BRRRR investing simplified
Our “Midnight Infomercial” house was an example of the BRRRR method. This method of funding a deal was coined by Brandon Turner of Bigger Pockets. It stands for Buy, Rehab, Rent, Refinance, and Repeat. This one concept blew my mind and is one of the critical factors that helped us scale up faster than we ever would have using more conventional tactics. To break it down a bit, we’ll go over the whole strategy here and later I’ll post about each individual piece in more depth.
For this strategy to work, you have to buy the house at a discount. You can use the “flippers formula” of 70 percent of ARV minus repairs as a good starting point. Let’s use a fictitious house for this entire post. Let’s say you see a house that you think will be work $130,000 when it is fixed up. This is an ARV (after repaired value) of $130,000. Write this down if it helps. Now multiply by .70 to get 70 percent of that. You should be at $91,000. This is now your starting point to begin your offer at. Let’s say you look the house over and think you can make it nice and rent ready (not flip ready) for $15,000. Now subtract that from the $91,000. This puts us at $76,000. This is the price I would love to buy this house for. I’ll offer cash (from a private lender) and a quick close to sweeten my offer a bit.
Let’s assume that you have this house under contract and can get in and start the renovations. Now we want to clean it up and do all those things we budgeted for. You’re planning on renting this house so you’ll likely forgo granite for laminate countertops and probably won’t use carpet or wood floors. We want this house clean so that it will appraise well later and will rent quickly. We also want it to have durable finishes to last several years. Let’s say that you get the house fixed up and rented in one month. Congratulations! Now you’ll sit tight for five more months and rent this house while you pay high interest back to your beloved private lender. Your equally beloved tenants will actually pay these five months of payments for you. Are you beginning to see the win/win/win opportunities here?
Okay, so you already have the house rented. You estimated rents before you bought this house and felt that the rents would be promising. You looked at houses for rent on Zillow and realtor.com but you also looked at, and called, the mom-and-pop signs in yards because many landlords don’t post their houses on MLS or these other sites. This helps you get a real feel for the rental rates in your neighborhood. You know your house will show well and will compete strongly against these other rentals because you just renovated it.
You need a good mortgage lender who knows investment loans! This relationship should come before the purchase. They will tell you all the underwriting requirements and check your personal financials to be sure you can get qualified for the refinance. The six month holding period from purchase to now is a current requirement for cash-out refinances when using conventional loans. These rules change often so depending on when you read this, it may or may not still be the case. This is why the right lender is critical. The bank will send an appraiser and in this perfect-world case, the house appraises for exactly what we thought; $130,000. They will do a cash out refinance of 75% of this amount ($97,500.00). Now this amount is enough to pay off your good buddy, the private lender for the purchase price of $76,000 and to pay off the renovations; which you may have borrowed from the lender or from another source or even used your own funds. This leaves $6,500 dollars that are unaccounted for. That is money back in your pocket. This will likely cover your closing costs or that plumbing repair you didn’t plan for when you estimated your repairs. It also can cover paying you back for that first month of interest to your lender. This is a very near-perfect example with no real surprises. You have to have some financial cushion in case any of these factors doesn’t play out as we have planned. Even if your numbers are off and you leave $10,000 dollars tied up in this deal and it isn’t a “true BRRRR” as we call them; you still have a cash-flowing house for WAY less than if you had gone out and bought the traditional way and saved 20-25% for a down payment. This hypothetical $10,000 isn’t gone, it’s just tied up in a nice little savings account we will call “equity”.
Remember that “beloved” private lender we mentioned? Well she just got paid off and her money isn’t making any money in the bank; in fact she’s pretty sure it is losing value–being devalued by inflation. She calls you and asks if you have any deals working. She wants to get her money back to work. So instead of you asking people if they WILL loan to you, now people are asking you if they CAN loan to you. You are not taking from someone, you are providing an opportunity to someone. This was a huge mind shift for us. The “Repeat” is what allows you to essentially re-use the same money over and over. This is a beautiful thing.
A few more points
As you evaluate deals, remember that just because you built in some equity and can recoup your initial investment and pay off lenders, if that new loan amount is too high and your payments are too high, you won’t cash flow. This might be the case in pricier neighborhoods and places where property taxes and/or insurance are higher. You have to be sure that your PITI (principal, interest, taxes, and insurance) are well below the rent you expect to be able to charge. Where it doesn’t work for cash flow, it may be a flip opportunity, but that is for another discussion.
Also magical to me is that you aren’t extremely highly leveraged this way. Although you haven’t put a lot of your own money into this deal, you still have 25% equity! This means that you created $32,500 in equity, or wealth for your family! This isn’t the old pre-recession lending where you could get into a house with nothing down and have negative amortizing loans etc. This is a solid investment. This is insurance for you, that you have some options if unforeseen circumstances happen. But for now, you take that cash flow from rent each month and put it in an account for repairs. Since you already fixed up the house there probably won’t be many. As this account grows, so will your confidence to go out and do another deal. Even though the cash flow may not be mind-blowing, remember that your tenants are paying down this note every month with the “P” of that PITI. That is principal being paid into that account we are calling “equity”. You also own a property that will likely increase in value over the years which amplifies the growth of equity and gives you even more options in the future! Isn’t this amazing?!?!
This was a long post but I hope that you can follow the logic in it. We’ll dive deeper into each of these aspects over time but this will get us started on the same page. I hope this gets you excited for the potential that exists. And the best advice I ever received I’ll pass on to you: “keep the main thing, the main thing”.