for Every Homebuyer
The Plan:
BRRRR Method - Buy, Rehab, Rent, Refinance, Repeat. A relatively new strategy compared to some others mentioned within this grouping, but its popularity can contend with the oldest of methods, if not exceed them entirely.
The basic premise of this method is simply purchasing a distressed property, making significant improvements and repairs to form equity in the property, and using this newfound equity to secure an entirely new property while retaining and renting out the previous one. Rather than selling your home and upgrading to a new one, which keeps your portfolio size the same, you retain ownership of the original property and secure a new one through this process.
It is a simple yet incredibly effective strategy. Through utilizing the BRRRR method, an average individual can transform a modest, one-property portfolio into a small empire of rent-generating assets in a handful of years depending on the efficacy of their execution and prevailing market conditions. However, it is an intensive process that demands both time and resources, and is certainly not without risk. Investors with a discerning eye for interior design, great entry prices, healthy safety margins and high renovation potential can use this strategy effectively. Those who find themselves lacking in these areas should enlist the aid of an experienced mentor or pursue your project as a joint venture with willing and able friends.
Process Breakdown
Step 1: Investor Secures Financing
Financing for a property that only needs cosmetic improvements and lighter renovation will not be all that much different than regular home financing, if at all. The only difference is that this financing will be for a non-owner occupied (NOO) property, and will subsequently be accompanied by stricter loan terms and higher pricing.
This is due to NOO properties presenting greater risk to a lender, as an owner would likely be much more inclined to abandon their responsibilities to a mortgage on a property they do not reside in versus their primary residence, should they find themselves in a situation where they can no longer support both payments. Down payment requirements will be higher for NOO property mortgages as well, with usually a minimum of 10% down for a second home (for short term rental strategies), and 10% - 25% down for an investment property depending on the loan program used.
Distressed properties that will require major improvements and renovation are typically significantly more difficult to acquire financing for. Paradoxically, these types of properties tend to provide the highest potential as BRRRR investment opportunities. Consider the fact that in a mortgage loan, the home you purchase is the collateral for the loan, and serves as a strong factor in ensuring that you satisfy that mortgage obligation lest the home be repossessed by the lender via foreclosure. Now consider how attractive, as collateral for a mortgage loan amounting to hundreds of thousands (if not millions) of dollars, a damaged and uninhabitable property would be to the average lender.
However, we have plenty of options for investors to secure financing for great investment opportunities where traditional lenders fall short. When it comes to distressed properties, we have a dedicated suite of loan programs offered by lenders who are not only open to financing this type of home, but actively work with investors on these types of projects.
Step 2: Investor Purchases Property with High Renovation Potential
Note that this does NOT limit you to distressed properties. While distressed properties can often present great BRRRR deals depending on their price, homes located in great areas that are just dated in interior and exterior design (and otherwise in great condition) can also be great BRRRR opportunities.
While scouring the MLS on sites such as Zillow or Trulia is an option, consulting a wholesaler can save time in finding a suitable property to work with. Wholesalers make a living by finding properties with attractive investment potential, securing the purchase contract, and charging a fee for transferring that contract to an investor (a process known as "assigning" a contract).
It is imperative that you conservatively plan out the expenditures and timeframe that will accompany the repair process, as well as obtaining an accurate after repair value (ARV) figure, before committing to a purchase. Consult with reputable contractors to obtain accurate quotes for the work that you intend to perform if you cannot accurately assess such figures on your own. Likewise, when it comes to determining a realistic ARV, you should also consult the aid of a reputable and competent real estate agent to perform a market analysis and provide to you a potential property value after intended repairs are completed. Determining an ARV may be done on your own provided you have thoroughly researched the methodology behind the process of procuring a realistic value. To see a rough breakdown of how to calculate potential ARV, see step #2 in the Fix & Flip strategy section.
Step 3: Investor Improves the Property
Investors can either rehab property themselves (not recommended unless experienced in home renovation and improvement), or hire trusted, skilled, and LICENSED contractors to improve property from an undesirable (or even unlivable) condition to a living space that looks and feels brand new. It is of critical importance that the contractors you use can provide valid licensing in their craft; your property insurance coverage may be left with large vulnerabilities in coverage should any of the major improvements be performed by unlicensed contractors. The safety and longevity of your improvements are also better solidified by licensed professionals.
This process can take several months to complete. Costs and time consumption always run over budget and almost never under. Be sure you prepare adequately and conservatively with this in mind. You should also carefully plan out the new design (if performing major improvements) against the preferred tastes of the local tenant base. Catering to a base of young professionals near a university town will likely lead to different design choices than you may choose if catering to a base of families in older, suburban areas with a focus on school systems and child care.
Step 4: Investor or Investor's PMC Seeks Out Tenants
The investor or their PMC (Property Management Company) will begin the process of securing (usually) long-term leases to offset the cost of the current and future mortgage loan. If you are not enlisting the aid of a PMC, be sure that you understand the laws regarding tenant's rights in your state and city to avoid any legal complications. Understand what you can and cannot do when it comes to: tenant application processing, requiring security deposits, raising rent in the future, visiting the property without prior notice, eviction proceedings, etc.
Step 5: Investor Performs Cash Out Refinance To Recoup Investment
The investor executes a cash out refinance on the improved investment property for the (usually) maximum 75% LTV allowed, collecting enough needed for down payment and rehab costs for the new home. On occasion, you may be able to qualify for cash out programs that allow you to withdraw greater than 75% LTV, but the availability of these programs often vary with the conditions of the wider housing market, and may be priced higher due to the increased risk of the high loan amount. Certain loan programs, such as conventional financing, may also have what is known as a "seasoning" period, or a waiting period that lasts 6 months from the purchase of a home to when you can perform a cash out refinance on that property. There are plenty of programs that do not require this waiting period.
By performing a cash out refinance, the investor pays off the original mortgage used to finance the property purchase, recoups their initial down payment, and hopefully ends up with significant excess cash after both of the previous conditions are met, which will be applied towards the down payment of a new BRRRR property. This is the final "R" of the acronym, or "repeat". By capitalizing on the new equity from the increased value of your improved investment property, you have regained the capital you need to begin the process all over again, but this time you have an entire new property within your portfolio.
Summary
Pros:
High potential returns due to cumulative profits from expanding property portfolio.
One of the faster-moving strategies, allowing for significant results to be achieved in a comparatively short time period.
Strategy yields high-quality investments that provide you with an asset that presents both profitability and longevity.
Lowered risk from planning the project without relying on selling the improved property at a required price.
Cons:
Added operational expenses from closing costs of the purchase mortgage and refinance mortgage.
Strategy can seem deceivingly foolproof at first glance by mostly relying on borrowed funds. Do not attempt to take on more properties than you can comfortably afford.
Hinges on dependable tenantcy after improvement. Tenants can be unreliable. Be sure to vet them well.
Risk of appraisal coming back lower than expected in a dropping housing market.
Conclusion:
Overall, the BRRRR method presents the real estate investor with an extremely powerful tool that can see their passive income multiply several times over if executed properly. It’s an extremely fluid strategy as well, which can be applied to a variety of situations. For example, in the event that you already own a primary home which has built up significant stores of equity over time, you are already in a prime position to execute a BRRRR strategy by capitalizing on the equity of your current home. Subsequently, a non-investor can quickly use a variation of the BRRRR method to pick up another property as a source of passive income.