3 Things Real Estate Investors Should Know About the BRRR Strategy
You’re ready to purchase your first investment property, or maybe you’re ready to try a new real estate investment strategy to earn more profit.
Congratulations!
If you’ve done some research on real estate investing, you may have come across the acronym BRRR. This represents a popular way to build a real estate portfolio, and the good news is that it works for many investors. BRRR, or in some cases BRRRR (we’ll talk about that extra R later), can be a great way to make money on rental real estate without a huge initial outlay of capital. The key is to understand the nuts and bolts of the strategy, choose the right loans, and know how to reduce risk.
Here’s what you need to know before you take out a loan.
What Is BRRR Real Estate Investing?
If you’re not familiar with the BRRR investment strategy, it can seem complicated. In practice, however, it’s a straightforward approach.
BRRR stands for Buy, Renovate, Rent, Refinance. If you love real estate investing and you want to own several properties, you can tack on an extra R for Repeat. Let’s take a quick look at each of those steps:
Buy: With a BRRRR strategy, you buy an undervalued property, renovate it, and rent it, just as you would with a fix and flip investment. The goal is to improve the condition of the property and increase its value so that you have built-in equity when you refinance. When you purchase the property, you will typically take out a short-term interest-only fix and flip loan to cover the cost of the property purchase and renovations
Renovate: In this step, you’ll rehab the home to make it functional and to increase its value. Evaluate each potential upgrade to determine whether it will cost you more than it adds to the overall value and/or rental rate. For example, structural improvements like new bathrooms are worth the investment, but high-end floors and appliances may not be, depending on your intended market.
Rent: It’s usually best to have a good track record of renters in the home before you refinance, and sometimes seasoning (a certain amount of time) is required. Vet tenants thoroughly and charge enough to immediately generate positive cash flow. As a rule of thumb, aim for a monthly rental fee at 1% of what you paid plus what you invested in renovations.
Refinance: If BRRR has been your strategy all along, then you have probably already planned for this step. However, some investors decide to rent a property instead of flipping it during or after renovations. Either way, this step gets you out of the short-term interest-only loan and into a 30-year, fully amortized loan so that you can hold the property in your portfolio. In the optimal scenario, the rehab creates enough value that you can do a cash-out refinance to supercharge your next investment.
Bonus Step! Repeat: Use cash from your refinance for your next purchase and start the BRRR process again. Be careful, however, that your rental properties are generating positive cash flow with a healthy DSCR on a monthly basis and that you build a buffer for capital expenditures and vacancy.
What Type of BRRR Financing Do I Need?
BRRRR investment typically requires two different types of loans. When you buy the property, you take out an interest-only fix and flip loan to cover the cost of the purchase and renovations. Then you will refinance to a long-term rental loan with a lower interest rate and full amortization.
Fix and Flip: Fix and flip loans can cover up to 90% of the purchase cost of the property with a term length of 13 months. At Lima One Capital, we offer a loan to after-repair-value (ARV) ratio of 75%. In other words, you can finance 75% of the estimated value of the home after renovations.
Rental Loan: When you’re ready to refinance, you will take out a long-term rental loan. Typically, this is a 30-year, fully amortized loan with a maximum loan-to-value ratio of 75-80. Since your rental loan is based on current value, you will need to do a new appraisal that assesses the material improvements you have made.
Single Close Loan: A third option is to finance the property rehab through a single close construction-to-permanent-financing loan. With this type of loan, you pay interest only on the balance of the loan during the rehab phase, and then convert the loan to a 30-year note to hold the property. Lima One Capital’s innovative Fix2Rent loan is the first loan product like this for real estate investors. The benefit is that since it’s not a traditional refinance, you don’t have to pay a second round of underwriting fees and closing costs.
Takeaway
BRRRR can be an excellent option to create passive income without a huge initial outflow of capital. When you understand the basics of the strategy and you work the terms out in your favor, it’s a great way to build your real estate portfolio, create passive income, and achieve your goals as an investor.
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