193: BRRRR – Friday Fundamentals

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BRRRR

Building wealth in real estate is entirely possible. Usually the question is, just how quick? There are many different ways one can invest in real estate – from buy and hold single family homes, to note investing and private lending, syndications, and so many more.

Now as far as I know, this term was first coined by my pal and host of the BiggerPockets podcast, Brandon Turner. First, the acronym:

Buy – The first step of the process is to buy a property that has value-add potential, meaning you can increase the value with repairs.

Rehab – Rehab is the phase where you start to add value to the property with repairs, upgrades, and such.

Rent – Once you have rehabbed the property, you’re now ready to rent it out to a good qualified tenant.

Refinance – The refinance is a transaction that allows you to pull out that equity in the property that you’ve built up by rehabbing it. Often times, you’re looking to secure a long term fixed rate loan. This loan will first pay off any existing loan on the property, and the rest goes in your pocket.

Repeat – With that extra money from the refinance, you can repeat this process with another property, completing the BRRRR cycle.

You have just completed a BRRRR.

Case Study

The BRRRR strategy is phenomenal , especially for those who are willing to put in some sweat equity. The returns on that sweat equity can be great though. Let’s look at a case study.

Sarah is interested in buying her first investment property. She has identified a couple markets close to her home. She has an idea of what type of property she is looking for – a 2-4 unit specifically. Sarah finds an off-market deal through a really creative and unique way (we’ll get to that later).

The property is a duplex in the neighboring town. It’s completely vacant and looks a bit rough on the outside. The interiors are rent ready, but could certainly use some TLC to demand the market rents. Sarah finds the owners – siblings who have inherited the property and want to sell, rather than be landlords. They strike a deal and Sarah agrees to purchase the property for $55,000.

Knowing that each unit will rent for approximately $600/month, Sarah is feeling pretty good about the deal. She goes to her local bank to get a loan for the property. Given the relatively low purchase price, she is only able to get a 15 year loan at a competitive interest rate of 3.375%. Her mortgage payment is $387/month. She puts down 20%, or $11,000.

Over the next couple months Sarah, with the help of family and friends (mostly her dad), focus on rehabbing the interior of the property. After putting in some sweat equity and getting the interiors rehabbed with fresh paint, new fixtures, replacing and cleaning floors and carpet, etc., Sarah finds tenants for the property. Each unit rents for $595/month. With the property fully occupied, Sarah and her team (i.e. – Dad), turn their attention to the exterior. They repaint, landscape, and dramatically improve the curb appeal of the  property. The tenants really appreciate this too.

At this point Sarah has bought the property, rehabbed it, and rented it. You can probably guess the next step. That’s right, after approximately 18 months Sarah has realized that this once vacant and ugly $55,000 duplex is now looking quite nice, and has two paying tenants. Time to go to back to that lender and talk about refinancing options.

The property appraises for $110,000, twice the amount she paid for it just 18 months ago! Sarah s pleasantly surprised to find out she has a good amount of equity she can pull out of the property and reinvest. So she refinances the property, and secures a new loan. This time a longer term loan of 30 years, with newly adjusted interest rate of 5.65%. Since Sarah went from a 15 year loan of $55,000 to a 30 year loan of $110,000, her mortgage didn’t change too much. Her mortgage payment increased from $387/month to $556/month, leaving her plenty of cash flow every month.

Sarah was able to pull about $35,000 of equity from that property, which she invested in yet another investment property. Afterall, this strategy is working out pretty well. Why not, right?

This is a real scenario, with real numbers. I know because I am Sarah is this scenario. This duplex was my second real estate deal I ever did, and provided the capital for me to do my next deal.

Be Aware

There are some things to note and be aware of with the BRRRR strategy.

  • Increased mortgage – When you refinance to a larger loan, your mortgage increases. As a cash flow investor, you have to make sure that the rents can support that higher mortgage. With a higher property value usually comes higher property taxes and insurance as well. Make sure that the numbers still work out for those increases in expenses.
  • Loan to value – it’s important to note that you often have to leave more than the traditional 20% equity in the property. With Fannie/Freddie loans, specifically with duplexes, you must maintain 30% equity in the property, or a 70% LTV. For example, if you refinance your property for $100,000, the lender will only loan $70,000 in this scenario. Make sure to talk to your licensed lender about the details before you get too far into the refinance process.

Real estate investing, done right, can and will help you achieve financial freedom and build wealth over time. Have fun with it. Be creative. You mind is the only thing that will limit you.

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