BRRRR: Cash Refinancing as a Real Estate Investment Strategy

BRRRR: Cash Refinancing as a Real Estate Investment Strategy

No, it’s not just a sign that it’s cold. BRRRR is an acronym for a strategy used by real estate investors to try to maximize opportunities in the hot housing market. Here are the basics and tips for when it’s time to refinance.

What is the BRRRR method?

BRRRR stands for “Buy, Rehabilitate, Rent, Refinance, Repeat”. Real estate investors use the BRRRR method to buy real estate at an undervalued price, fix them up and find tenants for a passive income source. At this point in the equation, the investor has completed BRR – Purchase, Rehabilitation, and Lease. Then the investor teams up with a mortgage lender who will refinance the cash (the third “R”) to borrow more money to buy another undervalued home, checking the last R option: repeat.

While the BRRRR method includes some advanced real estate expertise, the thinking behind it is simple: Increase the value of distressed or older properties to make them attractive enough to rent, then leverage that appreciation to continue to get more properties to generate more rental income. If done correctly, the BRRRR method is a route to collecting passive income and building a large portfolio of rental properties. How successful you are, of course, depends on a number of factors, including how much you can save on the initial purchase price and how experienced you are in budgeting for renovations and judging the rental market.

Example of the BRRRR strategy

Here’s a simplified scenario: Suppose you buy a foreclosed property for $150,000 with a 20% discount ($30,000) and renovate it to $50,000. So far I have invested $80,000.

With a new kitchen, new bathroom, and new floors, the property is now valued at $250,000, and you can rent it out for $2,000 a month to cover your initial loan expenses and pocket some extra cash. (Of course, the specified rental price should be in line with the local market and also account for insurance, property taxes and other costs.)

Let’s say you are now at the point where you owe $115,000 on the initial $120,000 loan. While earning rental income, you refinance a cash withdrawal of $187,500 – 75 percent of your newly assessed value. You pay off your first loan ($115,000), leaving you about $72,500 left (less closing costs). You can then use part of that to make a down payment on another foreclosure and use another part of that to cover rehab expenses. This cycle continues, with you requalifying, renting and refinancing to withdraw cash.

How to finance a BRRRR property

Financing an investment property comes with additional requirements and considerations because the house will not have a roof over your head and therefore will be more risky for lenders.

If you’re an investor interested in the BRRRR method, start by building a relationship with a local community bank, says Charles Tassel, chief operating officer of the National Association of Real Estate Investors.

“This is the most important aspect for an investor,” says Tassel. “Community banks understand individual investors better than large institutions, and can be more creative when it comes to making room for you in their portfolios.”

Expect the bank to check your background and experience as an investor. If you’re new to the game, it can be helpful to show your bank that your business plan includes local experts — trusted contractors, for example — who can help you address issues that can arise when buying real estate that needs work, he says. Tassel.

Even with a solid business relationship and business plan, securing your loan won’t happen overnight.

“The shutdown schedules were all over the place,” Tassel says. “If you don’t have the time for due diligence, you could run into big problems. It’s important to have that conversation with a bank to put the right schedule in place and save yourself a lot of trouble.”

Some real estate investors are also looking to hard money lenders to help fund their projects. This is not as traditional as banks and credit unions, but the main advantage is the ability to get cash faster. So, if you find a deal on a distressed property that you really don’t want to miss, a hard money lender can eliminate the long wait to close. However, there are significant downsides, so don’t make this your first go: Interest rates on hard money loans tend to be much higher compared to mortgages, and these types of loans often require you to pay more points up front. They also tend to have much shorter loan terms.

Tips for the third R: Refinance

You have completed rehab, and you are now ready to refinance a property that is worth more than it was when you bought it.

First, consider when you closed your first loan versus now. Some lenders have spice requirements, which are restrictions on how quickly you can refinance the loan. For example, a lender may ask you to wait six months.

Consider the possibility of additional fees and guarantee payments as well.

“Regular refinancing will incur closing costs that investors will need to consider very hard if they refinance often,” says Vikram Gupta, executive vice president and head of real estate equities at BNC Bank. “Typically, equity refinancing does not have closing costs, but it does have an early closing fee, as the borrower is required to pay a prorated share of the closing costs if the loan is closed within three years. Borrowers should consider whether the cost savings associated with the refinancing are They outweigh closing costs in this price environment.

No matter how long you need to wait, also consider the stricter restrictions on cash refinancing on investment properties.

“The underwriting is a little tight” on commercial real estate, says Tassel. “The loan-to-value ratio and credit scores will become even more important.”

Pros and cons of the BRRRR method

If you are considering running the BRRRR method, carefully consider the advantages and disadvantages of this real estate investment strategy.

Positives

  • You can take profits without flipping the house. Instead of repairing distressed property and selling it right away, leasing helps you retain that value and earn regular passive income.
  • You can build a network of rental properties without huge expenses. Instead of making down payments with your own money, the BRRRR method essentially recycles your initial purchase on your first property. You are using borrowed money regularly to increase the value of real estate, and you are building a portfolio of passive income generating units.

Negatives

  • You may underestimate what the drug needs. At first glance, rehab may seem rather simple, but what’s beneath the surface can (literally) ruin your budget. Tassel says the most common mistake new investors make is overspending without budgeting enough for the necessary expenses: “When you open the wall for repair and you discover bigger problems with the property, your budget is thrown out. If you don’t have the capital, it can really sink you.”
  • You must be the property owner. Passive income may sound great, but you will need to do the active work of your landlord – running credit checks on potential tenants, solving problems with the property, paying for increased insurance and more. Bottom line: It takes time and effort to receive those monthly checks, and if you work 9 to 5 or are limited in time, this can be too much.
  • You must be able to tolerate the uncertainties and risks. What if the rehabilitation process does not increase the value of the property as much as you expect? What if you overestimated how much you’d get to rent – or had to deal with a vacancy? What if you had to deal with the challenges of evacuating your tenant? What if you are struggling to find additional properties? The BRRRR method is not suitable for novice real estate investors – you must be prepared to face a lot of challenges and complications.

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