What investor wouldn't want a few hundred dollars in cash flow per month while being able to cash out the entirety of their principal investment within six months to a year? That is the promise of the BRRRR method.
You may have heard of the BRRRR (Buy, Rehab, Rent, Rehab, Refinance) method coined by Brandon Turner. It is a bit of a hybrid between the strategy of buying and hold and fix and flip. You can take advantage of a rental's long-tail semi-passive revenue stream on the buy and hold side. On the fix and flip side, it allows you to take advantage of buying a distressed asset and causing forced appreciation.
The primary reason why BRRRR has gained popularity is that it is a quasi-low or no money down approach to real estate. As a result, you can pull most, all, or even more principal back out when you refinance than you initially invested. Refinancing allows you to re-use your initial capital repeatedly to grow your portfolio over time.
Buy and Hold Benefits
Some people refer to rental income as mailbox money because it comes in every month whether you work or not. Single-family is less passive than a larger multi-family or a limited partner in a syndication deal. That is not necessarily bad, though, as being less passive allows you to influence your returns to a greater degree.
Investors typically look for a couple of hundred dollars of cash flow per month after all expenses and reserve accounts in a BRRRR investment. They also look to take advantage of the tax benefits of depreciating the entire asset. The real icing on a buy-and-hold investment is principal paydown, and after the refinance, there will be a large amount of principal on the loan.
One of the challenges with single-family buy-and-hold investing is that it is relatively hard to project capital expenditures. However, with the BRRRR strategy, you are doing your renovations, making it easier to estimate future capital expenditures. For example, it is much easier to project the life of a roof if you just put it on vs. estimating the age and condition of an existing roof.
In my opinion, this is the real workhorse of the BRRRR strategy. It is where the magic occurs that makes the rest of the method a possibility. You can enjoy the benefits of creating value through the renovation tax-free by refinancing instead of selling like a typical fix and flip.
The general idea is to find a property that can be purchased and renovated for 70% of the ARV. When you finish, you will be sitting on 30% of created equity. This value goes directly to your balance sheet and works to increase your net worth.
The downside of the Rehab portion of the BRRRR strategy is that renovations are time-consuming, stressful, and challenging. They are not a passive activity, and even with a streamlined business, they will still take significant time to manage. Fortunately, the rehab portion is short-term, and the investment becomes a semi-passive asset once you are complete.
What Makes for a Successful BRRRR Method
Not every property makes a great candidate to be a successful BRRRR property. However, they should be significantly distressed properties requiring a decent amount of rehab at the sweet spot. Typically, the more minor renovation required, the less likely you will find them at 70% ARV.
So we are looking for a property that can be purchased and rehabbed for 70% of the total ARV. We are also looking for properties that meet the 1% rule. We are also looking for a property that meets these criteria in the best neighborhood to find the deal. Another good option is looking for a property that will require relatively low maintenance once completed.
Why the best neighborhood?
The sweet spot of buy and hold is typically low-value assets that collect the most rent possible. With a conventional loan, you will have to put down 20-25% as a down payment. However, the downpayment is mitigated with the BRRRR strategy because you are refinancing money back out of it.
Because you are refinancing the down payment, there is more opportunity to benefit from appreciation and principal paydown. These become the secret weapons in the BRRRR arsenal that lead to spectacular long-term wealth creation. That makes it a good idea to invest in neighborhoods with higher opportunities for upside. Usually, these neighborhoods are in the mid-stages of gentrification and not the stagnant “rental areas.”
Another benefit of the BRRRR strategy is that it often makes sense in “B” neighborhoods. It might not make sense to buy a house for 150k and rent for $1,500 a month with nearly 40k down, it makes a lot more sense when you can refinance the down payment back out. The great thing about doing this is that managing rental properties in these neighborhoods is usually a lot easier. It is generally easier to find qualified tenants.
What About Less Rehab?
Though there are still benefits that can be had by buying outside the model of 70% ARV and at the 1% rule, sometimes I come across properties that would beat the 1% rule but do not require much work to get them to rent ready. Since the rehab would not be extensive, the forced appreciation would be minimal.
The Math Behind The Benefits of BRRRR
- Principal paydown
- Tax benefits
- Reduced maintenance
- Return of capital
- Sale of asset
Let's take a minute to explore each of these in detail. Then, I will be comparing the two strategies with what I consider a typical deal for each in my market.
|The BRRRR deal||The Buy and Hold Deal|
|Purchase price: $70k||Purchase price: 100k|
|Rehab: $30k||Rehab: 3k|
|Transaction + refinance + holding costs: 10k||Transaction and holding costs: 5k|
|ARV: 140k||ARV: 100k|
|Rent: $1,500||Rent: $1,100|
Benefit #1 Cashflow
Ignoring the difference in maintenance and the likelihood of a higher quality tenant resulting in lower turnover costs, consider expenses at 50% of the rent. Of course, in reality, they should be lower than this, but this is a simple way to compare two hypothetical deals.
That means the expenses for the BRRRR property would be roughly $750, leaving $750 for debt and another deal. The ARV is 140k, allowing for a 112k loan which would pay for the purchase, rehab, holding, and transaction costs and have $2,000 extra. At 4% on a 30-year fixed, the payment for a $112,000 loan is $535. This leaves $215 a month in cash flow.
We would consider costs to be $550 a month for the buy and hold deal. The loan would be $80,000, and payments would be $382. This leaves $168 a month in cash flow.
Benefit #2 Principal Paydown
We will consider a 7-year hold on both properties.
At the end of 7 years, the loan on the BRRR property would have $96,173 remaining. For a paydown of $15,827 over the 7-year term. This averages to $188 per month.
At the end of 7 years, the buy and hold property loan would have $66,826 remaining. This makes the paydown $13,174 over the 7-year term. This averages to $156 a month.
Benefit #3 Tax Benefits
The depreciation schedule for residential real estate is 27.5 years. The value of the land does not get depreciated. We will assume the land value is $20,000 in both scenarios.
In the BRRRR strategy, your basis would be $100k. This would have an annual $3,636 depreciation benefit for your taxes.
The basis for the buy and hold property, in this case, is $100k as well. Therefore, neither strategy has a benefit over the other in this specific example.
Benefit #4 Reduced Maintenance
This benefit helps with scalability just as it helps with actual cash flow. Since most people interested in the BRRRR strategy probably have a full-time job or a means of generating income outside of their rental portfolio, management intensity can play a significant growth factor. Knowing that the roof and mechanicals are new and all major issues with the property have been addressed with long-term solutions can provide great peace of mind when growing your portfolio.
On the cash flow side of things, in that same 7-year hold with the BRRRR strategy, the brand new HVAC and the new roof did not require replacement. So there were $0 capital expenditures during the rented period.
On the Buy and hold, the heater failed, and you replaced the AC at the same time because it was in bad shape. This costs $6,000. The average monthly cost of this expense over seven years was $71.
Benefit #5 Return of Capital
Because there is forced appreciation, you have the opportunity to refinance out some of the created equity. In the BRRRR example, if you had a bank that gave you 20% of the initial 70k, and you funded the 30k in renovations out of pocket, you would have 44k of cash into the deal, 7k of the closing and holding costs. Upon the refinance, you would get back all 51k invested and 3k to cover loan closing costs and an additional 2k, which you could use in future deals.
There is no cash-out refinance on the buy-and-hold deal because there is no forced appreciation. So you would still have the initial $20k of equity and 5k of closing costs in the deal for the duration of the deal.
Benefit #6 The Sale
This may be slightly understated because, as previously mentioned, BRRRR does great in neighborhoods that have above-average appreciation. Therefore, this example will consider a flat 1.5% per year appreciation between both strategies. In addition, we will consider the same seven-year hold period.
In this example, the BRRRR house, which had $140,000 ARV in year 1, would be worth $155,378. Therefore, the loan balance would be $96,173 for total proceeds of $59,205 at the sale.
The buy and hold house started at $100,000 and would have a future value of $110,984. The loan balance would be $66,826 for total proceeds of $44,158. After paying back the $25,000 initially invested, the profit on the sale is $19,158 over seven years.
The Big B: Buy
They say you make money in real estate when you buy, not when you sell. While this is especially true on traditional buy and hold, the purchase and purchase are important in the BRRRR strategy.
When buying a property for the BRRRR strategy, you are looking for a distressed property. The simplest way to define a distressed property is one that needs some repairs to be move-in ready.
Flippers are typically looking to acquire a property for 70% of the ARV (After Repair Value). That means the purchase price + holding costs + renovations add up to 70% of the ARV.
The BRRRR strategy doesn't have quite as hard and fast a rule for what percentage of ARV you need to buy. Though most investors I have talked to seem happy with getting in around 80% ARV, they can refinance out most of their money after the renovation.
Where To Buy
Setting up your portfolio and which neighborhoods you buy in is entirely up to you as the investor. I have found success in mid-level blue-collar areas. The finished product might be targeted toward professionals just starting their careers.
You cannot change the location. This is why the age-old real estate mantra has been location, location, location. There is a lot of truth to this, but if you pay too much, location won't fix negative cash flow.
The BRRRR strategy blends both cash flow and appreciation. For greatest capital appreciation, you want to look for properties that are in the “path of progress.” Otherwise known as the areas in a market that people are moving to, where businesses are investing, and real estate prices are stable and increasing. Usually, the most in-demand neighborhoods have spillover, where the neighborhood beside them benefits from people moving in that were priced out of the most in-demand markets.
Finding the perfect house to do a BRRRR strategy with can be overwhelming. Since you are buying for the long haul, you want to look at houses that, when you have the finished product, you would be ok withholding for the long haul.
Picking the specific house will involve running the numbers. You can use a BRRRR Calculator to help with that. You can look at BRRRR as a strategy to maximize IRR, or you can view it a little more simplistically. For instance, you could look at it as a way to get a certain amount per door, and you can recycle your capital every year. So if you get $250 per door but do it ten times over the next ten years, you are making $2500 per month on your initial capital investment.
There are several different methods you can use to source your properties. I recommend focusing on one or two of these first but not completely neglecting the other methods.
You can source potential houses in several different ways. Many investors will say the MLS doesn't have any good deals. This method still works, but you might need to get more creative. For instance, if you see a two-bedroom house with 1,400sq ft. Maybe you can convert that into a three-bedroom somehow in the renovation.
You can also work with wholesalers. These people send out mailers, run radio ads, etc., to find distressed properties. They then turn around and sell them to investors, usually stipulating that they need quick two-week closings.
Getting out there and letting people know what you do and what you're looking for also works. This is called networking. Having meetings with realtors, colleagues, other investors. That way, when they see something that might fit, they can send it along to you. Offering a referral fee can help with this. Though referral fees on real estate transactions are not legal in all areas or circumstances without a real estate license, so be sure to ask an attorney about that beforehand.
Instead of going through a wholesaler, you can do the marketing yourself. For example, you can go to places like yellowletterscomplete.com and set up mailing campaigns for prospective houses to buy. Then you take the call and negotiate directly with the homeowner.
- Direct Marketing
The type of financing you use to fund the purchase and rehab also matters. Again, there are a few options here. Some investors use their cash or JV partner with a capital partner. You could also go the traditional mortgage route, financing the purchase and paying out of pocket for the renovations. Finally, you could get a 203k renovation loan, though it involves more steps to get approved and a longer closing timeline.
Another option is getting a mortgage through local banks or credit unions where they hold the loan in their portfolio. These lenders can usually work in the quick timelines required to buy a distressed property. Portfolio lenders are also less likely to balk at issues facing distressed property renovations.
Hard money lenders are another popular option for BRRRR investors, especially for projects with significant renovations and highly distressed properties.
- JV Partner
- Traditional Mortgage
- 203k Renovation loan
- Portfolio Loans
- Hard Money/Private Lenders
The First R: Rehab
Rehab is the riskiest part of the BRRRR strategy. There is plenty that can go wrong in the rehab stage. For example, your budget can run over, it may take way longer to rehab than expected, and the holding costs run-up, or you can run into unexpected problems. The key to mitigating some of these risks is to be prepared.
Prepare Scope of Work
Besides the purchase agreement, I think the scope of work/budget is the most important part of the BRRRR process. It even informs your purchase decision. A few things make for a good scope of work document.
Some investors like to make their scope of work as a text document in paragraph format or possibly in a table. I make mine in excel and tie it to my budget. I have a line item for every aspect of the project. Things like countertops, cabinets, vanities, finish electric fixtures, rough-in electric, plumbing, etc. So the document has the category, line-item budget, and a description of the work to be done.
Then I reference the line items on a separate sheet in excel. The more complicated line items of the original sheet tie out to more details. For instance, I pick out every light fixture with a link and the price for the light fixtures. Then, I added up all the light fixture costs and put that in my budget.
I do not use too much verbiage in my scope because I will be acting as the general contractor. However, if you will be hiring a general contractor, it pays to be specific in your description of the contractor's work.
Cultivate Relationship with Contractor
Because the rehab is the section of the BRRRR process with the most significant risk, your contractors will be one of the most influential people in your team to mitigate this risk. You may decide to act as the general contractor and sub out various trades to specialists in that trade or hire a general contractor. Sometimes, you can do both by hiring heavy lifting, like roofing, and paying a carpentry-focused contractor to handle the interior work.
I see a lot of investors get involved in skinny deals. To make the numbers work, they then raid the rehab budget. While you can often save money on certain things, it stresses the contractor relationship.
I see many investors who think they always have to “win” in relationship with their subcontractors. In these cases, they usually only end up working with a subcontractor one time. Because either the sub walks off the job or doesn't want to work with the investor again. The sub then either does not bid on the next job or gives the investor a higher price bid than they would traditionally because they know it is a pain working with that investor.
What to do when the unexpected happens
I am sure you have seen one of those house flipping shows on tv. Every single episode, they run into the same problem. The wall they were planning on knocking out is load-bearing, and there are pipes or duct runs in it. This is either TV drama or borderline negligence. It is relatively easy to figure out if a wall is load-bearing and speculate on whether there are pipes in the walls.
The majority of the issues that arise are similar, though. Mainly you can prevent them, but they were oversights in the planning process. For example, supporting a load-bearing wall is one misstep that can occur in the planning process. Deciding you need to move or remove a window to get an ideal kitchen layout is another. Another common issue is misestimating the amount of material required for something.
It is easy to let the scope of work expand as you are renovating the house. For every item you replace, it makes all the existing finishes of the home seem older in contrast. For example, replacing an outlet and outlet cover makes all the other outlets look way older, even when they started perfectly fine-looking.
When you open up the walls and start working on things, you can expose problems with rotted framing, electrical system, plumbing, and more. For example, you may discover a problem with the roof; commonly, there is a problem near the chimney that was not readily apparent before you started working on the house.
How do you manage all the issues that come up during a renovation? Well, one line of defense is your contingency budget. If you run into a problem that makes your initial vision more expensive to complete, an option is to reduce the scope of work to not include that item after realizing there will be an additional cost. Another option to stay within budget is to reduce the scope of another renovation item. The third option is to come up with more money and be content with going over budget.
The fact of the matter is that when you find something wrong structurally or with a major house system, you need to repair it while you have the house under construction. But unfortunately, it will not magically fix itself and will likely only get worse or more costly to repair in the future.
No matter how well planned a renovation is, there will always be loose ends. These can range from small tasks that got overlooked and were not included in the scope of work of the trades, outlets or lightboxes that need to be moved, and other finishing touches to get to completion. How well punchout goes is often a good indication of how skilled, prepared, and experienced an investor and crew is.
The Second R: Rent
Renting the property is the glue that holds the process together. Therefore, how you manage your property over time will greatly impact your wealth growth. Where the rest of the cycles of this process are short cycles, you will be managing the property for five or more years.
How you market your rental, get a good tenant in place, collect rent, and handle maintenance will be your biggest processes for your rental business.
Self Manage Vs. Hiring Property Manager
You will have to make one decision to manage the property yourself or hire a professional property management company. My recommendation is to manage your first property yourself to learn the process. You will learn what good property management is, how property maintenance is performed, and what bad property management is. Of course, by managing the first property yourself, you will likely have some learning pains. There will be mistakes, which will likely cost you both time and money.
There are pros and cons to both sides of the choice of managing the property. Hiring a property management company directly impacts your bottom line. A professional property manager is likely 6-10% of the gross rents taken off the table. This can slow down your growth. However, self-managing could take about an hour per unit per month. Using your time working in your business instead of owning your business could also slow your growth.
Listing Your Property
There are a few main platforms that you can list your property on. The ones I recommend are:
- Facebook Marketplace
A few things to mention when listing your property. Having good professional quality photos are going to help a lot. I see so many listings with terrible-looking photos. They make the place look uninviting. If your place looks uninviting, do you think the best quality tenants that get to pick any apartment they want are going to be applying? Or do you think you will mostly get tenants who do not fit nicer apartments' screening criteria to apply?
Another important aspect of getting your property listing correct is setting the price. I find that there is a sweet spot with rental property pricing. Too high, and the only people that express interest are the ones that cannot afford it. Too low, and you are simply leaving money on the table. To research rental pricing, you can look through the sites you list to view the competition. See how your unit compares in size, condition, location, and amenities. You can also get an estimate of market rent from rentometer.
Once you get an application, it is time to run the screening process. You must use the same screening and rental process with all your tenants. If you give one tenant preferential treatment or ignore screening criteria over other tenants, you may run afoul of fair housing laws.
You can set up your screening to involve as many criteria as you want, but remember not to discriminate against any protected classes. Here are a few essential screening criteria:
- Income at least 3x monthly rent
- 650 Minimum credit score
- No previous evictions
- Positive references from previous landlords
Once a tenant passes your screening criteria, it is time to sign the lease, get your deposit and first month's rent, and move the tenant in.
My first property was a house hack. I collected the rent by going downstairs and asking my roommate for the check for the month. I do not recommend this method for any sort of scale. However, having an electronic process for collecting and managing lease payments will save you time and headaches.
Nowadays, there are so many online platforms and payment methods to simplify collecting rent for landlords. You can use full-blown property management software like Buildium or App Folio. Some platforms focus on just the rent collection side. Making them more affordable. One of these is Cozy.
We have all heard the cliche about fixing toilets at 2 am on a rental property. While I have never dealt with this, maintaining your parcel will take time and money.
Usually, the best way to maintain a property is to fix something the right way and move on. It rarely makes sense to opt for the extra frills in finishes.
The Third R: Refinance
This is the stage where you realize or lock in all the hard work and decisions you have made up to this point. To fully realize this return, you have created enough value in the rehab and collected enough rent to have a DSCR (Debt Service Coverage Ratio) sufficient to cover the loan.
Long Term Loan
When refinancing, you are looking for a long-term loan. Balloon payments create risk and could force you to sell at a time that is not appropriate for the market. While you could have picked a short-term loan for the purchase and rehab stage of a BRRRR project, it is essential to select a loan that will work for you for the long term when refinancing.
Most banks have a seasoning requirement of 6 months or a year before they do a cash-out refinance that allows the value of the new appraisal to be higher than the purchase price plus renovation expenses. However, I have found a few lenders offering portfolio loans with shorter or no seasoning requirements in my market.
Refinancing Lowers Cashflow
The most challenging part of getting used to BRRRR is how much the refinance affects cash flow vs. a simple buy and hold. Since the result is usually to have a higher quality product than you would buy with the buy and hold strategy, there is more capital at work. As a result, the dollar amount of cash flow can be lower, but the other benefits of principal paydown and appreciation can outweigh the cash flow throughout the hold.
Return of Capital
The goal of the refinance is to return your initial capital. In this stage, you are getting your down payment back. This worked when you increased the property's value in the previous steps by 20-30% more than you have into the property in hard costs.
You may not be able to refinance 100% of your invested capital during this process. That is ok; a 75% return on your principle will get you much closer to being able to repeat than no return. For example, if you get a 75% return and the property has a 15% cash on cash return, you will be able to repeat it in less than two years. You might hit a home run for some properties and get 120% of your capital back at refinance.
The Fourth R: Repeat
At this point, you now have a lucrative asset in your portfolio, and you have some or all of your initial investment returned to you. Now is the time to repeat the process. You start the buying process again. You are searching for properties that will fit your model.
This process depends on how long you spent in the rehab, what bank you use for your refinance, and their seasoning requirements. It is theoretically possible to buy a property, renovate it in 2 weeks, have a waitlist of tenants looking for a place, move someone in instantly, and immediately refinance with a bank without a seasoning period. However, the more likely scenario is that it will take about six months to a year to complete the process. You may even take longer to do the refinance or repeat portion as there is less of a rush once the property is rented and cash is flowing.
Building wealth through real estate using the BRRRR method can be a lower-stress way to achieve your financial goals than other assets or strategies. It is not a get-rich-quick scheme, but it isn't so slow you cannot see the growth.
There is value in identifying distressed properties and buying them with enough profit margin to pull out all your capital in the refinance stage. While renovations are never simple, it is a process that will significantly front-load the returns on your investment.