How the BRRRR Strategy Works
Buy, Rehab, Rent, Refinance, Repeat...
BRRRR is a real estate investment strategy that is increasingly being employed with great success by people wishing to gradually grow their real estate portfolio. It is also a preferred method for people who want to build passive income over time. BRRRR is an acronym that stands for Buy, Rehab, Rent, Refinance, and Repeat.
The first letter ‘B’ stands for buy. This is the first stage of this investment process and thus plays a key role in determining the profit margin the investor will realize.
Deciding on the right property can make or break the potential for a profitable venture.
Factors to consider while checking for a property suited for BRRRR strategy:
- Location of the property: Ensure that the property is located in an area that will provide potential tenants within the expected rental income.
- Potential rental income: Ensure that the rental income in that neighborhood matches the value you expect based on the purchase and repair price.
- Condition of the property: Determine the expected repair costs and use that to determine the best price you can offer for the property.
- Variable and fixed expenses: These are costs such as property management costs, insurance, and security, among others, that you’ll incur after the property is repaired and rented out.
- Property management: Determine if you want to be hands-on or offer it to a management company. This should determine how far from your residence this property can be.
If a property is in a good rental area and you have determined the repair cost and the estimated rental income, you can then proceed to determine your offer price. Most investors use the 70% rule while coming up with an offer price. The 70% rule dictates that the investor should not make an offer of more than 70% of the after-repair value minus the repair costs to be incurred.
For instance, if the after-repair value is estimated to be $150,000, and the repair cost is estimated at $40,000, the investor should not pay more than $65,000 for the property.
(After Repair Value * 70%) - Repair Costs= Max offer value
(150,000*0.7) - 40,000 = $65,000
The remaining 30% ensures the investor gets a profit and also covers miscellaneous costs. However, this is not a binding rule for investors; ultimately, the investor can have other positive factors attached to the property that make them break the rule and go above the 70%. By using 70% you ensure that the profit margin is protected.
The second letter ‘R’ for ‘Rehab’ represents the second step of the BRRRR investing strategy. This is a critical step that requires the investor to balance between the cost of repairs and the value they will add to the property. The investor’s best-case scenario is to have each repair undertaken to add more value than the cost.
The rehab process is meant to make the purchased property livable and functional. You want to ensure that the house is good enough to charge rent that makes the venture profitable in the long run.
To achieve this the investor should avoid adding luxury items that would unrealistically raise the repair cost. Instead, focus on adding value at a lower cost.
- Engage the contractor you intend to use before purchasing the property. This will ensure that the estimated rehabilitation cost matches or almost matches the actual repair cost. If you estimate the costs without a contractor, you might be shocked by the actual cost charged by the contractor you engage. Ensure you select a contractor with a good reputation and experience in handling your specific type of repair.
- If you’re able to remodel the house by adding an extra bedroom or bathroom at a reasonable cost, always do it. These are known to add value to the property as well as increase the chances of getting a tenant fast.
- Make security plans for the property to ensure it is not vandalized when the contractor is not on site. This can set back the complete schedule as well as increase repair costs.
The next step is renting out the property. You need to decide whether to use a property management company or directly handle the rental process. Some investors prefer to use property management companies in order to get a tenant fast and also avoid future vacancies. This is because these companies have potential tenants contacting them regularly and can therefore handle a tenant's vacating and another tenant planning to come in simultaneously. In some areas, an individual may have difficulty attracting the specific type of tenant that they are looking for. Ensure that you thoroughly screen potential tenants to avoid future conflicts or loss of rental income. Potential problems from a bad tenant include:
- Unreasonable damage to the property
- Illegal activities on the property
- Failure to pay the rent on time
- Being a nuisance to the neighbors
- Inability to maintain the property in a clean and livable condition
All these problems can negatively affect the value attached to the property during the appraisal process. Bad tenants and vacancies can lead to the property being listed for foreclosure. However, this is not to mean that the BRRRR strategy is not very effective; it is to make one aware of the need to be keen on every step of this investment strategy.
Refinancing is the fourth step. There are two refinancing options that are commonly offered by banks.
1. Cash-out refinance: Under this option, the bank offers a new higher mortgage on the rehabbed and rented property to replace the old mortgage. This allows the property owner to gain some cash from the deal. Some of the benefits that an investor will gain with this option include:
- Reduced interest rate
- Renegotiated repayment period
- Decreased monthly payments
2. Debt pay-off option: Under this option, you pay off the existing loan only and negotiate new terms attached to the new rehabilitated and rented out property. This allows the investor to get out of the unfavorable terms and negotiate new terms that are favorable.
As an investor, you should choose the first option as it sets you up to repeat the process.
Things to consider when choosing the lender:
- ‘Seasoning period’: this is the period that the bank will require that the borrower owns the property before they can consider refinancing it.
- Refinancing pre-approval: it is always a good idea to get pre-approved by the bank you are planning to use before you buy the property. A delay or failure to be refinanced can stop the BRRRR investor from expanding their portfolio and leave them cash strapped.
This is very important with single-family homes that are not easily approved for a refinance.
How to prepare for an appraisal
The appraisal process is very important and will play a big role in determining how successful the investment was. At this point, the investor gets to know how much their property is valued by the mortgage market. Their goal all along was to ensure that the property fetched as high an appraisal value as possible. Below are some tips that can lead to the property getting a higher appraisal value:
- Ensure the property is clean on the day of the appraisal
- Ensure the appraiser gets access to the property to avoid drive-by appraisal
- Ensure that you inform the tenants of the upcoming appraisal so as to gain access easily
If you do not know the banks that are offering refinancing options, you can easily find them on websites such as CoreLogic or ListSource.
After you have successfully completed your refinance process, it’s time to analyze the whole project and the lessons learned. The whole process will have accumulated a lot of paperwork.
Benefits of BRRRR Strategy
- Scalability: it is relatively easy to build a profitable real estate portfolio with BRRRR. You start with one property and can use that property to gradually acquire more properties, one at a time.
- Growth in skill and experience: with the first property you might feel overwhelmed, but as you continue increasing your portfolio you learn more about best repairs, best contractors, and value addition, among others. As the investor gains more experience they make better decisions on the property to buy, the estimated repair cost, and the items that add the most value to the property.
- Passive Income: When well-executed, this strategy can guarantee an investor a consistent income contributing to the growth of their net worth.
- Does not require a lot of capital to start: If you get the right deal, you can start with very little out-of-pocket cash. Your passive income can then grow as you increase your portfolio without injecting more out-of-pocket cash.
- Potential to attract quality tenants: After rehabilitating a property using the latest trends in house design, the potential to attract high-quality tenants who are willing to pay top dollar increases.
Cons of BRRRR Strategy
- It is not easy to get a good contractor who’ll give a repair cost estimate that matches the actual cost of the repair. In many cases, contractors have ended up inflating the repair cost while the work is ongoing by adding new items that need to be replaced.
- If you are purchasing a property out of State, the property may be vandalized while still being repaired. This happens if the property is in a neighborhood with a higher security risk and the contractor takes too long to complete the repair.
- It can sometimes take too long to find a tenant, even for a good house, because the price is seen as too high or the economy is not doing very well. In most cases when this happens, the landlord has to lower the rent while still incurring lost rental income when the property is vacant.
- Getting the right tenant at the set price is not easy and can sometimes take too long. Landlords however prefer to wait for a tenant who’ll meet their requirements and not lower the property value by causing unnecessary damages or present problems when it's time to pay their rent. Even with a thorough screening process, some bad tenants can still pass as meeting your set criteria.
- High interest rates: Expensive mortgages/loans can scuttle even the best laid BRRRR plans.
The Risks of BRRRR Strategy
- Long Renovation Period: This can be caused by a dishonest contractor or other factors outside of anyone’s control. For instance, extreme weather will cause a project to be delayed for the safety of the contractor’s staff as well as the quality of the work. It is therefore important that you consider the season before starting out on a renovation project. Renovations projects stopped halfway for long will sometimes cost more as some of the repaired and exposed areas might be damaged.
Contractors who are not fully invested in the project can also delay the project by limiting the manpower working on the project or by being absent from the site for many days. Delays in renovation translate to a loss of potential rental income and can affect the refinancing plan. Since the investor has already tied his capital to the project, it would be best for the rehab to end as soon as possible and for a tenant to settle into the property. This way they are able to cash out first and move on to the next project.
2. Economic Upheaval: Economic upheaval can cause vacancies or cause tenants to be unable to pay their rent on time. Lack of consistency in income can make BRRRR strategy ineffective in the long term.
During the COVID-19 pandemic, the government banned eviction of tenants under some income categories. This order did not extend to the banks foreclosing on properties and is expected to have a long-term impact on investors holding BRRRR guided property portfolios. It is therefore important for an investor to take into consideration the market status before venturing into this investment strategy.
Is BRRRRR strategy right for you?
Based on the information we have discussed up to this point, what is left is deciding whether the BRRRR strategy is right for you or not.
This strategy works best for people looking to grow their passive income from their real estate portfolio. It is a slow process and you have to be patient and ready for hiccups along the way. However, when done right, you can be sure of great success in the long term.
In addition, investors willing to go through this route must be ready to get their hands dirty. You must be willing to do a lot of research, engage contractors, and monitor renovations.
If you do not have the time, will, or ability to keep up with the demands of this strategy, you could still partner with somebody to make it work.
BRRR & Bookkeeping: Handling The Financial Side Of The Strategy
The BRRR strategy can certainly be an excellent method for generating a healthy income from the world of real estate, but unfortunately it’s far easier said than done. You need to master the art of bookkeeping and accounting to stand any chance of making a respectable return on your investment, as there are countless costs and discrepancies that could easily cause you to lose money and potentially tarnish your reputation or credit score.
There are many costs that are associated with real estate investment and the BRRR strategy, and properly managing these costs should be your top priority.
The costs associated with buying can fluctuate and change depending on your unique situation, but buying a property outright is likely going to be the most expensive aspect of your investment journey. Many things can influence the price of a property, including its condition, location and size. The current financial climate can also impact on the price of a property, as the housing market is a volatile one that can fluctuate depending on the economy. Ensuring that you have taken the opportunity to properly budget for your purchase is key, as you should aim to give yourself a little leeway - it’s difficult to purchase a property for an exact figure you had in mind, as a seller may have their own expectations and no doubt haggling will ensue. There are also other costs associated with buying a property, that will need to be paid after the purchase is complete. These are costs that first time investors may not be aware of. You may need to pay ground rent if you have purchased an apartment, and it’s more than likely you’ll have to start paying property tax too. Tax preparation should be a main focus to avoid unexpected bills and potential fines. If you have a mortgage then you’ll need to start paying homeowners insurance too, along with any utility bills - this will be explained in greater depth shortly.
It's fair to say the cost of rehabbing your investment property will be influenced by the current condition of the property itself, as of course, the worse the condition, the more you’ll have to pay. You must give yourself a large enough budget to cover the entire project of rehabbing your property, from the materials that you’ll need such as paint and carpets, to the smallest details like light switches and door handles. You’ll also need to budget for the cost of workmen to complete any rehab tasks that you are unable to do yourself. It’s also vital that you can provide yourself with an emergency fund, as the possibility of things going ‘wrong’ during renovation work and the chance of encountering unexpected costs is fairly high. You may discover an issue with your property that you didn’t notice previously, such as rotting floorboards. Failing to budget for any unexpected repairs or maintenance fees will leave you in hot water, as this will simply eat into your profits and send all of your calculations into free fall. As mentioned above, you will also take on the cost of utility bills - any electricity or water that you or your workmen use during renovation work (which will no doubt be high, especially with power tools involved) will need to be factored into your budget. Always keep a detailed breakdown of each and every rehab cost that you encounter, as this way you can ensure you are sticking to your budget. To stay within your budget, avoid spending too much money on luxury goods - make the property liveable and homely, nothing more.
Renting out your property is likely the least costly aspect of your BRRR journey, but it does require considerable bookkeeping and accounting to ensure you remain in control and on track. Your decision as to whether you handle the rental side of things yourself or seek out a property management firm will influence the amount of time and money you spend on renting out your property. If you have the time and would like to vet potential tenants yourself to provide more peace of mind on rental security, then you can post your own advertisements and manage your tenants without the need to pay a property management company. Alternatively, you can hire an estate agent to find and manage tenants on your behalf, but they will take a fee for their services. No matter what you choose, always request for evidence that tenants will be able to pay their rent - this may include a recent bank statement, or a positive reference from another authorized rental agency. Keep track of rental payments using a purpose built program like quickbooks or use an outsourced bookkeeping agency if necessary, and take the appropriate action when any rental payments are missed. There are various legislations in place to protect landlords against nonpayment of rent, so make use of these to protect your investment financially.
Refinancing your rental property can provide great financial benefits for your real estate investment, but it can be a fairly complex and confusing process. Having your accounts in order will be absolutely key for this step of your journey, as you’ll need to be able to back up every claim that you make with clear evidence and data. You have to show that you’re making progress and profit, that your investment was certainly worth it, and will continue to be profitable for years to come. There are issues that can impact on your ability to refinance, so be sure to prepare yourself on the day to increase your chances of success. Having good tenants that pay their rent on time and maintain your property well is vital, especially when it comes to a property appraisal. Without this, your chances of succeeding are low. Keep your paperwork in order, and ensure your bookkeeping and accounting is clear and concise. Any errors could jeopardize your ability to refinance your property. When you are negotiating terms for your new mortgage deal, take the opportunity to perform a few calculations beforehand. Knowing the numbers in advance will allow you to steer towards a more favorable deal on the day.
BRRRR strategy is a very effective method of growing a profitable real estate portfolio gradually. When implemented well the investor is able to secure passive consistent income that keeps growing as the market grows and their portfolio expands.
Before deciding on the property to buy, the investor should do their due diligence to understand the rental market in that area, refinancing options for the property, and the repairs required to make the property livable and functional. Failure to do due diligence can lead to high repair costs incurred, low rental income, or low appraisal value. The investor should keep in mind how much the property is bringing in and the possibility of short-term vacancies when negotiating refinancing options. This strategy remains one the best real estate investment strategies for investors looking to grow their portfolios gradually.