BRRRR Your Way To Financial Freedom : A Simple Strategy To Help You Reach Your Goals
Real estate investing consists of several different acquisition and exit strategy's. These different types of strategy's are what appeal to several new investors. The issue with having so many strategy's is that it is very easy to pull you off course before you have completely mastered, streamlined and implemented systems and processes for this specific niche.
Although there are many shiny objects in the real estate industry, once you learn the basic concepts and fundamentals of real estate as a whole, several of these strategy's begin to play off of each other. The concept that we are going to talk about today is a blend between a couple common investment strategies.
You will be purchasing a property at a fairly deep discount, which may include you doing a lot of direct to seller marketing. You will buying a property and adding value through strategic renovations in order to maximize the value of the property without over renovating the property, this is similiar to the rehab and sell strategy. Lastly, you will be placing a tenant in the property and becoming a landlord.
So in short, this strategy includes several of the more common real estate investment strategies and just may be the most lucrative of them all.... If executed properly.
So let's learn a little bit more about it.
What Is BRRRR?
Before we get into talking strategy and implementation, let's first touch base on the basics behind this strategy.
Buy Rehab Rent Refinance Repeat
With this strategy, you will be purchasing a value add property with the intentions of rehabbing it, stabilizing the property with tenants and then refinancing the property into a traditional mortgage. At a high level, you will purchase a property with cash (or use private money to get into the property), make the necessary repairs to reach maximum appraisal and rents, find a tenant and begin renting to them. Depending on your bank, credit union, portfolio lender (whoever you use), there is typically a 6 month seasoning period to refinance the property and pull the cash out or pay off the existing private lien on the property.
The 4 Stages Of The BRRRR Method
The most important part of any real estate investment is the purchase. In this business you have to pride yourself on buying great deals and this method is no different. We are going to focus on buying a great deal. Before we go into the purchase of the property, we have to know that we are going to implement this strategy so that we can work backwards to determine a purchase price that will fit this model. There are specific thresholds that we have to stay under in order to maximize the benefits that this strategy has to offer.
When go to refinance the property, a standard LTV that a lending institution will offer is 75%, so that is the number that we are going to work off of. (This means that the lending institution will place a mortgage on the property for 75% of the appraised value of the property).
1) ARV or After Repair Value
Run your own comparable market analysis or speak with your agent / broker. Residential buildings and commercial buildings are valued differently, so if you are unfamiliar with this process, please educate yourself or speak to someone that is familiar with this process. Make sure you get this number right, because it is the most important number for our analysis.
2) Repair Estimate
One of the most difficult aspects of a value add investment for real estate investors is accurately estimating the repair costs associated with the project. Understanding labor and material costs for your projects will take some time but there are specific documents that you can use to help organize and estimate your renovations.
Scope of Work
These are just a few of the documents that you can use to help you produce an accurate repair estimate on your project. If you would like more details on the Construction Documents that we use and our process, feel free to drop us an email and firstname.lastname@example.org and we would love to help in any way possible.
3) Closing Costs (Purchase)
Whenever you purchase or sell a property, you will have closing costs that you have to pay for. Let's start with discussing the purchase closing costs. The type of capital that you use to acquire the property will have an effect on how much you will have to pay at closing. For the sake of this post, we will touch on closing costs for a true cash purchase and also a private money purchase.
True Cash Purchase
Taxes paid in advance
Abstract/ Tax search & update
Closing document preparation
Government Recording Fees
Title Insurance (if used)
Private Money Purchase
All of the above costs
Origination Fees / Points
Daily interest charges
These are all costs that we will have to account for when running the analysis on our subject property to determine our purchase price.
4) Holding Costs
Your holding costs are costs that you will have to account for when the property is vacant. For this specific delivery method, your property will only be vacant when you are renovating the property and searching for a tenant. Your schedule will help you determine how long you need to account for the holding costs for this specific project. Here are some of the holding costs, that you will have to account for during this period of time.
Taxes (typically paid in advance at closing)
Lender Interest (if you used private money to acquire the property)
These costs should be minimal throughout the 1-3 month renovation and tenant search period.
5) LTV & Refinance Closing Costs
As previously stated, a standard Loan To Value on the refinance of an investment property is 75% (some lending institutions will go up to 80%). This means that the lending institution will issue you a loan on the property for 75% of the appraised value or after repair value of the property. To account for the closing costs associated with the refinance, we typically run our numbers off of 70% of the appraised value to account for 5% in closing costs on the refinance. This will really by the second step of the process that you go through to determine the price you are willing to acquire this property at to ensure it works for this model. Before we can refinance, there is typically a 6 month seasoning period that lending institutions require. This means that you will have to own the property for more than 6 months before you can refinance. Depending on your relationship with the lending institution, it is wise to start this process at about month 4, so that you can refinance the property on the first day after the 6 month seasoning period is up.
Determining Your Purchase Price (Example)
After Repair Value - $100,000
LTV (including closing costs) - 70%
Repair Costs - $20,000
Purchase Closing Costs - $3,500
Holding Costs (For 2 Months) - $800
($100,000 x .70) = $70,000
$70,000 - $20,000 = $50,000
$50,000 - $3,500 = $46,500
$46,500 - 800 = $45,200
Purchase Price = $45,200
Once you have completed your acquisition analysis and determined how you will finance the purchase, it is time to focus on the renovation aspect of the subject property. Renovating a property to execute the BRRRR strategy is both a science and an art. We don't necessarily want to renovate the property like we are flipping it but we may also want to do a little more of a renovation compared to a standard rental. The reason for this is because, we want to renovate the property in the most cost efficient manner to reach the highest appraised value when the renovation is complete.
This is the middle ground that all real estate investors try to find. Once you get familiar with your market and the lending institution you are working with, you will have a better understanding of how you need to renovate these properties to produce maximum value without over renovating the property.
When renovating a property that we are going to hold for the long term, we want to renovate for durability. This means that we want to ensure that all of the important mechanical's and capital improvements are in good standing condition and that we use the right material on the interior of the home to withstand the tenants daily wear and tear on the property. For example, try to opt for durable flooring material, such as vinyl or ceramic tile over carpet which eventually becomes stained and damaged much quicker.
Your renovation costs are very important and knowing your numbers going into the project may be the difference of staying under your threshold (70% of the appraised value) on the refinance. In order to produce and accurate rehab estimate, stay on schedule and under budget we must have the property tools and systems in place.
1) Pre-Acquisition Scope of Work - Before we purchase our property, we will have an opportunity to walk the property to determine the condition. This may be before you put the property under contract or during your "inspection period" when you have the property under contract. During this period of time, we will put together a high level idea of the tasks that we will want to perform during the renovation.
2) Professional Home Inspection - Before we purchase any property, we have our home inspector walk through the property and put together an "investor inspection" to give us a more detailed look into the condition of the capital expenditures and the mechanical's of the property. We will use this home inspection to help us create our final scope of work.
3) Scope of Work - After we work through our pre-acquisition scope of work and our professional home inspection, we will sit down and create our final scope of work for the project. Your scope of work will be all of the tasks that you want to have performed on the property to add the value you need to reach the appraised value you have determined. You will also use the scope of work to send out to your contractors for pricing for these specific tasks.
4) Estimate - You will use your scope of work to put together an estimate of the labor and material costs of the project. This estimate is going to give you a high level look at the total renovation cost for the project. If you are unfamiliar with the costs of labor and material, we recommend that you sit down with a qualified General Contractor and work through the scope of work to help you determine these prices.
5) Schedule - Your schedule will help you stay on schedule. Simple enough : ). Once again, you will use your scope of work to put together a high level schedule as to how long each task will take your contractors to complete. This will help you limit your holding costs and get you to the point of tenant placement sooner.
6) Material List - Besides the labor on a project, we will also have to account for the material costs of the project. We will work through our scope of work to determine which material we will need to use for which tasks. Everyone has different relationships with material vendors, so the pricing varies. However to get a high level determination of pricing, simply determine the material that you want to use and and go on (Home Depot or Lowes) website and look up the pricing for the material that you will need for the project. There is a much more extensive system that we use to produce our material list and gather our pricing but this is outside the scope of this post.
7) Budget - Your budget will be your final numbers for your project. You will determine which tasks will be performed by which contractors and send that portion of the scope of work to them to be priced. At this point you will have a good understanding of the labor and material costs of your project. Always include a contingency within your budget for unforeseen conditions or change orders that come up through out the renovation. It is nearly impossible to account for all of the costs of a renovation so be sure to add in this buffer to help you stay under budget and account for these additional costs.
You will use this final budget number as the costs associated with the renovation of your project.
Remember our goal is to stay under 70% of appraised value with the purchase, renovation and additional costs associated with the project.
We have made a great buy, successful renovated the property, now it is time to find a quality tenant to place in our property. Whenever you purchase a property to hold, you have to understand that your tenant is the one who pays your bills and produces the cash flow for the property. This means that you can't just put any old person in your property to be your tenant. Before you begin marketing for tenants make sure that you have a few steps of the process straightened out, such as:
Where you will market to find your tenant
A solid rental application
Rental requirements and guidelines
Where you will obtain background, credit and criminal checks
A solid rental lease agreement
At a high level these are some of the steps of the process that you will have to have proper documents and systems for to be a successful landlord.
Lets go over a quick scenario on how this should work at this point.
You bought a deeply discounted property with good bones & mechanical's with cash. You rehab the property to a degree where you reach the full market price potential for the property. This rehab will take anywhere from 1 -3 months depending on the resources and level of renovation of the property. You will find a high quality tenant at the tale end of your renovation. You will have your tenant in the house and paying rent after month 1. From the time you place a tenant until you refinance you will be reaping the cash flow, since your monthly rent will be much higher than your expenses during this period.
Now, lets discuss the next aspect of this process.. Refinancing
This is the fun part. You made all the right moves, if you purchased the property with cash and made the repairs in cash, this step will be just that much more gratifying.
Before you reach the standard 6 month seasoning period in order to refinance, you must do some preliminary work to ensure that you will be approved and your plan is justifiable. This preliminary work starts when you begin searching for properties to implement this strategy with. Now some of you may have a great relationship with a lending institution while others are just getting started. If you are just getting started, you have to get out there and network with different lending institutions. You have to find a lending institution that is investor friendly and that is a fit for the goals you are trying to accomplish. Early on you may get turned down by a lot of banks, but I promise you there are investor friendly lenders that will be willing to work with you.
Also, if you have little money or poor credit, you want to ensure that you meet all of the regulations and qualifications in order to successfully be able to refinance when the time comes. The last thing that you want to happen is to be unable to pull your money out or worse unable to pull your private money lenders money out.
Make sure you complete this preliminary work, build some relationships with lending institutions and get approved for a refinance for the estimated amount on your subject property. By taking these preliminary steps you will feel much more comfortable going through the process. To complete your refinance, begin the process with your lending institution on month 4. This is where you fill have to complete the tedious application process and provide your financial documents to the bank. These documents will include:
Last 2 week pay stubs
W2's (Last 2 Years)
Federal Tax Returns
And sometimes more
The reason that we want to start this process in month 4 is because banks work slow. They process paperwork slow and do not really have an intention of moving fast. This process typically takes about 2 months to run your reports, collect all of your documents and ensure that you will be capable of refinancing.
You have successfully completed a transaction from start to finish using the BRRRR strategy. Congratulations!
One of the biggest benefits of using this strategy is that you can repeat it as many times as your lending institution will allow you to refinance. Several residential mortgage lenders have limits on the number of loans that they can issue (mostly 4, sometimes 10). However, there are private lending institutions out there that do not have to work off of Fannie and Freddie guidelines and have a little more leniency when it comes to the number of residential loans they can have out at any given time for a specific client. This is why it is very important to network with different lending institutions to see which one will help you reach your goals.
Anyways, just take what you learned and repeat the process.
Buy a property at a discount, Rehab the property for durability, Stay under the 70% threshold accounting for all costs, Place a quality tenant and Refinance the property after the seasoning period has expired.
It is a very scalable and repeatable model. Give it a try!
HS Property Funds