Flipping homes, or any property for that matter, can provide you with a great return on investment if done correctly. Numerous risks come with flipping properties, but you can easily make a …
Biggest Risks Of The BRRR Method Read More »
Flipping homes, or any property for that matter, can provide you with a great return on investment if done correctly. Numerous risks come with flipping properties, but you can easily make a profit if you understand them and plan accordingly. One of the more popular methods is the BRRR method which involves leveraging the power of traditional banks and hard money to your advantage and using the investment property as a steady source of revenue. However, before diving in, you need to know the most significant risks of the BRRR method and how you can avoid them.
The biggest risks of using the BRRR method involve the amount of competition you’ll face that affects your purchase price, your rehab timeline, finding the right tenants, and getting the right rate for refinancing. Any of these can destroy your potential for profits but facing multiple risks in any combination is a surefire way to end up in the red.
But we’ll get into all of that in a minute. First, let’s break down what the BRRR method is (and isn’t) and do a deeper dive into each of these risk factors. Plus, I’ll give you a few tips for how you can successfully navigate each risk as it comes to keeping your business revenues in the black.
What is the BRRR Method?
First off, no, BRRR is not about buying properties in the Northeast in January (I know, lousy Dad joke). Pronounced “burr,” BRRR is simply an acronym that has been applied to an investment strategy employed by some investors for years, whether they’ve thought of it that way or not.
- The “B’ stands for buy.
- The first ‘R’ is for rehab or renovation.
- The next ‘R’ is for rent.
- And the last ‘R’ is for refinancing.
So to use the BRRR Method, you simply buy a property with borrowed money, renovate it, rent it out, and then refinance your initial loan for a better deal. You may see additional R’s added on for things like repeat or resell, depending on where you see the acronym and the tactics are being discussed but typically, most investors stick with the B + 3Rs.
Is the BRRR Method a Good Strategy for Real Estate Investing?
BRRR works because it takes the basic premise of real estate investing, i.e., buying a home to flip it, and adds the potential for higher returns over a more extended period of time. Instead of rehabbing a property to resell, you’re trading that upfront sale price for a longer, steadier stream of income via monthly rents. BRRR is also excellent for a Plan B approach if you get stuck in a buyer’s market and need to hold on a bit longer to get back your projected profits.
BRRR is also popular because it rarely involves bringing your own cash to close, so new investors can dive into this easily. Hard money lenders typically have BRRR loans that give you enough capital to get you started without you needing to put much skin into the game. Once your rehab is complete, and your refinancing goes through, you simply pay off the hard money loan with your new mortgage and can be on your way to the next investment property without having to dip into your nest egg or retirement accounts.
However, BRRR isn’t for every real estate investor.
- If you’re looking for a fast profit, this isn’t going to be for you.
- If you’re not interested in becoming a landlord or dealing with a property management company, BRRR isn’t for you. Property managers come with their own pros and cons so take some time to consider just how you’ll run your rental properties before jumping in.
- If you’re not meticulous with timelines and budgets, BRRR can easily bankrupt your business. Not only that, defaulting on your BRRR loan can cause your lender to seize ownership of the property. Then you’re not only out the cost for the work that was already done and the loan, but now you don’t even have the house.
The Risks of Having a BRRR Strategy for Your Real Estate Investment Portfolio
All real estate investing involves taking on some risk, but the more you know ahead of time, the better off you’ll be. Here are the four biggest things you need to create a plan for dealing with to become a successful real estate investor.
BRRR Risk 1: Your Purchase Price
If your sole method for generating revenue is looking for the cheapest property out there, you’re in for a bad time. The truth is that while you want to get the best deal possible, not every property will work, and not every real estate market is going to give you properties with rock-bottom prices.
The success comes not necessarily in your purchase price but in your After Repair Value (ARV).
Starting with an incorrect or unrealistic expectation of ARV is one of the biggest mistakes that investors make. Negotiate with the seller to get the property at a price that will generate a net profit once the renovations are done. You can use comps to help determine what your projected ARV should be.
How to Better Calculate an ARV
Finding an ARV of your potential property doesn’t require a Ph.D. in mathematics, so don’t worry if you get overwhelmed with numbers easily. The best way to calculate the ARV works like this:
- Get an appraisal of the property as-is,
- Calculate how much your renovations will cost,
- Find three recently-sold comps and three comps that are currently on the market.
BRRR Risk 2: Your Rehab Timeline
This step carries two major risks: the rehab taking too long and the rehab going over budget. Both of these scenarios can quickly eat up profit and cause delays. Unfortunately, they often take place simultaneously.
If you’ve financed the property purchase and rehab with a hard money loan, dipped into your retirement accounts, or used some other personal line of credit, you end up paying more interest if the rehab takes longer than you’ve budgeted for.
Unforeseen timeline extensions also eat into the time you allotted looking for the tenants you need so that you’ve got the cash flow banks will want to see when it comes time to refinance. To give you an idea, here are some of the average timelines for the most popular types of home rehab projects:
|Type of Renovation
|1 - 6 weeks
|3 - 12 weeks
Source: House Beautiful
Here are some things to keep in mind when rehabbing a property:
- Budget properly and don’t overdo your rehabs. You need to walk the fine line between making quality-of-life upgrades and still leaving room for the home to be customized by your tenants. Letting little purchases trickle in here and there might seem like no big deal but can destroy your budget and make it that much more difficult to generate much-needed revenue that allows your business to grow (or even survive).
- Make sure that the repairs are done on time, and always pad your timeline with a few weeks to ensure you’re able to stay on schedule (and will have enough money to make your hard money loan payments).
- Check with the contractor to ensure that the repairs are within your budget and meet your expectations. Having an itemized list of work will help you with this and can be a huge help if your contractor ghosts you or ends up doing a shoddy job that requires a new contractor’s help.
BRRR Risk 3: Finding the Right Tenants
Before you even purchased the property, you should have looked at the vacancy rates and time to rent data in your market. Even if you’ve done your homework ahead of time, you need to redo it once your property is ready to go on the market since trends change so quickly now. It might seem like overkill to research and then re-research rent data but the more info you have, the less likely you’ll be scrambling for money.
Finding the right tenants is a major key to success. You’ll need to carefully consider each applicant’s qualifications and personality, as well as their willingness and ability to adhere to your specific rental requirements. Make sure you have a strong enough screening process in place to weed out those who won’t fit into your property or who will cause trouble.
If you want a little help, I have a method I’ve used repeatedly that keeps my tenants around for 5+ years. I’ll warn you that it’s a little different from your standard rental techniques, but I’ve found it more than pays off every time.
BRRR Risk 4: Getting a Competitive Refinancing Rate
Your most considerable risk in this step would be waiting too long even to begin trying to obtain this financing. Ideally, this should be in place before you finalize the initial property purchase and begin the rehab. Suppose you choose to fund the first part of the transaction with a hard money loan. In that case, your lender may even require you already have the refinancing set up before they’ll fund you, so don’t try to dodge this until the last minute and hope you’ll have time to improve your credit score or have a better income level before applying for your mortgage.
The Fed and Your Business
Also, a risk you really need to keep an eye on are the current interest rates and what the Federal Reserve (AKA “The Fed”) is up to because their repercussions could tank not only your refinance rate but your chance to find the best tenants.
This is big picture stuff, but investors who use the BRRR Method need to be aware of how the economy plays a role in what rates they can receive now or six months from now once the rehab is complete.
To give you a brief history and economics lesson: The Federal Reserve is a government body created in 1913. Its primary purpose is to manage the nation’s money supply and keep inflation under control. It also oversees the banking system and regulates the financial industry.
Basically, the Fed monitors the current state of the economy and decides whether interest rates on loans and bank accounts should be increased or decreased to keep things stable.
The Federal Reserve typically announces hikes to interest rates. Still, if you’re not paying attention, that “sudden” increase in interest rates will cause the value of your property portfolio to decline unless you’ve locked in a good rate ahead of time. You’ll also need to deal with inflation and how both of these factors affect not only your own income but that of your potential pool of renters and their willingness to take on a new lease.
The BRRR Method is a useful way to invest in real estate without putting much of your own cash into the deal. However, many risks come with using this strategy that you need to know ahead of time. The better you strategize before putting an offer in, the more likely it is you’ll end up with a comfortable stream of income that keeps your business running smoothly and allows you to grow.
Have you used the BRRR method successfully when you were a new real estate investor? Leave a comment and let me know your tips for how others can do the same.
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