What is the BRRRR method in residential real estate investing?
The BRRRR method stands for Buy, Rehab, Rent, Refinance, Repeat, and is a common real estate investment strategy involving buying a distressed property, fixing it up, renting it out, and then refinancing to cash out on the increased value in order to fund additional investments. Before working with this strategy though, there are several important considerations. Below, we'll walk through more about how this process works, along with the potential risks.
How does the BRRRR method work?
This method (as the acronym implies) is comprised of the following components:
- Buy a property
- The property you find should be distressed and generally require work to get it ready for occupancy. Due to the nature of the home's condition, it should be cheaper and easier to purchase than a 'rent ready' home. This method generally assumes you're buying a property with a traditional loan (at 20-25% down).
- Rehab the property
- Here is where the bulk of the work (and risk) can come into play. You'll need to renovate the property, including anything from structural to aesthetic improvements in order to prepare for and attract renters. If you don't have a lot of experience estimating the cost of rehab, it can be tricky. This means you may run a risk of overpaying for the initial property + rehab and end up running with negative net cash flow after renting out the property. We'd recommend using very conservative (high side) estimates when estimating renovation costs, and getting a good inspection done prior to purchasing the distressed property so you know everything that you're getting yourself into and can factor that into your offer to purchase.
- Rent the property out
- As soon as you've finished fixing up the property, you'll then want to find a tenant and rent it out. You will of course want to estimate your expenses / net cash flow and aim for a positive ROI prior to factoring in any future appreciation in the property. You can read more about what's generally factored into rental expenses, as well as how to calculate the future return on your investment here.
- Refinance the property, and cash out on the incremental value
- Once your property is occupied and cash flowing, you will begin building equity in the property (as is the case with any residential rental). Additionally, since you did meaningful rehab and repair on the distressed property, it will likely now have a higher value than when you took out the initial loan to purchase it. So, you can refinance the property at the new (higher) value and take out the remaining cash.
- For example, say you buy a $100k distressed property (putting a simple $20k down). From there, you renovate it and increase the market value of the property to $150k (spending a meaningful amount of money of course on the rehab along the way). So, you can now go back to the bank, refinance to take out a $150k loan on the property, and take out the delta in equity as cash to fund future investments
- It's also worth noting there will be closing costs on both the initial loan and the refinance that will eat into your profits, so plan accordingly for that as well
- Once your property is occupied and cash flowing, you will begin building equity in the property (as is the case with any residential rental). Additionally, since you did meaningful rehab and repair on the distressed property, it will likely now have a higher value than when you took out the initial loan to purchase it. So, you can refinance the property at the new (higher) value and take out the remaining cash.
- Repeat the process
- Using the cash obtained from the refinance, you can then find another property to buy, and repeat the process all over again
What are the pros / cons of the BRRRR method?
Pros
- You can profit meaningfully from the increased value in the home without flipping it. Refinancing is also generally not a taxable event (you'll want to read about the specifics for your given state)
- By focusing on obtaining renters, with hopefully solid cash-on-cash returns, you de-risk yourself from potential market downturns to some degree, since even if the property value does not appreciate as expected you still have a positive cash-flow asset under your belt (that you're continuing to build equity in as the mortgage is paid down)
Cons
- As mentioned above, it can be tough (especially if you lack experience) to correctly estimate the full cost of rehab in order to get the property rent ready. This poses a risk when employing BRRRR. We'd recommend an inspector prior to purchase so you fully understand the scope of work, and significantly over budgeting against whatever the estimated costs are.
- Finding a tenant and acting as a landlord will take time and effort. The income is not truly 'passive' in this sense, so be prepared for property management duties (or consider hiring a property manager + factoring in their cost)
- If the property you're buying stretches your personal budget, you may find all of the uncertainties and risks to be quite stressful. Everything from the cost of rehab, the timeline of getting the property rent ready, the time it takes to find a tenant, and estimating what market rent might be can take a toll on you mentally and a single bad purchase could cause serious financial issues if purchasing a property is stretching your budget. Be careful!
Overall, the BRRRR method is a solid way for investors to get involved in residential real estate with little up front capital but, like most things, is not without risks / caveats. So, be sure you are doing your due diligence, don't stretch yourself too much financially on a project, and be conservative in your cost estimates to ensure you're getting a positive ROI for your efforts.