The BRRRR Method: How To Make It Part of Your Investing Strategy
Building Wealth Through Rental Properties
Every real estate investor has the same goal in mind: financial freedom. To achieve it, you need an investing strategy. One that works for many investors is the BRRRR Method.
The BRRRR Method (Buy, Rehab, Rent, Refinance, Repeat) is a popular 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 BRRRR because it’s a combination active-and-passive income strategy with limited personal outlay.
Read on to learn about how the BRRRR Method works, its pros and cons, and if it’s the right method for your financial and real estate goals.
How is the BRRRR Method different from a traditional investment property strategy?
Unlike a traditional buy-and-hold strategy that focuses on acquiring properties in good condition, the BRRRR method targets undervalued, distressed properties with the potential for significant improvement through renovations. This allows investors to leverage the increased value after rehab to refinance and recoup their initial investment—essentially using one piece of capital to acquire multiple properties and grow their portfolio. The ability to both source and create value are critical, which makes BRRRR an exciting and challenging strategy to master.
How the BRRRR Method Works
Let’s break down BRRRR’s 5 steps:
Buy – As with most real estate investments, “you make your money on the buy”. With BRRRRs, you typically want to be buying in areas where your purchase price and rehab are no more than 75% of ARV (After Repair Value). Another good test: would the monthly rent equal at least 1% of the purchase price, supporting a healthy debt service coverage ratio (DSCR).
The Backflip Analyzer is an easy way for an investor to compare a property’s potential cost basis (that is, purchase price + rehab) with its ARV, to estimate the refinancing and rental cash flow. Having a tool saves lot of time for evaluating whether a property fits your target “Buy” criteria for a BRRRR, as well as what offer to make.
Rehab – Once the property is acquired, the next step is to execute the rehab and create the value that will ultimately enable you to refinance out. To do this well, 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.
Look at your rehab budget: are you getting enough return on the investment so that your cost basis stays below 75% of your ARV? For example, does a $10,000 investment in the kitchen result in a $30,000 value increase (good), or a $12,000 increase (bad), based on comps? You can use Zillow or the Backflip app to review interior and exterior photos of recent flips to see what level of finishes and updates the best performing comps in the market are maintaining.
Rent – Now that you have finished your rehab, the property is ready for a renter! As with any great business plan, doing all the homework upfront sets you up for success. 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.
A critical aspect of the rental stage is finding a renter, as many lenders want to see that you actually have tenants before refinancing. Remember, a good tenant makes managing a rental property much easier. Make sure to check rental history, references, look for criminal record, and pull a credit report.
Refinance – The moment you’ve been working towards! Time to pull out that cash so you can start thinking about placing that equity into your next deal.
The goal is to get the whole of your cash outlay back out on the refinance. The amount you can usually refinance tops out at 75% of the home value. Now you understand why knowing upfront what your cost basis is to ARV is so important.
There are ways to optimize the process. But here are three things to bear in mind:
• Leverage (aka Loan Amount) – The rule of thumb is you can get 75% loan-to-value (LTV) on a refi. So if an investor’s cost basis is greater than 75% of ARV, they cannot pull all of their equity out when they go to refinance.
• Timing – Depending on this lender and the types of capital products they offer, you may 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 has substantially been added by the rehab not market appreciation since purchase. It is also important to know if there are any prepayment penalties or lockout periods on the loan.
• Debt service coverage ratio – DSCR is a metric that measures a 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 require at least a 1.2x, 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.
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
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 Fix & Flip 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 Fix & Flip loan from Backflip ($305K), and the rest goes to you. That’s $50K cash back on the $45K you invested. You 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.
Put that $50K into your 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 initial value means more working capital for your next investment. Using the BRRRR method greatly increases the amount of work that your money can do for you. Your money grows and gets freed up to make new investments, which again increase your returns, allowing you to make yet more investments, over and over.
- 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) and systems (tools/common practices) in place, 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
A lot of patience that is needed to execute this strategy correctly. First, your 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. It can all take several months. If you’re looking for a strategy that allows for a quick exit, 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 if you don’t have the time or the skillset to be a landlord.
Is BRRRR Right for You?
The BRRRR method offers a powerful strategy for building wealth. However, it requires research, planning, and an understanding of the risks involved. Carefully consider your risk tolerance and ability to manage rental properties before diving in. Taking the time to properly plan can make all the difference as you scale your business. Calculate whether your next investment will be a strong addition to your portfolio: Implementing a strategy that you’re not prepared to see all the way through is a detriment to the rest of your portfolio, and can hurt your returns goals.
If you’ve decided that the BRRRR method is a good fit for you, let us mention that Backflip’s suite of tools and services are designed for investors like you to close on deals quickly, rehab quickly, and secure new properties to add to your portfolio. Give us a look, and good luck out there!
