Before I became a real estate entrepreneur, I thought “Brrrr” was something kids said when they were cold. But in today’s real estate market, BRRRR is an acronym for an investment strategy entrepreneurs should consider if they wish to combine active and passive income to build wealth.
BRRRR, which stands for Buy, Rehab, Rent, Refinance, and Repeat, are steps successful entrepreneurs have been using for years. When implemented in this order, entrepreneurs are building equity they can leverage later to invest in more properties and grow their portfolio.
(B)RRRR – Buy
While step one—buy a property—sounds simple, entrepreneurs must take as much time as necessary to research their market before making an offer. Purchasing the wrong property or at the wrong price could have a significant impact on the success—or failure—of this method.
Experts suggest the best scenario for success is when the total investment—the purchase price plus renovation costs—do not exceed 75% of the after-repair-value (ARV). This is because many lenders will only finance up to 75% of the property’s value.
Renovation costs can go over budget. As a matter of fact, they are more likely to exceed budget, than be under budget.
For those entrepreneurs that are new to rehab, experts suggest using 70% as their guideline. Having an extra 5% margin would help to cover any over budget situations that could arise.
To explain how these numbers work, consider a property in need of repair. If the property were in great, renovated shape, it would be worth $100,000. Using the recommendation from experts, the purchase price and renovation costs should then not exceed $70,000-75,000.
If the entrepreneur buys the property for $60,000 and expects rehab to cost $10,000, he would have $5,000 available should unexpected expenses come up.
B(R)RRR – REHAB
The biggest mistake an entrepreneur can make when renovating an investment property is spending more on updates than they will receive in return.
Entrepreneurs should keep functionality and livability top of mind when considering renovations. Repairs to leaking roofs or replacement of non-working heating/cooling systems should be priority rehab projects. But upgrading countertops to granite, replacing working appliances with stainless steel, or adding whirlpool tubs to bathrooms may be bad decisions if they cost more than the value added to the property. The exception may be luxury rentals—or amenities expected in their market.
Entrepreneurs must also keep in mind competitive rental offerings. If most rentals in their market have two bedrooms and their property only has one, it may be more difficult to rent or to get the price they are looking for. In this case, the cost of adding a bedroom may be a worthwhile investment.
BR(R)RR – RENT
Once the rehab phase has been completed, getting the property rented quickly is best. Most lenders will not refinance a rental property if the unit is vacant.
Owning a rental unit comes with a set of obligations entrepreneurs should be aware of. This would include locating and screening potential tenants, responding to maintenance or repair calls, and managing turnover.
While rehabbed properties in good rental markets tend to attract quality tenants, vacancies do occur. Entrepreneurs need to keep these costs in mind when establishing their budget.
BRR(R)R – REFINANCE
To take advantage of the newly acquired equity, refinancing the initial loan is the next step in BRRRR. Entrepreneurs should look for a lender that would offer a cash out.
However, keep in mind, some lenders require ownership for a period of time before they would consider refinancing based on the appraised value instead of the investment amount.
BRRR(R) – REPEAT
Using the cash acquired from the refinance, entrepreneurs are ready to start the process again.
It’s A Great Strategy, But Not For Everyone…
It’s obvious that any strategy has its advantages as well as its risks, and the BRRRR method is no exception.
When done correctly, the BRRRR strategy has the potential for a high return on investment. Renovation creates immediate equity. And if the property is properly rehabbed, it should attract good tenants who are paying top dollar for certain features and amenities that they will likely take better care of. Besides creating a strong cash flow for the entrepreneur, good tenants could help reduce expenses in the long run.
However, many entrepreneurs make mistakes from not researching their market well enough, to incorporating personal preferences into the renovation that raise the budget or do not add value to the property overall.
Entrepreneurs don’t always consider all costs, such as those affiliated with loans or refinancing. Or the cost of vacancies due to turnover or during renovation periods, especially if the rehab phase lasts longer than anticipated.
And of course, there’s always the risk that the property will not appraise at the value expected—or needed—to refinance.
Also, Consider Tried and True Strategies Like Wholesaling
All-in-all, the BRRRR method can be the perfect strategy for the entrepreneur that is comfortable with some risk, who has capital available for an initial down payment and is willing to spend time researching the market.
But an entrepreneur that is not comfortable with the above or is intimidated by the rehab phase may opt to look at alternative strategies instead.
One of our favorite strategies that tend to come with less risk is Wholesaling. In fact, we have an amazing podcast that we published recently all about Wholesaling. If you’re interested in learning more about this method of investing in real estate, check out this podcast here.