Having multiple revenue streams is important – whether that’s trading shorter timeframes (i.e., day trading), medium and long timeframes (i.e., swing trading and/or buy and hold), or investing in more illiquid assets. With respect to the latter, this can include real estate, one of the oldest and most proven forms of building wealth.
Today we’re going to talk about the BRRRR method to investing in real estate.
The BRRRR method is how many real estate investors are able to acquire a trove of properties for very little upfront in equity and also without over-leveraging themselves in a dangerous way.
The BRRRR method is fundamentally about cash flow and equity, and many real estate investors have increased their net worths quickly using the basic tactic behind it.
The BRRRR method in a nutshell
The BRRRR method uses the equity and cash flow from one property to go on and buy another property, repeating the process multiple times to go on to own multiple properties.
Let’s get into it by going through each part.
This is straightforward; first, you have to buy a property.
Yes, this will take some savings. What properties sell for will depend on the area you’re located in. You can always buy out of your immediate area, but ideally you should stick to what you know.
You will usually be expected to put down 20-25 percent to buy a property. For a $400K-$500K property, that means a down payment of around $100,000. This might require that you first have a steady paying job and living below your means. Saving up this amount of money can take time if you’re just starting out in your career or have to build up your savings. But it’s very doable.
The best properties to buy are either:
a) undervalued relative to the market, and/or
b) have some fix-up potential that will yield positive ROI for any renovations that you do.
Of course, other people will want and will be searching for these opportunities as well.
That means these deals are going to be infrequent and you will need to have a knowledge, information, and/or analytical advantage over most people in the market you’re targeting. Ideally, you should know that market extremely well. And you need to have patience to find these opportunities. Naturally, very few deals will make sense.
Properties that are undervalued often are because they need work completed on them. Not everybody is willing to do this because it takes time, money, and can be somewhat of a hassle. Not everyone is a “hands on” type and some renovations are more complex and involved than others. But that means that it could be a money-making opportunity for somebody else to take advantage of.
The basic idea is that you’re going to complete renovations that add value to the house in excess of what you’re spending to complete them.
This is generally the easiest and best way to increase the value of the property.
What these renovations are can go from more cosmetic upgrades like drywall, flooring, kitchen, bathroom, landscaping, or similar. It could also be something more complicated and essential like properties that have issues with the foundation, electrical, roofing, and plumbing.
What types of renovations have the highest ROI will depend on not only the work that needs to be done on the property, but will also be contingent on your area and what types of upgrades other properties in the vicinity usually undergo.
There is also the time element. Fixing up the walls and flooring can take a matter of a few weeks whereas more involved renovations (e.g., fixing up foundational issues) can take several months or more.
Cash flow from properties comes from renting it out.
You need to know how much a property can rent for before buying it. There should be no surprises as to what the rental market for your property will be.
Ideally you should want something to cash flow from the beginning. It should be enough to cover the mortgage, renovations, insurance, homeowners’ association (HOA) fees, property taxes, and any other costs associated with owning the property.
Note that most properties will not be able to give you this from the get-go. Some might be cash flow positive after a few years. For some, it might take longer. So, you will need to do your homework.
If you’ve gotten to the part where refinancing plays a role, you have a mortgage loan and you ideally have a positive cash flowing property. So, now it’s time to put the heart of the strategy into motion.
At this point, you do a cash-out refinance (“refi”).
This is where a bank appraises your property for a higher value than the one at which you bought it for.
They can then give you a new loan that pays off the new loan, which then gives you what’s called “cash at closing”.
This would be helpful to illustrate with an example, so let’s run some hypothetical numbers.
– Let’s say you buy a property for $500,000
– You put $100,000 down, so you have 20 percent down
– Your loan is $400,000
– Let’s say you put $50,000 into the property to fix it up
– Your total investment so far is $150,000 adding the down payment and cost of the repairs
– Now, let’s say you get the property re-appraised for $580,000 after all of this is finished
– That means if you get your same loan on the property (80 percent of property’s value), that will come to $464,000
– The difference between the loans in $64,000 since your original loan was $400K
– That $64,000 is known as cash at closing
– That means you paid in $150,000, got $64,000 back, so you have $86,000 tied up in that investment in total, taking the difference between the amount paid in ($150K) and amount received in return ($64K)
– And again, ideally, you’re cash flow positive on this property, or at least will be soon (a fixed-rate mortgage makes your payments steady through time, while rent typically increases over time, improving your margins)
Now you can use that $64,000 and go out and buy another property using that money only, or the $64K plus additional savings, and repeat the process all over again.
With that said, you usually have to wait around six months before a bank will re-appraise a property and give you a new loan to wipe out the old one. Some will require you to wait as long as one year. This is called a “seasoning period”.
That means if you close on a property, fix it up, and have everything ready to go within a few months, usually the bank will not allow you to get a new loan quite yet. However, this entire process will typically take a while, so going six months is generally not that big of an issue anyway.
From there, the final R stands for repeating the process over again.
This works if you’re either:
a) buying properties under market value, or
b) buying properties that need a lot of work such that you can then fix up and bring to their true market value.
This will have the dual effect of both increasing your net worth and also your cash flow at the same time assuming you’re able to get them cash flow positive right away.
Moreover, the higher your net worth and the more cash flow you have, the more likely banks will be willing to lend to you to continue the process. Higher creditworthiness also tends to go hand in hand with receiving lower rates to borrow at.
The BRRRR method to investing in real estate can take you a long way.
It simply requires having enough of an upfront investment – down payment plus a budget for renovations – to get started. The more below-market and upgradable the property is, the more you’ll be able to get out of the strategy.
You’re profiting from the difference between the price you paid and the price that it’s really worth, or can be worth, through the upgrades and improvements you’re making. That difference can then be pulled out as a down payment and upgrades budget for the next property.
If you’re not able to do this – i.e., you can’t get the property re-appraised at a higher value than what you bought it for – the BRRRR method won’t be applicable.
Accordingly, it will go as far as your ability to identify and buy properties that are selling below-market either as-is or through any cost-effective improvements that can be made to them.