The BRRRR method is a strategy of constructing an investment property portfolio by buying distressed assets, rehabbing them, renting them out, and then refinancing them to pull out the equity. The cash from the refinance is then used to purchase another property with the same idea in mind. However, be mindful that a large property portfolio built on the BRRRR strategy might be sensitive to changes in interest rates and/or drops in price value.
The great part about real estate is that it enables your average Joe to use leverage to build wealth. Not only can they buy a property with a mortgage but leverage also enables them to pull cash out of their property via equity in a refinance scenario. However, different investors will have different strategies that suit their own needs and risk profiles. The BRRRR method is one of these, and any BRRRR veteran will swear by it as the most surefire way to expand your portfolio. However, it is not without its risks. What exactly is BRRRR other than a sound you make when you are cold? Let’s break it down below.
What is the BRRRR method?
BRRRR stands for Buy, Rehab, Rent, Refinance, Repeat. It’s a more defined way of saying, “rinse and repeat” this real estate investment strategy. The strategy involves buying foreclosed homes or distressed properties and then rehabbing them in a way that will increase their value so they can act as suitable rental properties. Ideally, your rental income will be enough to pay the initial mortgage payments, as well as the new payments once you refinance.
Now that the value has increased, you should be able to tap into it via a cash-out refinance. With this cash in hand, you can buy another property and use the same rinse-and-repeat real estate investing strategy. If done correctly, you could expand your property portfolio quickly in a small amount of time. This strategy differs from other property investment strategies in that the focus is on distressed assets with a cash-out refinance rather than an alternative exit strategy. For example, this differs from house flipping, in which you rehab a house in order to sell it for more money.
Step 1: Buy
The first step is to buy the real estate. This might be your first purchase or somewhere down the line of your BRRRR strategy. What you should seek is a property that, with some improvements, can increase in value. Essentially, search for a deal. A good rule of thumb is what is known as the 70% rule. This means that what you pay should be 70% of the property’s after-repair value minus the costs to repair. A deal like this could be hard to find, so here are some ideas of where to look.
Look for popular neighborhoods and see if you can spot a property where the purchase price seems well below market value. This could be a perfect distressed asset in need of repairs.
Drive around and see if you can find some dilapidated and/or abandoned houses. These could be unlisted, but if you can find the owner, you might be able to convince them to sell.
Foreclosed home auctions are a great way to get properties at low prices. Make sure you are well aware of all the potential repairs, as you might need to bid on the home without seeing it in person.
Step 2: Rehab
The second step is to rehab the property. This means putting money into the property to increase its value. Some of this is not necessarily rehabbing but rather restructuring. For instance, if you have a large one-bedroom property, you can change it into two bedrooms to increase the value substantially.
In many cases, this involves redoing the kitchen, the basement, or something that adds value to the home. In fact, there are “hard money lenders,” which offer private loans backed up by your property that can lend you money for rehab costs.
If this is your second BRRRR property, make sure that the capital you have withdrawn from your previous property is enough to cover this property purchase as well as the rehab.
Step 3: Rent
Once you have completed the renovation and rehab, it’s time to rent out the property. You want your rent to cover the mortgage payments and then some. Ideally, the rent can cover both your initial mortgage and the increase in payments once you refinance, according to Denis Smykalov, a broker at Wolsen Real Estate. “The BRRRR method can be a potent strategy for expanding a real estate portfolio because it allows investors to reinvest their capital into new properties. However, it requires thoughtful planning and execution. Post-rehab, the property’s value must be high enough to permit a refinance that recovers most or all of the initial investment. Additionally, rental income must be enough to cover the new mortgage payment and other costs.”
You sign a tenant for a year contract, possibly more. A long-term tenant won’t give you as high a rental income as a short-term tenant but will offer assurance. Furthermore, you don’t risk as much damage to your place as you would with a short-term let, as you don’t have different people coming and going.
With the invention of Airbnb and its competitors, short-term lets can be options in cities as well as holiday locations. However, be careful, as Airbnb regulations are pretty strict for some cities and municipalities in the U.S.
Step 4: Refinance
The: “refinance” strategy of the BRRRR method focuses on a cash-out refinance. With a cash-out refinance, you exchange your old mortgage for a completely new one. As part of the BRRRR method, you search for a property you know will grow in value with a bit of rehab and refurbishment.
Once you get the rent stabilized, you can get an appraisal on the home and go to the bank. The bank trades in your old mortgage for a new one, and you can use those funds to repeat the BRRRR method with another “buy.” Plenty of lenders are willing to give a cash-out refinance on home loans, but you might also want to consider what type of interest rate and structure you want, such as a fixed-rate vs. adjustable-rate mortgage.
Fixed vs. ARM
The idea of the BRRRR method is that you continually build a property portfolio over time, and thus, you need to prepare for changes in the interest rate environment. With low-interest rates, you will surely opt for a low fixed-rate mortgage. However, in a high-interest-rate environment, you might want to consider an ARM, depending on how you feel interest rates will rise.
You might not want to opt for the maximum loan-to-value ratio on a cash-out refinance, according to Sebastian Jania, the owner of Ontario Property Buyers. “In order to mitigate risk, in many cases, it may be advisable to keep the loan-to-value low by not doing a full cash-out refinance. We have completed ‘BRRRRs’ before; that being said, it should be a quick project if it’s a small building or single-family home, or relatively quick if it’s a bigger multifamily, as costs during holding when someone is turning the building over can be very high.”
Step 5: Repeat
The final step of the BRRRR method is starting over. This means going back to square one and finding another distressed asset. However, if you do the BRRRR method correctly, you should be able to cover the cost of the next property and possibly more. This allows you to move higher up the value chain when it comes to property.
Example of the BRRRR method by the numbers
Below is a model of how one would start their BRRRR with three properties. Pay attention to the total amount of the cash-out refinance and what is needed for the next property. Remember, these are estimated costs and could be more or less expensive.
|Property 1 Price||$400,000.00||Property 2 Price||$375,000.00||Property 3 Price||$450,000.00|
|Down Payment||$80,000.00||Down Payment||$75,000.00||Down Payment||$90,000.00|
|Money Put Into Rehab||$25,000.00||Money Put Into Rehab||$10,000.00||Money Put Into Rehab||$15,000.00|
|Closing and Lending Costs||$6,000.00||Closing and Lending Costs||$5,625.00||Closing and Lending Costs||$6,750.00|
|Total Needed||$111,000.00||Total Needed||$90,625.00||Total Needed||$111,750.00|
|Value After Rehab||$500,000.00||Value After Rehab||$475,000.00||Value After Rehab||$600,000.00|
|Cash Out Refiance @ 80%||$400,000.00||Cash Out Refiance @ 80%||$380,000.00||Cash Out Refiance @ 80%||$480,000.00|
|Debt Owed on Original Mortgage||$280,000.00||Debt Owed on Original Mortgage||$262,500.00||Debt Owed on Original Mortgage||$315,000.00|
|Total Net After Cash Out Refinance||$120,000.00||Total Net After Cash Out Refinance||$117,500.00||Total Net After Cash Out Refinance||$165,000.00|
In this example, we take a $400,000 property that needs some kitchen work and a bit of new carpeting. The property is purchased with a 30% down payment and a 70% mortgage. After the rehab and closing costs, it’s $111,000 all in. After rehab, you find a tenant and break even on the mortgage. Your new appraisal after the rehab is $500,000. You can then pull 80% of this out through a cash-out refinance, giving you $120,000 net income after you repay your old loan.
This $120,000 should be enough to cover your next BRRRR investment and the TOTAL needed. In fact, it’s best to overestimate the total needed than to underestimate your next BRRRR so that you can work yourself into a contingency plan.
The end goal of the BRRRR method
Any real estate investor employing the BRRRR method will likely try to build a real estate portfolio over time. Here are some ways you can build wealth using BRRRR rental properties.
Property prices tend to rise over the long term, and thus the overall portfolio’s value should rise with it. You have two options to take advantage of this.
Sell the portfolio in one go or in pieces
You can cash out by selling all of the assets when you feel the real estate market has reached its peak.
Continue taking equity out of existing properties
If you don’t want to sell the portfolio, you can continue taking equity out of the properties through a cash-out refinance, a home equity loan, or HELOC. This allows you to access the additional value of your home without having to sell it.
When you first start out in the BRRRR strategy, your goal should be to have the rental income cover not only the original mortgage but also the new mortgage that you obtained with your cash-out refinance.
However, as time goes on, rents will increase. This means that if you have a fixed-rate mortgage, you could start to see some stable positive cash flow even if you were breaking even initially. Then you can start generating some real passive income over time.
BRRRR method risks
The BRRRR method does indeed have risks. These can include:
Property values drop
Values could drop, meaning you might be stuck trying to sell all or part of your portfolio. Or, you can no longer significantly create enough property value for the numbers to make sense in a bad market.
Interest rates rise
If you use an ARM and interest rates rise, then your costs can increase, which means you might not be able to break even on your properties. Even if you always opt for fixed-rate mortgages, fixing yourself into a high mortgage rate can be an unattractive proposition.
Loan terms change
It’s possible that the terms of cash-out refinance loans could change, reducing your ability to get money for future projects.
Problems with tenants
With rental properties, you deal with real people and thus could experience real problems. It’s best to always have a contingency plan for poor tenants and missed rental payments.
What is the BRRRR method in real estate investing?
The BRRRR method stands for buy, rehab, rent, refinance, and repeat. It’s a strategy for real estate investors in which you buy distressed assets and rehab them. After the rehab, you should have increased the value of your home, and you should be able to get enough rental income to cover your mortgage payments.
What are the risks associated with the BRRRR method?
Drops in the market, rising interest rates, and changing loan terms are some of the risks associated with the BRRRR method.
How does the BRRRR method differ from traditional real estate investing strategies?
In real estate, the two main ways to make money are value appreciation and rental income. BRRRR does indeed take advantage of both of these but uses modern debt instruments such as cash-out refinancing to leverage returns. It also differs from house flipping in that you don’t immediately sell the property for a profit.
- The BRRRR method is a strategy of constructing an investment property portfolio by buying distressed assets, rehabbing them, renting them out, and then refinancing them to pull out the equity.
- The first step is to identify deals. Find properties that you feel confident you will be able to drastically increase in value with a little rehab. You then rehab, rent, refinance, and repeat.
- The BRRRR method can help you use leverage to build a property portfolio. You can then either sell the property, pull out more equity as property values increase, or start to produce positive cash flow as the rental income increases vs. the mortgage payment.
View Article Sources
- Selected Interest Rates (Daily) – Federal Reserve
- Mortgage financing options in a higher interest rate environment – Consumer Financial Protection Bureau
- How to Use Leverage to Build Wealth – SuperMoney
- Investing In Real Estate Pros and Cons – SuperMoney
- How to Invest in Real Estate: An Expert Guide for Beginners – SuperMoney
- How to Buy a House at Auction: Step-by-Step Guide – SuperMoney
- What is a Rehab Loan and How Does It Work? – SuperMoney
- Mortgage Rates: A Guide On How They Are Calculated – SuperMoney
- How To Avoid Capital Gains Tax on Rental Property – SuperMoney