How to Use the BRRRR Method: Buy, Rehab, Rent, Refinance, and Repeat
There are millions of investing strategies when it comes to real estate, and as you’ve heard before “it takes money to make money.” Although this is generally true, the BRRRR method is a popular investing strategy offering a unique framework. By following the disciplined and repetitive process, you are able to leverage your hard-earned dollars into a real estate investment that you can quickly recoup to maximize leverage.
What exactly does BRRRR mean?
HINT: we’re not cold!
Simply put, the BRRRR method stands for “buy, rehab, rent, refinance, repeat,” and describes an investment strategy that focuses on building passive income over time without having to keep a substantial amount of cash tied to each property. An investor starts by buying a property that they rehabilitate and rent out to tenants. Now that the property has been rehabbed it’s likely worth a lot more money than you have invested in it. The crucial next step is cash out refinancing into a new loan in which the property’s rental income covers the costs of the mortgage, while allowing you to recover your initial investment against the property’s value. The result is earning a residual net cash flow from the property while building equity over time. Time to find the next fixer upper and repeat!
The 5 Essential elements of BRRRR
B - Buy
There are various ways you can purchase your BRRRR property but in order to leverage and maximize this strategy, it’s important to understand the power behind utilizing financing options. When searching for your property, keep in mind that this is a critical decision that will determine the outcome of an investment. Finding a property in need of repairs and in the right neighborhood is not enough. It must be purchased at a low price point so that once rehabbed the property will have a substantially higher value than the cost it took to get there. Quite often, the “ugly house” in the neighborhood that is undervalued may be the best prospective purchase.
To ensure there is a potential for your investment to ultimately perform strongly as a rental property, you must research the rental markets to understand what type of rents you can realistically expect once the property is fully rehabbed.
It is a balancing act to find a property that upon being rehabbed has upside to the value and the prospect of strong rental income. If utilizing financing, a hard money or private money loan may be a good fit as it will provide funds toward the purchase and the rehab. Most of these lenders will provide a loan for 80% of the purchase price plus 100% of the rehab costs if the total loan amount does not exceed 75% of the rehabbed value.
R - Rehab
Your #1 goal here: complete the rehab as quickly as possible while keeping costs down. You’ll want to rehab the property right, that is, putting money into areas that will make the house livable and desirable to your future tenant. The rehab may consist of something light and cosmetic or a more substantial gut rehab, so make sure you account for both the expected costs as well as a contingency for any surprises you find. If you obtained a hard money or private money loan, 100% of the rehab costs are set aside as part of the loan structure to ensure that the project gets to completion. That said, lenders will typically require that you start the rehab process on your own dime, and then they will reimburse you fully as the project milestones are met.
R - Rent
Renovations are complete and you are now ready to rent the property. Being a landlord is not always an easy feat, so do make sure you are comfortable with all that owning a rental property entails.
Of course, getting top dollar for your rental property is important, but it is also important to understand the market rate rental value of your property. You will want to know what the monthly rental value is well before purchasing the property, as this income is going to be what ends up paying your mortgage over time. This step “stabilizes” the property, thereby making the property more attractive for a lender to provide you the highest leverage possible when you refinance.
R - Refinance
Once your rental property is stabilized with a reliable tenant and you have a successful rental history you can begin the process of refinancing. Refinancing can be challenging as many lenders have specific requirements, so you’ll want to speak only with lenders who will allow you to “cash out refinance” against the property’s as-is value.
Working with a conventional lender may offer the cheapest rates, but there may also be stringent income and credit requirements, limited ability to cash out against a recently acquired property, tenant seasoning requirements, and limitations on how many properties you can be finance in total. Alternatively, a private lender may offer tremendous flexibility at costs comparable to what a conventional lender may charge. Nonetheless, the now rehabbed property value and rental income will be considered together in determining the amount of loan that can be provided.
R - Repeat
Now you have made it to the fun part. With a lot of lessons learned, and hopefully with all or most of your initial investment back in your pocket, it’s time to repeat and find the next investment property. Each project has their nuances, but taking the lessons learned to improve where mistakes may have been made will help you grow your portfolio over time, while ‘recycling’ your initial cash investment, building passive cash flow, and building equity in your property.
BRRRR Method Example
Let’s look at an example using the structure outlined above.
BUY – You’ve identified a property that you can purchase for $150K. With the help of your contractor, you see the potential to invest $30K into the property to bring it up to the neighborhood norm. Upon completion, the property will be worth $240K. Your private lender will provide a loan for 80% of the purchase ($120K) and 100% of the rehab ($30K), for a total loan amount of $150K. Since the total loan ($150K) represents 62% of the after rehabbed value ($240K), this meets the lender guidelines. You will need to account on contributing a down payment ($30K), loan fees + closing costs, and covering a few months of interest payments until the property is completed.
REHAB – Improve the property based on the $30K budget as quickly as possible, with the least number of hurdles along the way. In most cases, the lender will require that you pay for work out of your pocket, and then prove to them that the work has been completed so that they can reimburse you fully. For example, let’s say you clean out the property, do some repairs, and complete flooring and painting in the first month at a cost of $15K, you would prove to the lender that this has been completed (usually by having them visit the property) and they would then reimburse you for $15K. The following month you complete the kitchens/bathrooms and finishes for the remaining $15K of costs, and likewise reimbursement would follow.
RENT – Now that the property is in great shape, you confirm that market rental rates are $1500/month, and you find a qualified tenant to sign a lease, pay a security deposit, and move in.
REFINANCE – Your property is worth $240K, generating $1500/month in rent, and it’s time to refinance. Your lender is willing to provide a loan for up to 75% of the current value ($180,000), as long as the property’s cash flow is strong enough to support a new loan. To determine this, they’ll calculate Net Operating Income (NOI), which is gross rent less taxes, insurance, and HOA. In this example, let’s say property taxes are $1500/yr, insurance is $600/yr, and there is no HOA. Thus, NOI = ($1500/mo x 12 = $18,000) - $1,500 - $600 = $15,900/year. Keep in mind, NOI doesn’t include the cost of the mortgage yet. So, the lender will then look at a ratio to determine how the property’s cash flow compares to the cost of a new potential mortgage by evaluating the Debt Service Coverage Ratio (DSCR). Simply put, the DSCR is a representation of how much “extra income” a property has compared to the monthly mortgage. Most lenders want to see a DSCR ratio of 1.20x or greater, meaning the property net income is 1.20 times higher than the cost of the mortgage. Said another way, there is 20% more net income coming in than the mortgage cost going out. Specifically, DSCR = NOI / Debt Service Cost. In our example, assuming a $180,000 loan at a 6.25% interest rate, the 30 year fully amortized monthly payment will be $1,108.29/month or $13,299.48/year. To calculate the DSCR, we look at NOI / Debt Service = $15,900.00 / $13,299.48 = 1.20. Great, we have enough of a “cushion” coming in from the property’s net income for the lender to be comfortable lending $180,000. Don’t forget, when we bought the property we had a $150,000 loan that we are refinancing alongside $30,000 of our own cash, so we are now able to restructure debt on the property with a new $180,000 loan that will payoff the existing $150,000 loan and recoup our original $30,000 investment.
REPEAT – If executed properly, this example resulted in you keeping $0 of your own money invested into a $240,000 property. YES, ZERO dollars of your own money is tied to a $240,000 property. The property is generating enough cash flow to cover the mortgage and provide $2,600 of passive annual income.
With repeated success, this can result in a very substantial and scalable business. Let’s say that you get to 10 properties in your first couple years with similar figures as this example; that means that you now own $2,400,000 of real estate, have ZERO dollars of your own money tied to each property, and are generating $26,000 of passive net income per year. As the cash flow creation game does take some time, some investors choose to offload and sell some of their properties to provide more substantial immediate cash flow, but its important that you think about your goals and what investment strategy makes the most sense for you.
SUMMARY
To review, the BRRRR method describes a strategy that involves buying, rehabbing, renting, and refinancing an investment property—before repeating the process over again. By building equity in a property through renovations, investors can leverage the after repair value to improve the property’s cash flow and invest in additional real estate by refinancing.
By understanding how lenders look at rehab loans and stabilized refinance loans, you can use “other people’s money” to both create a passive income investment while building up equity in properties over time. As many conventional lenders will not allow you to borrow against more than a handful of properties, private lenders are well suited to allow you to scale your real estate empire quickly and efficiently.
Have questions on private money financing? Carlyle Capital is a direct private lender that is well versed in the BRRRR strategy that provides attractive rehab loans and stabilized rental property loans. Reach out to Carlyle Capital to discuss your project and financing needs.
