The BRRR strategy is the real estate investing strategy of buying a property, rehabing it, renting it and refinancing it. When you repeat this process, we had an addition “R” to the end making it the Buy, Rehab, Rent, Refi, Repeat (BRRRR) strategy.
The Ultimate Guide to the BRRRR Strategy
On October 16, 2019 I taught a live class called The Ultimate Guide to the Buy, Rehab, Refi, Rent and Repeat (BRRRR) Strategy to the Northern Colorado Real Estate Investor Group. The video is posted below.
The following is my outline for the class:
- What is BRRR? Back story of how I “grew up” with my father doing this and how I implemented this strategy early in my real estate investing career.
- Financing BRRR
- Will be financing property twice (find lender first)
- Initial Purchase (cash, line of credit, HELOC, conventional, FHA 203K, Fannie Mae Homestyle reno loan, seller financing, creative financing like subject-to or lease-option, hard money, private money)
- Refi (cash out refi, rate and term refi, private, hard money, commercial financing)
- With refi: taxes and insurance will likely go up
- Seasoning: lender dependent, likely to be at least 6 months, sometimes 12 months.
- Interior appraisals versus drive-by appraisals and challenging low appraisals (what is your plan?)
- Rates for today for: 20% down, 25% down, Nomad™ (3 variations of PMI), Investment Cash Out Refi (75%, 80% LTV, anything higher?), Investment Rate and Term Refi (75% LTV, 80% LTV, anything higher?)
- Pros and Cons of BRRR
- Many of these are not discussed anywhere else.
- Pro over doing Nomad™ is don't need to move into the BRRR properties.
- In an ideal world can do it with no money down… more likely a low money down strategy (but you pay for that privilege with higher rates and increased financing costs)
- Possibly higher return on investment
- Can acquire properties faster (much faster than the 1 per year for Nomad™ and likely faster than 20% down payment if you require time to save down payments)
- Can invest remotely – invest in “better” markets
- Real Estate Investing Rules of Thumb: For every $10K you don't have to finance, you save about $50 per month in payment.
- Can reduce interest rate risk of rates rising while saving money for your down payments or to Nomad™
- Buying properties sooner in an appreciating market will allow you have more properties as values go up
- Severely limited property selection (most choose from the properties you can get at a big enough discount to do BRRR). These may not be the properties you'd want to buy for your rental portfolio long-term.
- Might have lower rent-to-price ratio (if you're not selecting properties optimizing to rental income)… again, less ideal rentals than selecting ideal rentals to begin. Further compounds with DSCR and qualifying for future loans.
- Might have higher maintenance than properties you might otherwise pick as a rental
- Might have reduced appreciation rate (based on having to pick from a limited pool of properties)
- Likely to have higher interest rates than doing traditional 20%/25% down payment buy and hold and definitely higher than buying as a Nomad™. This also will adversely impact your DSCR and your ability to qualify for future loans.
- Interest rate risk during rehab (rates could go up and it is unlikely you're able to lock a rate that far out for a reasonable fee)
- Holding costs during rehab increases your amount invested (and decreases your overall ROI)
- Market risk during rehab (market can decline and you're unable to refi at the level you originally believed you would be able to)
- Requires time and mental overhead to do rehab or manage a crew doing rehab
- Contractor and scope of work uncertainty during rehab
- Appraisal risk
- Buying properties sooner in a declining (negatively appreciating) market will see you have amplified losses. While worse in an appreciating market, dollar cost or dollar value averaging your property acquisitions through buying at regular intervals might be better.
- Finding BRRR purchase candidates (a discussion of property selection, low ball offers, below After Repair Value (ARV) property acquisition, off market deals)
- All other things being equal, simpler is better
- How much equity are you likely to end up with? If you're lucky 20%. More likely less. Cost to capture that equity? Equity wasted in finance costs? Even experienced investors aiming for 25% equity are rarely hitting 20%.
- Optimizing property selection: best discount, best cash flowing rental, best appreciation? Not usually the same! MREI book and ideal rentals.
- Likely to leave some money in the deal… rarely a true no money deal. If you're going to leave money in the deal, why not Nomad™ and get better long-term properties with better rates and better cash flow in your portfolio?
- Challenges with using LLCs and possible solutions
I had originally planned to do more modeling of the BRRRR strategy and how it compares to other strategies like traditional 20/25% down payment buy and hold, the Nomad™ strategy, house hacking and much more. However, I was unexpectedly selected to be a juror for a full week which prevented me from having the extra time I had planned to use to create that part of the presentation. I suspect I will do an updated version or a supplemental class in the future with the better modeling.
Here are some of the extra things I want to include in the supplemental material in the future:
- Basic BRRR modeling in appreciating market with the Real Estate Financial Planner™ (REFP) software
- How do you model with REFP (delay collecting rent, higher closing costs to model initial financing, buy for below ARV with maybe 100% financing)
- Analyze a deal with The World's Greatest Real Estate Deal Analysis Spreadsheet™
- Return on Investment Quadrant™ and Return on Equity Quadrant™
- Modeling BRRR with REFP in a declining real estate market
- Modeling BRRR for Financial Independence/Retire Early folks
- Comparing BRRR versus Nomad™ Property
Buying at a Discount to Refi and Hold
On January 25th, 2017 I taught a special real estate investing seminar on buying at a discount to refi and hold. If you're interested in the BRRRR strategy you may also want to watch this older recording.
Sample Scenarios With BRRR Properties
The following are sample Scenarios that you can copy to your own Real Estate Financial Planner™ account to model buying properties using the BRRR strategy.
- Sample Scenario 007 – Investing $100,000 in Stocks at 8.97%/yr and Earning and Spending $5,000/mo and Buy a Home To Live In with 5% Down Payment and 1 BRRR With Nothing Down
More posts: Scenario With BRRR
More Information on the BRRRR Strategy
Real estate investing has long been one of the best ways for ordinary people to build wealth. But there have always been formidable barriers to entry in the rental property market. And these have meant that a relatively small percentage of people have been able to build significant wealth through real estate investing.
The most serious problem is the sheer amount of time it takes most people to save enough to buy a new rental property. By the time someone can lay aside the $50,000 in cash that is often required to buy a $200,000 duplex, which would be an amazingly cheap property in many markets, a decade or more may have passed. And once that first property has been bought, all of the investor's capital will be tied up in that building until they have generated enough additional cash to buy another property.
Aside from being slow, this process will often cause ordinary investors to completely miss the best opportunities because they simply don't have the cash on hand to act when market conditions are most favorable.
The buy, rehab, rent and refinance strategy is a powerful means of freeing up capital.
The traditional way of buying rental real estate involves identifying a deal, securing bank financing and then managing the property for a long period.
But this method has serious drawbacks. Because many investors are looking for capital gains as well as cash flow, the deal-hunting investor is likely to be buying the property at it's cheapest point, only to renovate it later, sharply raising its value. This means that the investor will have all of their equity tied up in the property when it is worth the most. Not only will the investor not be able to access that capital to carry out new acquisitions, they will also be unable to realize any of the paper gains to the home's appraised value. And even if they haven't improved the property, instead paying full price for a pristine rental, then they will be taking a massive hit to their potential rate of return (return on equity).
The buy, rehab, rent and refinance strategy offers investors a way to constantly extract all of their equity from a rental property, allowing them to convert to usable capital the gains in the property's appraised value that would otherwise only be an unrealized paper increase in their wealth.
The BRRR strategy is also sometimes written as BRRRR, adding the term repeat to the end of the sequence. BRRRR emphasizes the most powerful aspect of the strategy: when done right, nearly all of the capital gains from a project can be extracted within weeks to months and plowed back into new deals. Not only can this send an investor's internal rate of return through the stratosphere, but it can also allow a budding real estate entrepreneur a way to grow their holdings at a rapid pace.
The best part is that, when done properly, this risky-sounding strategy has exactly the same risk profile as traditional mortgage financing. That's because the refinancing portion of the deal will leave the investor with around 25 percent equity in the home, the same amount that would have been present with a traditional down payment. We'll see why later in the article.
With that said, let's take an in-depth look at the buy, rehab, rent and refinance process and how you can use it to start building real wealth.
Unpleasant as it may be to those who have bought into market tops, much academic research now points to purchase price as being the most important factor in overall stock returns.
Unsurprisingly, exactly the same dynamic applies to real estate. For landlords, cash flow is also very important… and most would argue even more important for the long-term buy and hold real estate investor. But getting the best possible price when buying a future rental property is a critical part of earning solid returns from real estate investing.
In the aftermath of the 2008 housing crisis, great real estate deals were everywhere. Anyone with cash and a pulse who bought into the housing market in between 2009 and 2012 has likely made a killing. But since 2015, great deals have become an increasingly scarce commodity. Labor-intensive rehabs are being snatched up with lightning speed. And many homes are being sold before they even hit the market.
But that doesn't mean that finding deals has become impossible. In many locations, finding off-market deals has become a necessary tool in real estate investors' arsenal. Zillow, Trulia and even the local MLS sometimes carry off-market listings.
Building your own locally targeted investor website can be an even better alternative. This is a website that will let people in the areas that you will pay cash for properties that can be rehabbed or that are otherwise distressed in some way. At a minimum, it will provide interested clients with your contact information and the types of deals in which you're looking to invest. And ranking keywords for these websites, especially when they are geared towards specific smaller cities or towns, can often be surprisingly easy.
The bottom line is that, similar to house flipping, you want to find properties that are sufficiently flawed to have real upside potential after being rehabbed. But unlike house flipping, the goal is to create the highest possible differential between the purchase price and the appraised price while also maximizing long-term cash flow from renting the property. In other words, rather than choosing projects that will generate the highest hourly return when the house is sold, someone following the BRRR strategy wants to quickly cash out the most possible money on a refinance while maintaining the highest monthly cash flows into the indefinite future.
In practice, this means that house flippers would consider both low-end and high-end homes whereas BRRRR deals usually work better on lower-end properties for which there are likely to be a large pool of renters.
As with house flipping, a good rule of thumb is that those who buy, rehab, rent and refinance want to be all-in for between 70 and 80 percent of the final appraised price. As an example, this would mean that a home that is estimated to be appraised at $200,000 when all work is completed should only require an up-front investment of around $140,000 to $160,000. This money includes all cash as well as borrowed funds that the investor has put into the project.
When it comes time to refinance, most lenders will allow you to cash out around 75 percent of the property's appraised value. In the above example, if the rehabber has $50,000 of their own cash in the deal and $140,000 total has been invested, this means that they will actually get their entire $50,000 back upon refinancing while also realizing $10,000 in immediate profits via a “cash out” refinance. A downside of this is they will be paying interest on the $10,000 they pulled out in profit. In an ideal world the interest on the $10,000 is more than covered by the rent on the property as positive cash flow.
On top of that, they will have immediately gained 25 percent equity in the deal while having completely paid off the initial loan amount via a refinance. This means that the rehabber now owns a property with a 25 percent equity stake that, if done right, is cash flow positive, producing monthly income that more than covers the mortgage payments! And they have $10,000 more than their initial stake to go find another project and complete the final “R”, namely repeating the process.
But finding the right deal can be tricky. In the above example, if the buyer has cost overruns, the refinancing itself ends up costing more than anticipated or the final appraised value comes in below expectations, they may not be able to cash out nearly as much as they thought. In extreme cases, they may not be able to secure refinancing at all.
Such an outcome would completely defeat the purpose of the strategy. For this reason, it is recommended that buyers always leave a large margin of error, going for a 70 percent all-in target on most properties. With higher targets comes much higher potential risk.
In some markets, it is extremely difficult to find deals that meet this criteria and many investors utilizing the BRRR strategy in these markets will find themselves not hitting the 70% all-in goal and will leave some money in each deal… less than a typical 20% or 25% down payment, but not zero.
Once the property has been purchased, the next step is rehabbing. This is the step where the buy, rehab, rent and refinance strategy really starts to diverge from house flipping. It's important to understand the differences because attempting to rehab a home to rent it as if you were going to flip it can be a disastrous waste of precious capital.
Those who plan on holding the property for the dual purposes of generating long-term cash flow and gaining equity in an inflation-hedged asset have a very different aim than those who plan on immediately offloading the property and realizing their gains. And this means that the rehab strategy will focus on driving long-term value from rents rather than large immediate markups in the home's price.
Now, you may be objecting that part of the purpose of following this strategy is to immediately cash out the increase in appraised value through refinancing. This is true. But as we'll see, the long-term increase in monthly rents is at least as important to the strategy's long-term success as increasing the absolute value of the home. The Real Estate Financial Planner™ software allows you to see this clearly by modeling your own investing strategy.
On top of this, many people following a rehab-to-rent strategy may run into what is known as seasoning on the part of their bank. In short, this means that good flippers may be able to annualize smallish single or double-digit gains four or more times in a year whereas investors that are rehabbing to rent may only be able to realize that gain once or twice per year at the absolute most. In other words, small percentage gains can be vastly more profitable to flippers who plan to immediately liquidate their position within 90 days than to those who plan to hold the property indefinitely while refinancing in six months to a year.
Remember that the primary goal of most house flippers, especially those who do the work themselves, is to maximize their hourly returns and, secondarily, their return on invested capital or internal rate of return. This means that any improvement to the property that they expect to have a reasonable return on investment is going to serve their purposes well. And this is a big reason that house flippers can focus on high-end luxury homes where big-money renovations can result in million-dollar closings. The time spent on such deals can easily generate hundreds or even thousands of dollars per hour.
But the main purpose for those who are buying, rehabbing, renting and refinancing is preserving capital in order to repeat the process quickly and grow a profitable rental business. This means that pursuing big-money renovations—and especially renovations on more expensive properties that would not make good long-term rentals—tends to be counterproductive.
For starters, the strategy calls for dealing at the lower-to-median part of the market where rental demand is stronger. This means that, right off the bat, big-money renovations are unlikely to be profitable at all because doing so would simply be overbuilding for the market.
But the real problem is that big-money renovations will tend to tie up far more capital while generating much smaller-percentage returns and, often, yielding little to no benefits in terms of rent prices. Since the entire point of the buy, rehab, rent and refinance strategy is to free up as much capital as possible while generating huge returns on invested money, this completely undermines the strategy's purpose.
These are not necessarily easy concepts to visualize. So, let's take a look at an example for clarification.
Maximize rent rather than absolute property value
Let's say that someone buys a property for $500,000, $125,000 of which is their own cash. They subsequently carry out another $200,000 in high-end upgrades, which take three months to complete. The appraised value of the home is now $750,000, $50,000 more than the cost of the upgrades plus the purchase price.
From a flipper's standpoint, this might be an excellent (or…at least…acceptable) result. Assuming the home sells quickly, this would represent an annualized return on capital of around 100 percent. Additionally, the flipper will be able to get all of their capital out of the project when it sells. They can use some or all of it for living expenses and/or put it into another bigger deal or multiple deals at once. They have also just made $50,000 in three months, which probably translates to well over $100 per hour for their time—especially if they're not swinging a hammer doing the rehab work.
However, from the standpoint of someone following the buy, rehab, rent and refinance strategy, the above example may be a terrible way to go about things. For starters, they bought a home that would probably be considered higher end in many markets. And it was obviously high-end enough that $200,000 in expensive upgrades added an additional $50,000 in value to the home on top of cost.
Such upgrades are likely to include things like granite countertops, stainless steel appliances, bay windows and expensive hardwood floors. While these are upgrades that will definitely appeal to home buyers, they less likely to have significant effect on rent unless the rental is clearly in the highest-end luxury segment of the market.
Our rehabber now has $375,000 worth of equity in the property: the $200,000 they spent on improvements, the $50,000 in appreciated value and the $125,000 down payment. When they go to refinance, the bank is likely to loan them 75 percent of the home's value. This is called a loan to value ratio of 75 percent. In this case, the bank will loan them $562,500.
Since the rehabber still owes $375,000 on their existing financing, this means that they will only be able to cash out $187,500. This is actually less money than our rehabber has sunk into the renovations alone. Since a major goal of the buy, rehab, rent and refinance strategy is to maintain large amounts of investible capital by immediately extracting all of the initial investment, the fact that our rehabber now has $137,500 of their initial investment permanently tied up in the deal means that from a BRRR standpoint this investment was a failure. And this is a highly simplified example that completely ignores things like refinancing costs, the possibility of cost overruns and appraisals coming in significantly below target, all of which could turn this already bad deal far worse.
Now, consider a case where a rehabber buys a far lower-end property for $150,000, $35,000 of which is their own money. This time, our rehabber is only going to spend $50,000 on targeted improvements that are anticipated to sharply increase monthly rents that can be charged. In this case, let's say that the property's appraised value increased by a total of $75,000. But our rehabber can now charge 50 percent higher rents.
The rehabber now has $110,000 worth of equity in the property, which is appraised at $225,000. The bank will still refinance at the same 75 percent loan-to-value ratio, giving a total loan of $168,750, which the rehabber will use to pay off their $115,000 loan.
In this case, the rehabber is able to cash out $53,750 with the refinance, getting back all of the capital used in the renovation and a few thousand of the cash used to make the initial purchase. On top of this, assuming a 3,000 square foot property, this property owner is likely generating something along the lines of an additional $1,000 to $1,500 per month due to the renovations, allowing them to recoup their entire initial investment in a matter of months.
And a skilled rehabber who knows how to extract the most value from renovations can often do far better than this second example, often cashing more than their starting capital out of the deal upon refinancing.
What kind of rehabs work for rentals?
It's worth knowing what kind of rehab projects are likely to add maximum value to a property that is being improved for rental. In general, the following rehab projects are likely to maximize both a property's appraised value and the rents that the landlord can charge:
- Adding new vinyl siding.
- Painting the front door.
- Adding bark mulch to the front of the property.
- Adding appliances, such as dishwasher, washing machines and garbage disposals if the unit lacks them.
- Thoroughly cleaning the interior and adding fresh paint.
- In some cases, adding an extra bedroom, bathroom or turning a half bath into a full bath may be feasible. These are renovations that can have a large impact on the rent that can be charged when done right.
- Doing light landscaping on properties where the lot has been neglected can have a positive impact on rent.
Some of the most important factors that affect rent rates can only be influenced in the buying process. Chief among them is location. Rental properties that are near amenities like good schools, grocery stores, entertainment and centers of commerce will typically command much higher rents.
Renting out your property is another critical step in the buy, rehab, rent and refinance strategy.
A property that remains vacant for an extended period of time can rob you of cash flow. But having a bad tenant occupying your building can threaten to put you out of business.
Once you've found a good tenant, you should work hard to keep them. Things like always being professional, giving bonuses for signing up again, keeping the grounds clean and being attentive to maintenance faults are all possible strategies to keep good tenants occupying your properties.
However, the real issue lies in preventing bad tenants from ever moving in. And the best way to accomplish this is to adopt a rigorous screening process that can weed out the snakes and keep your business from the ravages of nightmare tenants.
Performing background checks
Every tenant that you consider renting to should fill out a complete rental application that includes their Social Security number, prior residences, current employment status, including the employer, and other relevant personal details. You need to make sure that a prospective tenant is who they say they are. And having a professional-looking application is highly recommended.
It is also recommended that the landlord either charge an application fee that will cover a complete background check or that they should be willing to foot the bill themselves. The performance of background checks on potential tenants is the last thing that you ever want to skimp on as a landlord. If you do, saving $50 up front can easily wind up costing you tens of thousands later on.
There are many online services that will perform comprehensive background checks against most jurisdictions in the U.S. for things like criminal histories and any history of evictions or collection actions against the individual. You can also check social media accounts as well as using Google to gain additional information about the tenant and their lifestyle. Additionally, many states have online criminal record searches that are provided to the public for free. These will tell you if an individual has committed a serious crime within a given state.
Verifying rental history and current employment
You should also ask for the prospective tenant's recent rental history. You should then follow up by actually contacting the prior landlords, making sure that you are in fact talking to the building in question's actual owner or property manager.
Tenants with shady leasing histories will often lie when asked about their eviction or collections history, sometimes using friends to impersonate previous landlords. Anything that is revealed to be an outright lie on the rental application should almost always be an automatic disqualification for the potential lessee.
Their current employment and income should also be double checked. Making sure that the tenant actually works at their job by calling their listed place of employment is a solid way to ensure that you don't lease to someone who is unlikely to be able to make rent.
Once you have rehabbed and rented out your property, it will then be time to refinance. In one sense, this is the most important step of all because it is the one that allows you to extract your equity, repeat the process and begin growing your portfolio. Therefore, it is critical to have a good idea of how the refinancing process works.
One issue is that many banks will require a six-month seasoning period. This means that they want to see stable tenants, cash flow and management of the property and for you to own the property for at least six months prior to going forward with a refinancing deal. This can limit the rate at which you get involved in new projects. This is still faster than Nomading™ which does limit you to doing just one property a year (since you need to move in and live there for a year to comply with the lender requirement).
Not all lenders will require a seasoning period, however. If you can find a local bank doing (likely doing portfolio loans) that will immediately lend against the entire appraised value of a property, that is an excellent tool to have at your disposal. In our current (as of the time of this writing) lending environment the conventional financing products will require seasoning.
The final step in the process is to start all over again.
Once you've become adept at handling these projects, the deals tend to get easier. At the same time, you'll be building real wealth by accumulating equity while constantly growing your monthly cash flows.
There are other ways to build real wealth. But for ordinary people who don't have access to millions in capital and extensive investing expertise, buying, rehabbing, renting and refinancing properties is one of the better ways to set oneself on the road to financial independence.