You might have heard someone saying "BRRRR" in a seminar, investor gathering, or online. It sounds like a training method for animals but in fact, it is a popular real estate investment strategy known as the BRRRR method.
Those wondering how to build wealth in real estate should consider this unique framework that represents a hybrid between active and passive income. Read on to find out more about the BRRRR strategy.
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 of time, 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.
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 will determine the outcome of an investment. There exists a complicated intersection between making sure a property represents a sound investment deal, while also 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, as well as making sure 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. By 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 both livable and functional for their tenants. Once these requirements are satisfied, updates or renovations that will add value to a property (and thus providing justification for increased rental rates) may be considered. On the other hand, however, investors must be careful not to make any excessive upgrades that will end up costing more than what can be produced through rental income. Representing the first ‘R’ out of four, the rehab phase of BRRRR 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.
Once the rehabilitation phase of the property 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 or not their practice of minding due diligence was satisfactory. Possible things that can go wrong include vacancies, bad tenants, or rental expenses that exceed 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 from 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; of these two options, you will want to select the former. You will also want to make note of the required ‘seasoning period,’ which indicates how long you must own a property before the lender will consider refinancing against the appraised value of the property. Although you may encounter some banks that are not willing to refinance single-family rental properties, investors can generally tap into their personal 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 when compared to other sources of capital, tax benefits, and having control over your own 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
Sale price : $450,000
Down payment 20% : $90,000
Loan amount : $360,000
Rehab : $50,000
Total Cash in : $90,000 + $50,000 = $$140,000
New Value after rehab : $560,000
Re-Finance 80% : $448,000
New loan - Old loan : $448,000 - $360,000 = $88,000(cash back)
Your initial cash investment : $140,000 - $88,000 = $52,000
Rental income : $2300/mth
Loan payment : $1800/mth
Tax/Maintanace : $350/mth
Total income : +$150/mth
While this example does use simplified numbers, it should help to illustrate the BRRRR process in action. It might seem $150/month is not a lot but in the long run, your rent will gradually increase and the value of the property will increase, and most important your tenant is building your equity for you.
Property Value after 10 years example simplified ($560,000):
Annual inflation 2%+1%(appreciation) =3% : 10years= $752,000
1350% return on your initial $52,000 investment.
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 in order to build a successful real estate portfolio.