Real estate investments present a way to earn money both in the short and long term. There are several potential strategies to use when buying an investment property or multiple properties, and it’s important to know which strategy is best suited to your needs before you begin to build your real estate portfolio.
At Addition Financial, we love talking to our members about their investments. One real estate investing method that you may want to consider is the BRRRR method. It might sound like an expression of extreme cold, but it’s really a detailed strategy that can help you use the money you earn from one investment to finance the next. Here’s what you need to know.
The BRRRR investing method is an acronym used to describe a five-step real estate investing method that is designed to maximize the investor’s profits. Here’s how it breaks down:
We’ll go into greater detail about how to execute each step of the BRRRR method in the next section.
Now that you understand the basic steps of the BRRRR method, let’s walk through each step in detail, so you understand what you’ll need to do if you want to try it.
The first step in the BRRRR method is to identify a property that you think has enough value to work within the method and purchase it. The most important rule when identifying properties to buy is known as the 70% rule, which says that your total expenses, including the purchase price plus any repair costs should not equal more than 70% of the property’s after rehab value, also known as the ARV.
To avoid overpaying, you’ll need to be as dispassionate as possible when evaluating properties to buy. Because you’re looking for investment income, you can’t afford to buy something that doesn’t have the value you need.
The second step is to repair and renovate the property you buy, something that has been shown in a lot of popular property-flipping shows. Before you buy a house to renovate, make sure you understand how labor-intensive and expensive a process it can be. Some shows make it look easy, but it’s not.
One of the most important cautions we can provide about this stage of the BRRRR method is that you shouldn’t cut corners on repairs. It might be tempting, but remember that you’re the one who’ll be renting out the property and thus responsible for repairs and maintenance. You should keep the age of appliances and other mechanical items in mind, as well as upgrades that can increase the property’s market value (and rent) including kitchen and bathroom remodels.
Next, you’ll need to find one or more renters for your property depending on what type of rental you purchased. If you decide to hire a property manager, make sure to build enough into the rent to pay for their services.
The key with renters is to conduct both a credit check and a criminal background check. Ideally, you want someone with a stable job and income who hasn’t moved around a lot. You’ll need to have them sign a lease, since you’ll need documentation when the time comes to refinance the property.
Now that you have a renter, it’s time to refinance the property you’ve rehabbed and rented. As we noted above, in most cases you’ll need at least six months of on-time mortgage payments to qualify for refinance. When it comes to refinancing, there are two primary options:
Refinance your loan completely. With a lower loan to value ratio after rehabilitation, you should have plenty of equity to cash out.
Take out a second mortgage on the property to borrow against your equity. In some cases, it may be more advantageous to leave your original mortgage in place and take out a second loan.
You’ll want to consult with an accountant or financial advisor because the most advantageous option can change based on interest rates and other economic conditions.
The final step in the BRRRR method is to go back to step one and start all over again. With the cash you got from refinancing the last property you purchased, you’ll have enough money on hand to make a down payment and buy your next property.
One thing that may be helpful is to review your experience with your last property and identify things that went smoothly as well as any mistakes you made. Learning from your errors can help you have a smooth transition into your next BRRRR transaction.
The BRRRR method isn’t the right investment strategy for everybody. To help you understand the advantages of using this method, here are some of the biggest benefits you can potentially reap if you try it.
The potential for a high ROI with the BRRRR method is significant. If you rehab your properties sufficiently to allow you to charge high rent, you can collect that money and either reinvest it in additional properties or put it into other investments to save for a comfortable retirement.
You may not need much in the way of cash to get started, particularly if you identify a property that’s going for a low price due to its condition. Some people use equity in their primary residence to pay for a down payment and closing costs, and there’s also the option of a short-term hard money loan. Since you’ll be using the equity in the first property you buy to fund the purchase of the second, you won’t need much cash going forward, either.
The rental income you collect after you rehab a property can add significantly to your income—and if you can either keep the same tenant or have no difficulty filling a vacancy, that rental income can continue coming to you indefinitely.
Rehabbing a home can add a lot to its property value, allowing you to build equity far more quickly than you could if you bought a home that had already been rehabbed and was valued appropriately. Putting your work and money into the property you buy will allow you to build 20% or 30% equity very quickly, often within just six months of your purchase.
One of the biggest benefits of the BRRRR method is that it is scalable in a way other investment strategies aren’t. Provided you follow the formula and make good choices about which properties to buy, there’s the potential for exponential growth.
In addition to the advantages of the BRRRR method, there are a few potentially serious risks to consider as well.
One of the biggest risks of the BRRRR method, and one that may trip up first-time real estate investors, is the chance that you might underestimate the cost of necessary repairs and/or the time it will take to complete them. Many BRRRR investors use short-term loans to buy properties, and if you don’t have the cash on hand to complete the repairs or they run over schedule, you might have an issue with your loan coming due before you can finish the rehab.
It’s common for interest rates for second homes and BRRRR investment properties to be higher than they would be for a primary residence. A higher interest rate will increase your monthly payments. On a related note, you’ll need to pay closing costs on both your initial loan and your refinancing loan, and it may not always be possible to roll those expenses into the loan itself.
Calculating the ARV of a property isn’t an exact science. If you overestimate the ARV and get an appraisal that’s lower than what you expected, you may not have as much equity as you thought you would—and may also have difficulty renting the property at a rate that will help you offset your expenses.
While there’s a lot of demand for rental units in many places, there’s no guarantee that you’ll be able to find a responsible, stable tenant quickly. When that happens, you might potentially have difficulty refinancing your loan to buy other properties.
As we stated earlier, it may take between six months and a full year to have enough on-time mortgage payments to be able to refinance your loan. Using a short-term loan to buy a property may result in a gap between when the first loan comes due and when you can refinance the property.
Using the BRRRR method is an effective way to grow your investments provided you do it properly. The information we’ve provided here can help you get started and turn one initial real estate investment into a perpetual stream of income.
Do you need assistance figuring out financing to try the BRRRR method? Addition Financial can help! Click here to read about our loan options and get started today.