The BRRR Method has been popular for a couple of years now. The idea of buy, rehab, rent, refinance, and repeat makes sense on its face and has proven to be a sound formula for building a real estate portfolio. The ability to generate rental income, while realizing the equity improvements to a property to fund other projects is a verifiably repeatable process and one that just about anyone can employ.
While more conventional property investment strategies require flipping the distressed property to realize value, the refinancing step in the BRRRR method ensures that you can generate profit through two different channels. But while it's more profitable, it also comes with some potential risks.
The world of investing is inherently a risky proposition, but understanding how to balance your upside and downside is paramount, and nowhere is that more important than when using a BRRRR Method.
The Hard Money Co. has seen both the good and bad and has some tips on how to navigate this popular strategy.
Lengthy Renovation Periods
Prior to your purchase of an investment property, investors typically have a crystal clear idea of how long their property renovation is going to take. But even the most seasoned investors run into issues that can dramatically increase the time period of their repair. This can be a result of inconsistent contractors, supply-chain disruptions, or any number of unforeseeable circumstances. In many cases, even the most diligent management couldn't have avoided the issue. If your project is operating with slim margins, be sure that your schedule has a buffer in it for delays and consider whether that risk is tenable before you buy.
Unexpected Renovation Costs
Delays can add cost and risk to a project, but it's not the only way that a budget can begin to inflate. Major expenses can pop up without any warnings and eat away much of your profit potential. This is especially true when dealing with distressed assets where underlying issues are often obscured. Experience will go a long way towards identifying potential issues, but it's always a good idea to employ a neutral property inspector who can thoroughly review a property before purchase.
Given the multistep process of the BRRRR strategy, you will likely need to invest significant time and energy into managing the endeavor. The rehab, rental, and refinance all have distinct challenges that they bring to the table and you are responsible for navigating each of them. How much is your time worth? Is that something that you've adequately accounted for when budgeting your project? Sweat equity counts for more than just the time spent swinging a hammer. Make sure that you aren't stretching yourself too thin and that you have the capacity to manage the intricacies of your deal.
With the BRRRR method, your profit is not determined by the price a buyer is willing to pay; it is determined by the valuation an appraiser places on the property. This may not seem like a significant difference, but it directly informs the amount of capital you can extract on your refinance. Appraisers may approach a valuation with a different perspective than buyers, so make sure the fundamentals of your property are in order to maximize the appraisal amount.
Time to Rent
The cash flow your property is able to generate through rental contracts is an important facet of the BRRRR strategy, both in your ability to profit as well as the ability to refinance at an advantageous valuation. This means that you need to get tenants into your property as soon as possible. Delays in renovations or rehabs can delay this profit and tip your investment's profitability. Many lending institutions will also require seasoning on your investment before a refinance can take place. This means that you need proof of payment on your existing mortgage by generating positive cash flows from renters. Disruptions on the rental side can sidetrack the entire process.
Some investors may have the financial backing to withstand delays, but for many who are just starting their investment journey, this can make or break a project.
In addition to the time it takes to rent a property, you must also be aware of the price you are charging your tenants. Your initial investment strategy should have a concrete determination for this figure. While it's true that you want to maximize your rental price, that may not be your core objective. Often times it may be advantageous to list your units at or below market rate in order to attract renters quickly. This will help establish a cash flow and ease your ability to refinance. The inverse of this is a price that prevents profitability on your investment. If the prevailing rental economy is too competitive you may find yourself with a negative cash flow or with vacant property.
There is no 100% correct answer for your pricing structure. You just need to ensure that your ultimate decision is well-informed and meshes with your overall investing strategy.
Time to Refinance
In the same way that it takes time to research, purchase, and renovate a property; it also is a time-consuming endeavor to refinance. A standard refinancing can take upwards of six months after considering seasoning requirements, appraisals, and other factors. What kind of costs are you accumulating in that time period? If you've used hard money or other costly capital to finance your investment, you may be operating on a significantly shorter horizon.
Before engaging in the BRRRR strategy, you should consider if the duration of the investment is tenable to your current needs. Is this the best use of your capital, or are there other opportunities or investment strategies that better fit your circumstances?
Return on your Refinance
The biggest strength of the BRRRR strategy is the ability to withdraw equity at relatively low-interest rates with long-term mortgage products. Leveraging your assets to broaden your portfolio is what makes this a great wealth-building strategy. That said, even with the most ideal investment property, you may not get the refinancing offer that makes your deal a home run. Often times lenders will only refinance a portion of your property valuation. It's also possible that interest rates at the time may not be conducive for month-to-month profitability. It's easy to see record low rates right now and assume that it will last, but it's not a given forever. There are also closing costs to consider. These are lump-sum payments that directly eat into your profitability. To what extent might these offset the return you're getting on the refinance? Don't take the refinance for granted. Shop around with different companies to maximize your profitability on your investment.
Why should I use the BRRRR Strategy?
This entire piece is filled with reasons why you might want to reconsider the BRRRR strategy, but our intent is not to talk you out of it. Rather, investors should be fully informed on all the costs and opportunities that might arise from their given strategy. BRRRR offers a high-profit potential, but the caveats outlined above are all legitimate downsides that need to be considered. If you are able to deftly navigate these risks, we're confident that you will be a successful investor. And if you aren't 100% confident right now, that's okay too. Take the time to research each facet of your investment and the answers to these questions and more will reveal themselves.
In the meantime, if you have any questions about real estate investing or how to get started; please reach out to us and we will get you started on your journey.