No, it’s not just a signal that it’s cold. BRRRR stands for a strategy real estate investors use to try to maximize opportunities in a booming real estate market. Here are the basics and tips for knowing when it’s time to refinance.
What is the BRRRR method?
BRRRR stands for “Buy, Rehabilitate, Lease, Refinance, Repeat”. Real estate investors use the BRRRR method to buy property at an undervalued price, repair it and find tenants for a passive source of income. At this point in the equation, the investor has completed BRR – buy, rehab and rent. The investor then partners with a mortgage lender who will do a cash refinance (the third “R”) to borrow more money to buy another undervalued home, checking off the final R: repeat.
Although the BRRRR method involves advanced-level real estate expertise, the thinking behind it is simple: increase the value of distressed or older properties to make them attractive enough to rent out, then leverage that appreciation to continue to acquire more properties for more rental income. Done well, the BRRRR method is a route to collecting passive income and building a large portfolio of rental properties. Your success, of course, depends on a number of factors, including how much you can save off the initial purchase price and your experience with budgeting for renovations and assessing the rental market.
BRRRR policy example
Here’s a simplified scenario: suppose you buy a foreclosed property for $150,000 with a 20% down payment ($30,000) and renovate it for $50,000. So far you have invested $80,000.
With a new kitchen, new bathroom and new floors, the property is now valued at $250,000 and you can rent it out for $2,000 a month to cover initial loan expenses and pocket some extra cash. (Of course, your exact rental price will need to align with the local market and also factor in insurance, property taxes, and other costs.)
Let’s say you are now at the point where you owe $115,000 on the original loan of $120,000. While earning rental income, you refinance cash for $187,500, or 75% of the newly appraised value. You pay off your first loan ($115,000), which leaves you with approximately $72,500 (less closing costs). You then use part of it to make a down payment on another foreclosure and use another part for rehabilitation expenses. This cycle continues, with rehabilitation, leasing and refinancing to get cash out.
How to finance a BRRRR property
If you’re an investor interested in the BRRRR method, start by building a relationship with a local community bank, says Charles Tassell, chief operating officer at the National Real Estate Investors Association.
“This is the most critical aspect for an investor,” Tassell says. “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 review your background and experience as an investor. If you’re new to the game, it might be worth showing your bank that your business plan includes local experts – reliable contractors, for example – who can help you solve any problems that may arise during the purchase of properties in need of work, said Tassell.
Even with a solid working relationship and business plan, getting your loan won’t happen overnight.
“Closing deadlines have been everywhere,” says Tassell. “If you don’t have enough time to do your due diligence, you can run into big trouble. It’s important to have this conversation with a bank to get the timing right and save you a lot of trouble.
Some real estate investors are also turning to hard money lenders to help finance their projects. These are not traditional like banks and credit unions, but the main advantage is the ability to get money much faster. So if you find a deal on a distressed property that you really don’t want to miss, a money lender can eliminate the long wait before closing. There are some big downsides though, so don’t make this your first go: interest rates on hard money loans tend to be much higher than those on a mortgage, and often these types of loans require you to pay more points up front. They also tend to have much shorter loan terms.
Tips for the Third R: Refinancing
You’ve completed rehab, and now you’re ready to refinance a property that is worth more than when you bought it.
First, consider when you took out your first loan versus now. Some lenders have seasoning requirements, which are restrictions on when you can refinance a loan. For example, your lender might ask you to wait six months.
Also consider the possibility of additional fees and escrow payments.
“Regular refinancing will incur closing costs that investors will need to seriously consider if they refinance too frequently,” says Vikram Gupta, executive vice president and head of home equity at PNC Bank. “Typically, real estate refinances don’t have closing costs, but they do have early closing costs, where a borrower will have to pay the proportionate share of the closing costs if the loan is closed within three years. Borrowers should consider whether the cost savings associated with refinancing outweigh the closing costs in this rate environment.
However long you have to wait, also consider the tighter restrictions for cash refinances on investment properties.
“Underwriting is getting a little tighter” for commercial properties, Tassell says. “The loan-to-value ratio and credit ratings are going to become much more important.”
Advantages and disadvantages of the BRRRR method
If you are considering applying the BRRRR method, think carefully about the pros and cons of this real estate investment strategy.
- You could make a profit without flipping the house. Instead of fixing a distressed property and selling it immediately, renting helps you retain that value and earn regular passive income.
- You could build a network of rental properties without huge overhead. Instead of making down payments with your own funds, the BRRRR method essentially recycles your initial purchase on the first property. You regularly use borrowed funds to increase property values and build a portfolio of passive income-generating units.
- You might be underestimating a property’s needs. At first glance, a detox might seem pretty simple, but what’s beneath the surface can demolish your budget (literally). The most common mistake new investors make is spending too much without budgeting enough for the necessary expenses, Tassell says: “When you open the wall for a repair and find bigger issues with the property, your budget is thrown out the window. If you don’t have the capital, it can really sink you.
- You must be the owner. Passive income may sound great, but you’ll have to do the active work of a landlord – perform credit checks on potential tenants, resolve issues with the property, pay for increased insurance and more. Bottom line: It takes time and effort to get those monthly checks, and if you’re working a 9 to 5 or are short on time, it might be too much to handle.
- You have to be able to tolerate uncertainty and risk. What if your rehab doesn’t increase property value as much as expected? What happens if you overestimate the amount you will receive for rent or have to deal with a vacancy? What if you had to face the challenges of your tenant’s eviction? What if you’re having trouble finding additional properties? The BRRRR method is not for novice real estate investors – you must be prepared for many challenges and complexities.