By Rob Parsley
If you’ve researched real estate investing, you’ve probably come across the BRRR (or BRRRR) strategy. This icy little acronym is a popular way for investors to build their real estate portfolios, and the good news is that it works wonderfully for many investors looking to start scaling their real estate business.
When we talk about the BRRR method, we need to start with what it means. BRRR stands for buy, rehab, rent, and refinance. Many add a fourth R to BRRRR which stands for repeat the process.
This investment strategy can be a great way to make money on rental property investments and rental real estate without a huge initial outlay of capital. The key is to understand the nuts and bolts of the strategy, choose the right loans, and know how to reduce risk as you build your real estate portfolio step by step.
If applied correctly, the BRRR or BRRRR method is a straightforward way for real estate investors to create passive income using a revolving method for purchasing rental property.
Here’s what you need to know about the BRRRR process before you take out a loan for an investment property:
Buy an undervalued property: The goal is to buy at a low enough price so that you can increase the value when you improve the condition of the property – just as you would with a fix and flip investment – and then have built-in equity available when you refinance.
Rehab the property: Evaluate each potential upgrade to determine whether the renovations will cost you more than the value they add to the property in terms of equity and/or rental cash flow. For example, structural improvements like new bathrooms are worth the investment and will provide the property investor ROI, but high-end flooring and appliances may not, depending on you’re the type of renter the property is likely to attract.
Rent out the property: Vet tenants thoroughly and charge enough rent to immediately generate positive cash flow. As a rule of thumb, aim for a monthly rental fee at 1% of your cost – defined as purchase price plus what you invested in renovations. Rents continue to rise in the market as a whole, so make sure you price in line with the area around your property so that you don’t lose out on cash or, on the other hand, have a property sitting empty because it’s overpriced.
Refinance to get cash out of the property: With a cash-out refinance on investment property, you pay off the short-term interest-only loan and move into a 30-year, fully amortized loan or other form of long-term financing so that you can hold the property in your portfolio. If you have created value, you may be able to turn some of the equity you’ve create through the rehab into cash in your pocket.
Bonus Step! Repeat: Use cash from your refinance to purchase your next real estate investment and start the BRRRR process again.
The Benefits of BRRR
Potential for creating cash flow: When done right, real estate investors can purchase a distressed property for a relatively low cash investment (buy), fix it up (rehab), and rent it out for strong cash flow that serves as passive income (rent).
Building equity: Along with that passive income, investors using this method create equity. That equity can be captured through a refinance, either on an individual property or by combining multiple properties in a portfolio loan.
Economies of scale: Once you hit your stride, you achieve economies of scale, where owning and operating multiple rental properties at once can help you increase your cash flow overall by lowering your average cost per property and spreading out any risk of capital expenditures or tenant issues.
Keys to Remember
Profits aren’t fast: The method doesn’t offer investors fast cash. It’s a step-by-step real estate investment strategy. You have to put in work and time before you start making money and stay patient while adding properties to your portfolio one at a time.
Time-consuming rehab: Rehab and fix and flip projects require project timelines, managing contractors and sub-contractors, and dealing with unexpected issues. Plus, rehab projects take time. The good news is that every rehab or flip you complete gives you more experience, which helps you improve your processes and streamline the time investment per property so that you gather momentum as you repeat the BRRR process.
BRRRR investments require two different types of loans: When you buy an investment property, you take out an interest-only fix and flip loan to cover the cost of the purchase and renovations. Then you refinance to a long-term rental loan with a lower interest rate and full amortization. Below are some details on how these loans work at Lima One Capital, but these principles of financing will apply in general.
Fix and Flip Loans: Fix and flip loans can cover up to 90% of the purchase cost of the property with a term length of 13, 18, or 24 months. These interest-only loans are ideal ways to minimize out-of-pocket costs during the rehab period.
Rental Property Loan: When you’re ready to refinance, take out a long-term rental loan. Typically, this is a 30-year loan with a maximum loan-to-value ratio of 75-80%. Lima One offers loans that are fully amortized, adjustable-rate mortgages (ARMs), or even with interest-only periods. Since loans for rental properties are based on current value, make sure you use appraisal that assesses the value of the property after the material improvements you have made.
The BRRR strategy is an excellent option to create passive income from rental properties and fix and flip investments without a huge initial outflow of capital. It’s a great way to build your real estate portfolio, create passive income, and achieve your goals as an investor.
Rob Parsley is the Director of Business Development at Lima One Capital. For more information, visit limaone.com.