
What will the home be worth after renovations?
You want the value of your home after renovations to be greater than the original cost of the home plus the amount of money you put into the renovations. To do this, look for homes on the market that are similar to what you think your investment home will look like once renovations are completed. Once you find a few properties in the same area with similar features, finishes, and of a similar size, you can use their listing prices to determine the value of your home after renovations.
What rents can I achieve?
A big part of the BRRRR method is achieving income through rent that can be invested into additional properties. You want to confirm that market rents in your area will be enough to generate solid positive cashflow after accounting for taxes, insurance, maintenance, and utilities. Follow the same process you did for finding your home value. Look for homes being rented that are similar to what you think your investment home will look like after renovations and use these rents to determine what you will be able to charge.
Once you have answered all of these questions, you will have an idea of what you can afford in terms of purchase price and renovations, and whether these will lead to a home value and rents that justify the investment. Keep in mind that the numbers will not work out for every property. In fact, they may not work out for most properties you research.
Investing is all about putting in the time to find the right deal. Many people make the mistake of putting in the time to find out how to make the wrong deal work. Do not get emotional about investing. Even if you really like a specific property, if the numbers don’t work, move on.
Step 2: Rehab
Once you have purchased the home, the Rehab step is where you implement your business plan. Pay close attention to standard finishes and features of homes in the area and try to renovate your home to similar standards as the comparable properties you researched in the Buy phase.
The success of your BRRRR strategy relies quite heavily on this step, as you must achieve a good after-repair value in order to take full advantage of the benefit of refinancing. If you put more money into the renovation than the renovation increases the property value, you aren’t going to be successful.
It is important to research the cost of the specific renovations you hope to complete. Look into costs for materials and labor. Speaking with a contractor to get estimates is a good idea so you know the renovations you can afford with your budget.
During the due diligence process of purchasing the home, you should relay any surprises the inspectors find to a contractor to determine how costly those fixes might be. You can generally increase your return potential by purchasing properties that need a lot of work, but it comes with an increased risk of finding even more issues than what you were originally aware of.
Step 3: Rent
Now that you have purchased a home and completed the renovations, it is time to find renters to live in the home. It’s important to determine an appropriate rent in the Buy stage because you need to make sure that the market rent for your property is enough to cover insurance, taxes, and whatever utilities you aren’t charging your renters.
The best way to do this is to use comparable properties from your area. Your comps to determine rent will most likely be different from your comps to determine your after-repair value because not all sold properties will be used for the purpose of renting.
Still, you should be looking for the same qualities in both sets of comparable properties. You need to find properties in a similar location of a similar quality in order to most accurately estimate the market rent you will be able to achieve. If comparable rental properties are scarce, consider that the location you are looking in is not appealing to renters.
Renting your property adds additional costs as you will have to advertise on a rental website like Apartments.com or Zillow in order to get traffic. You may need to pay to get your property advertised, and you could benefit from having professional pictures and video tours completed as a way to make your property stand out from the competition.
Once you get an applicant for your property, you will need to pay for a background check in order to confirm that the tenant meets your requirements, which includes income verification and a criminal background check.
You also need to manage the property and make sure you are able to handle any maintenance requests from your tenants. The process of procuring tenants can be costly and time consuming, so you want to make sure that good tenants are happy, and a big part of that is handling their requests in a timely fashion.
Step 4: Refinance
You have put in all the hard work for your property. It has been purchased, renovated, and now has tenants. You have accomplished your objectives and now you get your reward in the form of a cash-out refinance. A cash-out refinance is the refinancing of a home where you take some of your equity out of the property. It is a way to capitalize on an increased valuation of your property after completion of the renovations.
Here’s an example in the context of the BRRRR method. You purchase a home in need of repair for $200,000. You used $40,000 of your own equity to buy the home and got a loan of $160,000 to pay for the rest. You use an additional $50,000 of your own equity in order to renovate the home, and once it has been renovated, the valuation of the home has increased from $200,000 to $300,000. Now that the valuation is $300,000, you refinance with a loan of 80% of the new valuation, which is $240,000.
New Loan: $240,000
Minus Old Loan: $160,000
Equals Cash-Out Amount: $80,000
This shows that you get $80,000 in cash back after paying off your old mortgage. Your initial contribution was $40,000 and you put in an additional $50,000 in renovations, so your total equity contributed was $90,000. After you get the $80,000 from the cash-out refinance, you have effectively only contributed $10,000 of equity to this project.
This shows the value creation potential of the BRRRR method. You get rewarded for your efforts to improve the value of the home while also receiving monthly rent payments that can be put towards the purchase and renovation of new properties.
Granted, there are risks to this strategy. Everything does not always go according to plan. In the example shown, I assumed the $50,000 of equity put in for renovations increased the property value by $100,000. What if it only increased the property value by $50,000? Below shows how that math would shake out.
New Value: $200,000 + $50,000 = $250,000
New Loan: 80% of $250,000 = $200,000
Minus Old Loan: $160,000
Equals Cash-Out Amount: $40,000
Your cash-out amount of $40,000 is less than the $50,000 of additional equity you put into the property. This will decrease your returns and increase the time it takes you to build up equity to invest in your next property. You also might not be able to achieve the rents you were projecting when you assumed the after-repair value would be higher.
The benefit of the BRRRR method is that even if you don’t achieve the valuation you were hoping for, you’ll still be able to earn income from renting the property. This contrasts with house flipping where your ability to earn money relies solely on if you were able to increase the value of the property by more than you put into the renovations.
Another advantage of the BRRRR method over home flipping is that the money you get from a cash-out refinance isn’t taxable. This money is viewed as part of your current loan rather than income, so you don’t have to pay taxes on it and can put the full amount towards the next property. One negative is that you usually have to wait six months after purchase to refinance the home.
Step 5: Repeat
You’ve completed all of the steps. Now you get to do it again. Successfully repeating the process is what will allow you to build your real estate portfolio at a fast pace. The more properties you have, the more rental income you are receiving, which in turn leads to more money you will have to invest in new properties and renovations.
A bigger portfolio comes with added stress and work, and the only way to alleviate yourself of this is to hire more outside help. When your portfolio gets big enough, it can make sense to hire a property manager to handle the leasing, maintenance requests, and bookkeeping. They will usually charge a percentage of gross revenue, but it is worth the expense if you are not equipped to handle it all yourself.
Another important thing to remember when you’re repeating the process is that you do not need to perfectly execute every time. In fact, you are almost certainly not going to perfectly execute every time. Sometimes your renovation costs might be higher than the increased value in the home. Sometimes you won’t be able to rent a property for the amount you had hoped you could. So what?
When things aren’t working, you can get creative. Always be on the lookout for new homes and areas where people seem to be flocking. You can always sell an underperforming property earlier than you originally desired and purchase a new one if you think it will be better for your portfolio.
It is up to you to determine how to utilize the BRRRR method. Do you want to build up a massive real estate portfolio, or are you just looking for some extra passive income in the form of rent payments? Either way, the BRRRR method is a great strategy to consider as it will make you money if you can successfully complete each step.