If you’ve ever thought about investing in real estate, you’re probably familiar with the ‘BRRRR method’ of investing. When the market changes it dramatically affects how this strategy is used and may eliminate it altogether in some markets. First, let’s define the BRRRR method.
BRRRR is an acronym that stands for:
Buy
Rent
Rehab
Refinance
Repeat
Most real estate investors build their wealth by following these simple– but not easy– steps to buy properties, fix them up, and pull as much of their initial investment out of the property so they can move on to the next one. The best part about this method is that if you do it right, you can get back ALL of the money you originally put down to purchase and rehab the property. There are a few key things to know about what makes a successful BRRRR:
1. The property MUST make sense as a flip first.
This is something that you absolutely can’t miss– you ALWAYS need to have a plan B which is selling the property at a profit. Holding onto properties and renting them for the long term is great, but sometimes market conditions change which can force you to abandon your original plan.
Many investors who started marginal BRRRR projects in Q4 of 2021 and Q1 of 2022 are finding themselves in a very difficult situation where their monthly payment is going to be 10-30% higher than expected when they refinance, and now they don’t have enough rental income to make a monthly profit. I’ve seen more than a few cases recently where someone overpaid for a property expecting the value to keep rising, and now the market turned and they have no equity.
To make matters worse, if you find yourself stuck in this situation you may not be able to pull any of your initial investment out on the refinance and even if you do the property may cashflow negatively every month. So basically you’re forced to choose whether to sell at a loss now or hold onto a property that’s bleeding cash every month. All of this can be avoided by not overpaying up front.
2. Your all-in costs need to be below 75% of the property’s final value.
This point ties in to the first one; you generally need to be below 70% LTV to make a BRRR deal work smoothly. Why 70%? Because most lenders will let you refinance up to 70-75% of the property’s completed value. Don’t forget to add up ALL of your project costs in this calculation, including holding costs, interest on your rehab loan, property taxes, insurance, and construction contingencies.
3. The property must be able to cashflow as a long-term rental once all is said and done.
This one is for the Airbnb-ers out there. If you plan to boost the income by renting out the property short-term, be sure that the property still underwrites as a long-term rental. You never know when things will change, such as Philly’s recent laws and licensing changes which just made running an Airbnb operation MUCH more difficult in the city. Many investors purchased entire apartment buildings at inflated valuations expecting to Airbnb the whole building and make 2x-3x the rental income…and now some of them will be in for a rude awakening in January if they’re not able to get the building licensed and have to shift to only long term renters.
4. You (or one of your partners) need to be bankable so you can complete the refinance loan.
Similar to the other points, this one may also sound obvious but is often overlooked. Don’t forget to properly plan out your taxes and have conversations with your accountant every so often to make sure your taxes will be where they need to be so you can get a decent refinance loan. If you don’t do this or your taxable income isn’t where it needs to be, you may be forced to go with a no-doc lender which will charge you WAY more. These programs aren’t always around but when they are the rate could be 2-3 percentage points higher AND you won’t be able to borrow as much money in most cases.
I’ve seen instances where an investor had to reduce their loan amount by as much as 20% because the interest rate they were forced to take was that much higher. Think about this: If you have a property you just rehabbed that’s worth $300,000, your all-in cost could be around $210,000. Imagine if you were planning on getting a refinance loan for $210,000 and that number dropped to $170,000. What will you do? What if your hard money loan is for $180,000 and you now need to bring an EXTRA $10,000 to the table just to get the refinance? Hopefully you’re getting the point.
So is the BRRRR method dead in 2022? Overall, I don’t believe that it’s out of style yet, but it has become much more difficult to find profitable deals. It’s crucial now more than ever to underwrite deals more conservatively, be more selective with your area, and be patient. Buying a bad deal can be 10x worse than not buying anything at all. If you have marginal properties or ones that you don’t like for one reason or another, now is the time to get out from under them. If you have properties with a lot of equity, now is the time to consider cashing them out and waiting on the sidelines because there will be a lot of opportunities in the near future as investors that are stuck in properties are forced to unload them. There is a Warren Buffet quotation you can keep in mind: “It’s only when the tide goes out that you learn who has been swimming naked.” The tide is rapidly receding and many people are being exposed right now which will lead to plenty of opportunities.
Happy hunting!
Rodney Ross
July 22, 2022