Every real estate investor has the same goal in mind – make enough money to gain financial freedom. To do so, they need a solid investing strategy that they know works for them. One such method that investors may want to employ is the BRRRR Method.
The BRRRR Method (Buy, Rehab, Rent, Refinance, Repeat) is a common real estate investment strategy that involves rehabilitating a run down property, renting it out, then refinancing it to fund future rental property investments. Many investors like utilizing the BRRRR method because it’s a combination of an active and passive income strategy.
If you’re a real estate investor considering this type of strategy, read on to learn about how the BRRRR Method works, its pros and cons, and if it’s the right method for your financial, or real estate investing goals.
How is the BRRRR Method different from a traditional investment property strategy?
The BRRRR model is great because it can help investors scale rental properties quickly while using the same initial amount of cash (equity) over and over. One of the main differences between the BRRRR method and a conventional investment property strategy which makes this possible is that BRRRR focuses on distressed properties with a value add component (rehab), and on refinancing all of the investor’s equity out of one property in order to buy another.
With the goal of this method being to stretch the same initial amount of cash invested in one property across several over time, it is an ideal strategy for investors that are capital constrained and aspire to grow a rental portfolio without needing to personally come up with additional funds or raise outside capital necessary to pay for the same number of turnkey rental properties.
How the BRRRR Method Works
Finding opportunities and unlocking value where others might not be willing or able to is what separates great investors from good investors. The ability to both source and create value are critical to executing a successful BRRRR investment property which makes it a very exciting and challenging strategy to master. Let’s look at the 5 steps that make up this method:
Buy – As with most real estate investments, you make your money on the “Buy”. With BRRRRs, you typically want to be buying in markets where your purchase price and rehab are no more than 75% of ARV (after repair value). The 1% rule is possible on the backend to help support a healthy debt service coverage ratio (DSCR) and cash on cash return.
The Backflip Analyzer is great for helping investors to quickly understand their potential cost basis (purchase price + rehab) relative to ARV before making an offer while seamlessly underwriting their refinance and cash flow as a rental. Having this tool handy can help to save investors a lot of time as they evaluate if a Property fits their target “Buy” criteria for executing a BRRRR.
Rehab – Once you have acquired the property, the next step is to execute the rehab and create the incremental value that will ultimately enable the investor to refinance out of their existing cost basis. To do this, it is essential to have a clearly defined scope of work and understand which rehab components will add the most return on investment to your property for the least amount possible.
For example, does a $10,000 investment in updating the kitchen result in a $30,000 value increase, or a $15,000 increase in value based on the comps? Looking at your overall rehab budget, are you getting enough return on the investment you are making so that your cost basis and ARV stay in proportion?
The ARV Comping in the Backflip Analyzer is very helpful in this regard, as nearly all of the comps aggregated show interior and exterior photos so that you can quickly see what level of finishes and updates the highest performing ARV comps consist of in the market.
Rent – Now that you have finished your rehab, the property is ready for a renter! As with any great execution of a business plan, the investor sets themselves up for success by doing all of their homework upfront. Similar to comping for ARV, it is important to pull rent comps and understand the variances in rental rate based on property condition and location. Rentometer is a free tool that covers most markets to get quick insights on single family rental rates.
Another critical aspect of the rental part of the BRRRR method is selecting a high-quality renter. To do this, you’ll need to understand their rental history, check references, look over criminal records, and pull their credit report. This part of the process is also important because many lenders want to see that you have tenants before refinancing.
Being a rental property owner/manager can be the greatest blessing or curse depending on the quality and temperament of your tenants – so be sure to put in the due diligence for this step.
Refinance – The moment you’ve been working towards! Time to pull out that cash, enjoy effectively infinite returns and start thinking about placing that equity into your next deal.
Be aware that in order to refinance, lenders will need you to meet certain requirements:
- Leverage (Loan Amount) – The rule of thumb with BRRRRs is a 75% LTV cash out refi which is why knowing upfront what your cost basis is to ARV is so important. If the investor’s cost basis is greater than 75% of ARV, they will not be able to pull all of their equity out when they go to refinance. 75% is also an important number as it is the loan to value threshold which most lenders allow for an investor to pull an unlimited amount of cash out.
- Timing – Depending on the long term lender that the investor has a relationship with and the types of capital products they offer, an investor will need to wait 6 months before refinancing for what is known as “seasoning”. Not all lenders require this and typically value add strategies like BRRRR can be exempt as the value added has substantially been created by the rehab vs. market appreciation since purchasing the Property. It is also important for the investor to understand if there are any prepayment penalties or lockout periods on their acquisition/rehab loan if they didn’t use all cash upfront.
- Debt service coverage ratio – DSCR is a metric that measures the borrower’s ability to service or repay the annual debt service compared to the amount of net operating income (NOI) the property generates. Most long term lenders will require at least a 1.20x, and if the NOI of the property is not able to support that at 75% LTV, the loan amount will be decreased to a level that it can.
Backflip loves working with BRRRR investors, and are able to be a one-stop-shop for both the acquisition/rehab and long term refinance funding part of the process for our members. We achieve the greatest level of success with this strategy by underwriting the investor’s refinance at the same time as their acquisition to make sure it will be a clean and smooth execution all around.
Repeat – All done. That was easy, right? Time to just do it again!
During this step, it’s important to reflect on what you learned through this process and what you can take with you as you embark on your next deal. Did you stay within your rehab budget and schedule? How are your tenants and property manager performing? Are you getting as much cash flow as you expected?
Is there anything that you would change about your strategy and execution going into the next BRRRR? Have market dynamics shifted in a way that makes your next BRRRR more or less attainable or executable?
All great investors, regardless of their experience, make it a point to learn something new with each and every deal. It’s the only way to get better while growing their portfolio and returns in the right direction at the same time!
Example of BRRRR Method
To illustrate this method in action, let’s look at an example to better understand how the BRRRR method works.
Take a hypothetical investment property – 789 Newcastle Dr.
As discussed earlier, the BRRRR method only works when there is a value-add opportunity. In our example, let’s assume that 789 Newcastle has been owned by only two owners since the home was built in 1971. The original owners kept it until 1993, when they sold it to the second owners, who have owned it since then.
Over the years, the neighborhood has changed and been reimagined. When 789 Newcastle Dr. was built it looked like all of the surrounding homes – a fairly typical single-story brick home, with 4 bedrooms, and 2.5 bathrooms. Approx 2,600 sqft. The original owners made no changes, but kept the home in good condition; the second owners also made no changes or upgrades except for painting when they moved in. Recently, the home has shown signs of aging.
As new families moved into the neighborhood, some properties started to get slightly more updated with the times. People added extra rooms to their homes, converted half-baths to full baths, and eventually several brand new homes were built in the neighborhood.
Currently, the neighborhood has a mix of ~mid 1970’s builds, which are mostly one-story ~2,500-3,000 sq ft homes, and ~mid 2010’s newly built homes, which are one- and two-story and ~3,500-4,500 sq ft.
The makings in this neighborhood and the subject property specifically (789 Newcastle) represent a fantastic BRRRR opportunity.
Many people will see the newer homes and think, we should tear down 789 Newcastle, build a new home, and sell it for maximum profit. However, if the strategy is to BRRRR, you likely will be better off upgrading 789 Newcastle than building ground up. The reasons are two-fold: new builds are quite costly; the higher the cost-basis, the harder to complete a cash-out refi (an important step in BRRRR) or to generate profitable rental yield (the end goal of BRRRR).
So, what do we do with 789 Newcastle?
The first thing is to try to buy the property at a discount to current As-Is Value. If recently renovated, more desirable, 1970’s 4/3 homes are selling around $450,000-475,000 in the neighborhood, you can expect 789 Newcastle to sell for less due to the lack of a third bathroom and the current condition being unkempt.
Let’s say you can Buy 789 Newcastle Dr for $300,000 (not unrealistic). If you decide to scrape it and rebuild, you would likely budget $500K-1M+ in new build construction costs – depending on the size of the new home and finish outs. Instead, for ~$40K-50K rehab budget (~$20 per sq ft), you can nicely update the current home, convert the half bath to a full, and bring it up to the desirability of the neighborhood.
To fund the deal, you plan to use an Acquisition & Rehab loan from Backflip to finance 85% of the purchase + 100% of the rehab costs (total loan $305K). And you will bring $45K cash into this deal.
After you complete the Rehab, you have a very lovely 2,600 sq ft, 4 bedroom, 3 bath property with nice finishes and new appliances – perfect for renting to a nice family. It will still comp against the older, smaller homes (vs the larger new builds), but that’s ok because this is your goal with a BRRRR. When comping against the other 4/3 homes, 789 Newcastle can likely appraise at a similar value of ~$450-475K ARV now that it’s updated.
Now, it’s time to Rent the property. You see on Backflip that similar homes rent for ~$2,500/mo, so that’s where you list at, and quickly you have multiple rental applications. After your operating costs, your take home is $1,000 per month, but this is before paying interest on a long-term rental loan, which you don’t have yet.
The next BRRRR step is to complete a cash out Refi. The refi lender orders an appraisal, which values the property now (post renovation) at $475K, similar to the comps. Perfect! You are going to complete a 75% LTV cash-out refi, which means you’ll put a new long-term loan of $356K (75% x $475K valuation), on the property. The proceeds of that loan are used to repay your current Acquisition + Rehab loan from Backflip ($305K) and the rest goes to you. That’s $50K cash back vs the $45K you invested. You literally pulled 100% of your cash out of the investment, and still own a strong cash-flowing property (generating several hundred per month after interest) at conservative leverage of 75% / 25% equity.
Time to reuse your cash for the next investment! (Repeat) And congratulate yourself on another great BRRRR!
Pros of BRRRR
- Lower Barrier to Entry / Higher Return on Investment (ROI)
When implementing the BRRRR strategy, you don’t need to use as much out-of-pocket cash in order to get started. In fact, in some cases, you can potentially put little money down, allowing you to participate in projects you wouldn’t otherwise have access to. It also results in a much higher return on investment, as the cash flow you receive will be the same even though you personally invested less money in the deal.
- Higher Capital Turns
Being able to refinance your property at its ARV rather than its current value is a huge advantage because you will have more working capital for your next investment! Additionally, using the BRRRR method, you will greatly increase the amount of work that your money does for you. Your money will be freed up to continue making additional investments, which will once again increase your returns, allowing you to make more investments, as many times as you’d like to repeat the process.
- Increased Scalability
Like any proven procedure that is well-implemented, the BRRRR method is very scalable. Once you have the right people or team around you (agents, wholesalers, contractors, lenders, etc.) and systems (tools / common practices) in place then you can continue to repeat the process at a larger scale and with greater ease.
Cons of BRRRR
- Costs and work needed for rehab
One of the most complicated things about the BRRRR method is being able to accurately anticipate the amount of work that goes into rehabbing a property, as well as the costs associated with it. Adjusting to unexpected problems that may occur during the process can also add challenges and pressure as you’re trying to meet your returns goals.
- Patience is required
One thing about the BRRRR method that many investors don’t realize is there is a lot of patience that is needed to execute this strategy correctly. Waiting until the renovation process is complete, then you may need to hold onto a property for a certain period of time before being able to refinance, and finally, holding out for the right tenant can all take several months. If you’re looking for a strategy that allows for a quick exit strategy, the BRRRR method may not be right for you.
- Rental Management
Not every investor wants to (or should) become a landlord. In fact, many investors feel the pressure of needing to quickly find tenants in order to move onto the refinance stage of the process. This can lead to risk-taking that can end in many future headaches when they realize their renters aren’t able to make the promised payments, or are just generally difficult to deal with. You can do everything with your deal correctly, but even the best deals can turn south very fast if you’re not able to act as a good landlord. It pays off in the long run to really consider if you have the skillset and time to do so, but also to put in the extra effort to find the right tenants for your property.
If you decide that the BRRRR method isn’t right for you, there are other real estate investment strategies that you can utilize. For example, the tried and true method of purchasing a home that’s in good condition and renting it out in exchange for rental income is always a strong strategy (called “Turnkey Rentals”). You can keep the BRRRR method in your arsenal for when the right property comes along, or you feel your business is in a good place to try something new.
Additionally, you can utilize Backflip’s Returns Analyzer to quickly determine if purchasing a property under a rehab and rent strategy makes sense for your bottom line. Hundreds of investors are using the analyzer early in their sourcing process because they can assess if an investment meets their target return requirements. You may find that a property you were looking at for a rental strategy would operate better under a fix and flip strategy, in which case you can decide if it’s even the right investment property for you.
The Bottom Line
As you can see, the BRRRR method has several advantages and disadvantages that may not make it the right strategy for every investor. The process of buying, rehabbing, renting, and refinancing a property and repeating the process over and over again comes with a certain degree of risk that investors need to be prepared for. However, potential issues can be mitigated with the proper research and due diligence. To identify an investment property that would benefit from this method, investors need to ensure they’re taking on an optimal investment in a strong rental market.
It can be tempting to want to jump into adding new investing methods to your strategy, but taking the time to properly plan can make all the difference as you scale your business. With the number of potential SFR properties on the market, it’s imperative that investors calculate whether their next investment will be a strong addition to their portfolio (or not). Implementing a strategy that you’re not prepared to see all the way through can not only be a detriment to the rest of your portfolio, but also hurt your ability to hit your returns goals for the year.
If you’ve determined that the BRRRR method is a good fit for you, Backflip’s suite of tools can help save you hours of time researching and analyzing, so you can close on deals quickly and spend more time sourcing new properties to add to your portfolio. Additionally, as a Backflip member, you have access to our borrower-friendly capital that you can use to not only finance, but also refinance your BRRRR property. With a streamlined, tech-enabled loan application, you’ll get financing options that are tailored to your strategy, and terms that allow you to focus on creating value for your business and reinvigorate your local community.