No, it’s not just a signal that it’s cold. BRRRR is the acronym for a strategy real estate investors use to try to maximize opportunities in a hot housing market. Here are the basics and tips on when it’s time to refinance.
What is the BRRRR method?
BRRRR stands for “Buy, Rehab, Rent, Refinance, Repeat”. Real estate investors use the BRRRR method to buy properties at an undervalued price, repair them and find tenants for a passive income stream. At this point in the equation, the investor has completed BRR – buy, rehabilitate, and rent. The investor then teams up with a mortgage lender who does a payout refinance (the third “R”) to borrow more money to buy another undervalued home, and ticks the final R: repeat.
While the BRRRR method requires advanced real estate know-how, the thinking behind it is simple: add value to distressed or older properties to make them attractive enough to rent, and use that increase in value to keep buying more properties for more acquire rental income. Done right, the BRRRR method is a way to accumulate passive income and build a large portfolio of rental properties. Of course, how successful you are at this will depend on a number of factors, including how much you can save on the purchase price and how experienced you are at budgeting for renovations and assessing the rental market.
Example of the BRRRR strategy
Here’s a simplified scenario: Let’s say you buy a $150,000 foreclosure property at a 20 percent discount ($30,000) and renovate it for $50,000. So far you’ve invested $80,000.
With a new kitchen, bathroom, and floors, the property is now valued at $250,000 and you can rent it out for $2,000 a month to cover the cost of the original loan and rake in some extra cash. (Of course, your exact rental price must match the local market and also take into account insurance, property taxes and other costs.)
Suppose you are now at the point where you owe $115,000 on the original $120,000 loan. While earning rental income, you complete a $187,500 payout refinance — 75 percent of the reappraised value. You pay off your first loan ($115,000) and leave about $72,500 (minus closing costs). They then use part of it to make a down payment towards another foreclosure and use another part of it for rehab expenses. This cycle continues, with rehabilitation, rent, and refinancing to withdraw funds.
How to finance a BRRRR property
Financing an investment property comes with additional requirements and considerations as the home will not be the roof over one’s head and is therefore more risky for lenders.
If you’re an investor interested in the BRRRR method, start by establishing a relationship with a local community bank, says Charles Tassell, chief operating officer at the National Real Estate Investors Association.
“That’s the most critical aspect for an investor,” says Tassell. “Community banks understand individual investors better than large institutions, and they can be a bit more creative when it comes to making room for you in their portfolio.”
Expect the bank to question your background and experience as an investor. If you’re new to the game, it can be helpful to show your bank that your business plan includes local experts — reliable contractors, for example — who can help you solve the problems that can arise when buying property that requires labor. says Tassel.
However, even with a solid working relationship and business plan, securing your loan will not happen overnight.
“Closing hours were everywhere,” says Tassell. “If you don’t have enough time to do due diligence, you can run into big problems. It’s important to have this conversation with a bank to set the right schedule and save yourself a lot of hassle.”
Some real estate investors are also turning to hard lenders to fund their projects. These are not traditional like banks and credit unions, but the main benefit is the ability to get cash much faster. So if you find a distressed property deal that you really don’t want to miss out on, a hard money lender can eliminate the long wait to close. There are major downsides, however, so don’t make this your first go: interest rates on coin loans are typically much higher compared to a mortgage, and often these types of loans require you to pay more points up front. They also typically have much shorter loan terms.
Tips for the third R: Refinancing
You’ve completed rehab and are now ready to refinance a property that’s worth more than when you bought it.
First, consider when you took out your first loan versus now. Some lenders have conditional requirements, which are restrictions on how quickly you can refinance a loan. For example, your lender might want you to wait six months.
Also consider the potential for additional fees and escrow payments.
“Regular refinancing has closing costs that investors need to consider when refinancing too frequently,” said Vikram Gupta, executive vice president and head of home equity at PNC Bank. “Typically, home refinances have no closing costs, but there are early closing fees, where a borrower must pay a prorated portion of the closing costs if the loan closes within three years. Borrowers should consider whether the cost savings associated with refinancing outweigh the closing costs in this interest rate environment.”
Regardless of how long you have to wait, you should also consider the tighter restrictions on investment property refinance withdrawals.
“Underwriting is getting pretty tough,” says Tassell of commercial real estate. “Load-to-value ratios and credit scores are becoming much more important.”
Pros and cons of the BRRRR method
If you are considering using the BRRRR method, you should carefully weigh the pros and cons of this real estate investment strategy.
- You could make a profit without flipping the house. Rather than repairing a distressed property and selling it outright, renting helps you maintain that value and generate regular passive income.
- You could build a network of rental properties without massive overhead. Rather than making down payments with your own funds, the BRRRR method basically recycles your initial buy-in on the first property. They regularly use leverage to increase the value of real estate and build a portfolio of passive income generating units.
- You might underestimate what a property needs. At first glance, rehab might seem pretty simple, but what lies beneath the surface can (literally) crush your budget. The most common mistake new investors make is overspending without budgeting for the necessary expenses, says Tassell: “When you open the wall for a repair and discover major problems with the property, your budget is thrown out the window . If you don’t have the capital, it can really sink you.”
- You have to be a landlord. Passive income may sound great, but you have to do the active work of a landlord — running credit checks on potential renters, fixing problems with the property, paying for higher insurance, and more. Bottom line: Getting those monthly checks takes time and effort, and if you work 9 a.m. to 5 p.m. or are otherwise pressed for time, it might be too much.
- You must be able to tolerate uncertainty and risk. What if your rehab doesn’t increase the property’s value as much as you expect? What if you overestimate your rental income – or are struggling with a vacancy? What if you have to deal with the challenges of evicting your tenant? What if you’re having trouble finding additional properties? The BRRRR method is not for inexperienced real estate investors – you must be prepared to face many challenges and complexities.