There are many ways to get into real estate investing Some of these include flipping, wholesaling, and the popular “buy-and-hold” strategy for longer-term, passive income investments. One method that is popular with investors deploying a buy-and-hold strategy to build their rental income portfolio is through the use of the BRRRR Method for real estate investing.
The BRRRR Method is an investment strategy that offers a process used by many real estate investors today. It gives you a template to buy, rehab, rent, refinance and repeat a workflow to generate passive income.
Who Coined the Phrase “BRRRR Method?”
The BRRRR Method acronym was first used by Brandon Taylor of Bigger Pockets.
Taylor gained these insights when doing his first deal and then employed these techniques over a decade of doing deals.
It now become a respected, tried-and-true method to build wealth in real estate. You can view Brandon’s story about the power or partnerships and the BRRRR Method, here:
What is the BRRRR Method
The acronym breaks down into these easy-to-understand steps:
Buy a Property
This is where any real estate deal begins. You to find a great deal that ensures profitability after repairs. You need to find a property below market value that can be repaired, sold, or rented for a profit.
Rehab the Property
This is where a lot of work comes into play. You need to make necessary repairs that have the net effect of increasing the value of the home. To do this you need to understand home values for properties in the area that recently sold. Also known as “comps.”
Rent It Out
You’ll need to find a responsible tenant. Sometimes this is challenging. By placing a renter in the property you leverage those rent payments to cover the mortgage and expenses on the home, freeing you up financially for your next project.
Refinance the Property
You’ve calculated your After Repair Value (ARV), done your comps research, and placed a reliable tenant into the property.
Now begin approaching lenders for a cash-out refinance. You have many options when it comes to lending (covered below).
With the equity that comes with making repairs, you will now enable you to free up that cash inside the property for use in your next purchase.
Now with cash in hand, you can pay off any loans you accrued through the purchase and renovation, and begin the BRRRR strategy over by finding your next investment property.
Reasons Why to Use the BRRRR Method
The biggest reason?
The BRRRR Method allows the real estate investor to scale their real estate investing business without huge financial requirements.
Newbie investors think they need a ton of cash to get started as an investor. It’s just not true.
Challenges and Failures
That’s not to say there won’t be challenges and failures, but at least using the BRRRR strategy gives you a simple, step-by-step process to follow.
If your real estate investment strategy is buy-and-hold to build up your real estate portfolio, the BRRRR method is great. It is a well-known method used by many to do buy and holds.
As you use one property’s equity to purchase another property, you can establish momentum with your BRRRR strategy. You begin making connections and building relationships, which in turn accelerates your process to build a real estate portfolio.
Expand Your Network
Over this time, you’ll develop relationships with home inspectors, builders, real estate agents, mortgage lenders, and others in the real estate space. Partnerships accelerate everything you do as it leverages the talent (and money) of others.
This means more options for your real estate business.
Understanding the steps you need to go through to be successful with the BRRRR strategy increases your business know-how and connections, making it easier to scale.
You Make Money on “The Buy”
Making money on the buy is simple. It’s been expressed several ways over the years, such as buy low, sell high. And it’s true in real estate as well.
If the investment property is too expensive or doesn’t possess the potential to return a good margin at the time of a cash-out refinance, you are subject to risk. Meaning the money used in the deal, the time and the effort is subject to risk and ultimate failure.
For real estate investors, this is why “the deal” is such an important concept.
You need to find below market properties that you know will possess an improved market value once renovations are complete. Whether you are doing fix-and-flips or want to use the BRRRR Method, buying below market value on property is crucial.
Use the 70% Rule
So, what is the 70% rule? An investor, to ensure a healthy ROI, needs to make sure that their financing covers no more than 70% of your ARV (or After Rehab Value).
Different Markets, Different Returns
These percentages vary depending on the lender and market conditions.
Some markets or deals might be lower in margin. It’s up to the investor to understand their market to make the numbers work (or not).
Unforeseen and Unplanned Costs
Sometimes adjustments or unforeseen costs come into play, meaning your might be operating at 75% of the After Repair Value (ARV), resulting in a lesser return.
Smart investors know they need to plan for contingencies.
But you need equity to not only cover your expenses but to provide a potential profit that allows for a cash-out refinance.
The 70% Rule in Action
Let’s say you purchase a fixer-upper for $100,000 and do $25,000 in renovations. After some analysis, you estimate that the ARV of the property is around $150,000.
Purchase price: $100,000
Total costs: $125,000
ARV (for /the chosen market): $165,000
70% Rule: $115,500
Profit Margin. In this case, the investor is enjoying a healthy margin of 40%. In this case, the investor did better than what the 70% Rule allows. For many, this is a win and a great deal for the investor.
The above are some simple calculations. A lot more detail goes into estimating the cost of buying and repairing a home, so you’ll need to include these also in your costs. Think inspection fees, title insurance, homeowners insurance, and other additional costs that come into play when buying a house.
Renting the Property and Covering Expenses
The next step in the process of the BRRRR strategy is to rent the property out and cover your expenses. This is a well-known strategy for creating passive income. These expenses include any loan payments, maintenance expenses, and any other expenses that a landlord needs to include in their accounting.
Renting Out Your Property
There are many ways you can go about renting out the property. There are no-credit-check leases, so you can have a friend or relative move in.
You can use online services such as Craigslist to market your property and get an application from interested parties. Or, you can list the home on local real estate broker’s websites that offer rental services.
Renting out the property is your next step, but you’ll need to find great tenants to make it work.
Finding Great Tenants
Understand the rules regulating finding and screening tenants. Each state is different in these regards. Stay within the guidelines to ensure everything is upfront and legal.
You essentially protect yourself through the process by knowing the law.
If you need assistance in navigating tenant and rental laws in your state, check with a local attorney with experience in the field.
Knowing the law will help you. Knowing how and under what circumstances you can evict a tenant and your obligation to the leaseholder are critical in making sure that when you take action, it’s the right action.
Again, if it came to it and you needed to evict the tenant, you’ll want legal assistance from an attorney.
The biggest factor in making your life easier is by attracting and keeping a high-value renter. You can do this by creating an attractive rental property.
Create a Great Rental Property
You want renters that have an income and a lifestyle that demonstrates consistent earning potential and responsible financial management.
People live according to how they organize (or don’t organize) their lives.
By taking a few extra steps, you can find a responsible tenant that will set your mind at ease.
The Best Rental, Attracts the Best Renter
But to attract that type of tenant, you’re rental is going to need to look and function for that type of tenant. In other words, to get more (a great tenant) your rental is going to have to be more in its appearance and functional accommodation.
The cosmetics of the interior, the condition of the landscaping, the appliances—all of these influence a renter’s decision to sign a lease.
Rental Comps and Renter Income Levels
If your property is located in a desirable neighborhood, close to schools, grocery stores, and other amenities, your ability to charge more rent increases.
Take Note of Surrounding Properties
Considering adjacent properties and the neighborhood as a whole should be something you do in your rental comp analysis when you’re looking to employ the BRRRR Method.
If neighboring properties have landscaping that’s overgrown, stuff in the yard, and are generally in a state of disrepair, it will be harder to attract the best tenant for your rental property.
As a result, the caliber of available tenants will be lower as properties that are run down usually indicate a lack of concern by the property owners. Unfortunately, the tenants of those properties, most likely, will mirror the owner’s lack of concern. This translates to lower rents and a lower caliber of renter.
Advertise for Your Tenant
Craigslist is a tried-and-true platform for many landlords. Be sure to use good pictures and keep your listing up-to-date if there have been any changes. Craigslist attracts a wide swathe of renters, so being able to charge a good rental rate helps qualify and limit many people looking for lower-priced rentals.
Listing through Trulia is very popular. It will display your rental listing on not only Trulia but Zillow and Hotpads as well.
You can post your contact information on Trulia if you want to be contacted directly, or if you want to just receive email inquiries, Trulia forwards any correspondence to you through your rental listing.
After you’ve found a great tenant, it’s time to look into refinancing your property.
For investors looking to employ the BRRRR Method of real estate investment strategy, freeing up the cash for further investment is necessary.
This entails tapping into some (if not all) of the equity in your rental to free up your cash flow.
The Importance of Cash Flow
A consistent challenge for the investor is cash flow. You need to find deals, get the property under contract, and use it to springboard your next purchase after rehab and finding a great tenant.
The problem comes with tying up your cash. The value of your cash is now tied up in the property, meaning you do not have the liquidity to take advantage of other opportunities that might emerge.
This is one of the biggest challenges for investors looking to scale with rental properties. And once you start investing in real estate, there will be many times when opportunities just fall into your lap.
So having some cash flow is essential to growing passive income.
The Advantages of the Cash-Out Refinance
The BRRRR method involves taking cash out of the property to reinvest in another deal.
A cash-out refinance might also allow you to lower your monthly mortgage payments and can be a way to consolidate several mortgages under one loan.
There are several benefits to refinancing, but it’s important to make sure that you understand the process.
Your New Mortgage
When you refinance a property, you’re essentially taking out a new mortgage on the property. This new mortgage will have a different interest rate and term than your current mortgage.
It’s important to understand that when you refinance, you are not resetting the clock on your current mortgage. You are still responsible for those original loans, but these will be covered in the new mortgage.
One number you want to be cognizant of is your rent to debt/expenses ratio. Lenders will want to see numbers that pencil out, meaning you can show that you can cover your new mortgage payment, insurance, and related maintenance expenses.
This is one area some lenders will evaluate.
Rental Comp Analysis
Your initial analysis when evaluating your investment opportunity should come into play here. Along with calculating things like ARV and the 70% rule, you should have an understanding of rents in the area.
In addition, knowing your maintenance costs for the property and any fees is essential.
Do you plan to use a property management company to manage the property?
This is another expense that should go down on your balance sheet.
You’ll need these numbers before approaching a lender.
Comparisons and Costs to be aware of:
- Rental Comps
- Maintenance Costs
- Rental Property Insurance
- Rental Management Fees
Types of Lenders
Real estate investors have options when it comes to borrowing. Each lender has its pros and cons. Let’s evaluate them here.
National Lenders (Banks)
These are typically what comes to mind when people think of refinancing.
For many, this is the first place they go for financing
But be aware, these organizations exercise stringent requirements about who they provide financing for and on what types of properties
Traditional banks look hard at the borrower. They look to maximize their profits as well as those of their shareholders. That means finding safe bets. So much of their application processes involve looking carefully at the borrower and their credit history. Things banks look at include:
- Income History and W2s
- Credit Scores
- Debt to Income Ratio
- FICO Scores
- Credit History
- Other Requirements—at Their Discretion!
Since they lend to create returns for their shareholders, they want to lend with confidence, knowing they will get those monthly interest payments. They don’t want to own the property (through default and foreclosure) and are looking for an (estimated) sure thing.
One specific hurdle is that many banks won’t refinance on rental properties. The other caveat is that most banks won’t loan out more than four mortgages to an individual borrower. And if you have the property under an LLC, you might face further difficulties.
These institutions depend heavily on the Fannie and Freddie Mac rules and guidelines, as they want to move debt off their balance sheet to avoid risk.
Banks want to originate the loan, but not hold on to it. This is why they typically sell these loans to a second party to mitigate risk.
Federal requirements add more complexity to deals and can make it harder for borrowers looking for more “unconventional” forms of funding.
Traditional Lending Institution Pros and Cons
- Familiarity with consumers. Trusted brands.
- Wide variety of loan products.
- They look hard at the borrower, not the asset property or opportunity.
- Limited or nonexistent loan options for rentals and fix-and-flips.
- A limited number of mortgages are available to the investor.
- Harder to get loans when the property is under an LLC.
Community Banks and Credit Unions
Smaller lending institutions are the lifeblood for many communities. These tend to be regional banks that serve specific geographic areas.
For some of these lenders, their lending products can be specialized. For example, banks serving agricultural areas of the country might specialize in land and farm lending.
A big part of their business comes through relationships with those in the community.
Start with the Relationship
Unlike the big, national chain banks (see Bank of America and others), you can speak with individuals in charge of making lending decisions.
So, begin with developing relationships with decisions makers.
If you live in the same area where you employ the BRRRR Method, find opportunities to connect with managers and account representatives outside the office. This interaction might be through community fundraisers or charity events, Chamber of Commerce activities, professional groups, or other social events.
Managers live many times in the communities they serve. Find out where they hang out and make an introduction.
Through time and developing those personal connections, community banks can be a great asset.
Do some business and show your expertise in the real estate investing niche. Over time, these community banks will have more confidence in you and your business.
Community Banks/Credit Unions Pros and Cons
- A deal can happen because you know them.
- Fewer regulations and requirements.
- Longer fixed interest rate terms.
- Most have no prepay penalties (this is huge and gives you many options). If you do a cash-out refi after using the BRRRR Method and then 1 to 2 years later a buyer shows up at your door with an unbelievable price, you can sell without a prepay penalty.
- Some credit unions, because they know the area, will finance the purchase price and construction cost or a percentage thereof, if you have a track record.
- Rates are sometimes slightly higher.
- Amortization is usually 20 to 25 years, so payments are higher.
- You have to personally guarantee most of the time.
- Individuals in a partnership that have over 20% equity usually have to personally guarantee the loan.
- Can be difficult acquiring a loan under an LLC.
Unlike traditional lenders, Portfolio Lenders hold on to their debt. Banks and large lending institutions make their money from fees in originating the loan and then sell the loan to another lender, lowering their risk profile.
Not the case with Portfolio Lenders.
They take on more risk by holding on to the debt but have advantages over banks when it comes to real estate investing.
These are specialists in the lending space. For example, there might be a portfolio lender who specializes in commercial loans for rental properties, another one who works with health care facilities, and so on.
Developing these relationships can mean getting access to specialized lending products that other lenders don’t offer, like long-term rental loans.
In addition, these companies may have unique niches that others don’t. For example, some companies will lend on non-owner-occupied properties (important for rentals and fix-and-flip properties).
Non-Qualified Mortgage Specialist
Portfolio lenders provide investor-friendly, non-qualifying mortgages. This means they don’t adhere to the restrictive underwriting rules for government-insured FHA loans or loans sold through Fannie Mae or Freddie Mac.
This freedom from some of these restrictions is a boon to real estate investors and why portfolio lenders are popular in REI.
The lack of red tape and hurdles to get financing is alleviated as portfolio lenders look at more than just credit score and personal details from the borrower.
What About Interest Rates and Fees?
With a more open model for delivering funding and a higher risk profile, borrowers pay for the flexibility. This comes in the form of higher rates and fees.
There might be application fees, loan service fees, and other fees when acquiring a loan through a portfolio lender. But the flexibility of acquiring financing is very attractive for investors, especially when more conventional lending routes are too difficult.
- Open to lending on different types of properties
- Can lend on multiple properties or the entire portfolio of investor
- Less regulation
- Experienced with real estate investors
- Higher interest and fees
National Asset-Based Lenders
There are companies throughout the U.S. that offer asset-based loans. These organizations are also known as private and/or hard money lenders.
Asset-based lenders hold a first-lien position on the property. This means in the case of default, they have the first opportunity to foreclose on the property and take ownership.
In more general terms, the house is collateral on the loan.
Hard money lenders in this category are licensed in multiple states, and in some states, they might take on partnerships to lend in those states. States regulate these types of lenders so find one that can do business in your state.
Loan Interest Rates, Terms, and Fees
Like portfolio lenders, a hard-money loan will come with higher rates and fees. Most of your payments are interest only, as the lender seeks to generate interest on their deployed capital, just like a bank.
Since you are planning on holding on to the property for rental income, you’ll want a long-term loan, unless you only plan to hold the property for a short period.
So, shop around for the best rates and terms and make sure to understand the fees involved. Are there penalties for early repayment? Read about other questions you can ask an asset-based lender when you start your research.
- Flexible—will look at the property more than the lender
- Friendly to real estate investors looking for alternative financing
- Higher interest rates and fees
- Potential to lose property in the case of default
How To Evaluate the Options
Once you’ve found lending options, this is where experience comes into play.
You need to know various types of financing options and how they work together to give you the best possible solution. You should know your exit strategy, and what scenarios will provide the most flexibility for your next purchase in the future.
For example, if you are making a purchase for a cash-on-cash return, but will finance the next property with an FHA loan, looking at rate is only one part of the equation.
You also have to factor in points paid, fees and then compare that to your projected gains on the property.
Be sure to consider how much you can borrow, how quickly you can borrow, and other variables that will help you secure the best option.
These are just a few of the considerations that come into play when looking at your financing options. Knowing who to talk with, what questions to ask, and having done some homework puts you ahead of the game.
Cons of the BRRRR Method
Limited cash flow means limited ability to respond to opportunities that present themselves. When monies are tied up into a property, it’s not liquid. Meaning you don’t have the cash to use to purchase another property until you refi or sell the property that you have.
The cons of the BRRRR Method are that you may not always find a property that is below market value, or that the renovations will cost more than you anticipate. There is also the risk that the property may not sell for as much as you hoped for after it has been renovated.
if renovation or material costs skyrocket, or fixes take longer than anticipated, there can be a risk to the investor.
This results in a reduced margin for the investor, making it harder to scale their business.
The BRRRR Method is a popular way for investors to build their rental portfolio. By finding a great property, calculating all the numbers, finding good tenants, and getting financing in place, you can be on your way to a successful real estate investment. Have you tried this investment strategy before? Let us know in the comments below.
- Find a great property with rental income potential.
- Crunch your numbers. Make sure you will make money on “the buy.”
- Fix up the property to attract the best tenants.
- Find those great tenants.
- Refinance the property to take out the equity for your next purchase.
- Purchase your next investment property.
Interested in Deploying the BRRRR Strategy?
Let us assist with the education and financing to make it happen! Cogo Capital is a nationally licensed lender that works specifically with real estate investors. We speak the language of REI and the BRRRR Method. Give Cogo a call at (800) 473-6051 today!