The BRRRR method in real estate can be a good buy-and-hold investing strategy for people looking for a systematic approach to scale up and grow a rental property portfolio.
In this article, we’ll break down what the BRRRR acronym stands for, its pros and cons, and how to get started using this strategy.
- The BRRRR method helps you put real estate investing on autopilot.
- Investors use the BRRRR method of real estate investing to buy, rehab, rent, refinance, and repeat.
- Two formulas used in BRRRR are after repair value (ARV) and maximum allowable offer (MAO).
- To make the most of the BRRRR method, an investor should reduce personal debt and raise capital, consider working with a partner, and know where to find motivated sellers.
What is the BRRRR method?
The BRRRR method for real estate investing involves doing something that works over and over and over again. We’ll start with the basics of the BRRRR method.
BRRRR is an abbreviation for:
As the bullet points above outline, the BRRRR method involves locating a home in need of repair, adding value by rehabbing and making renovations, renting the property out to generate recurring cash flow, refinancing after enough equity is accrued, and repeating the process by using the cash pulled out to BRRRR another property.
While it may sound boring, using BRRRR to invest in real estate can actually be quite profitable when done correctly. Real estate investors who want to put their business on autopilot may find BRRRR to be an ideal real estate investing strategy.
How the BRRRR method works
Before discussing how the BRRRR method works there are a few terms to know:
- ARV = after repair value
- MAO = maximum allowable offer
- 70% Rule = Used to determine the MAO by multiplying ARV by 70%
With these 3 terms in mind, let’s look at the 5 steps of the BRRR method:
BRRRR utilizes the classic investing approach of buying low and adding value to create instant equity and recurring cash flow. To illustrate, assume that the asking price of a home in need of rehab is $120,000 and the property requires another $25,000 in rehabbing and repairs to make it rent-ready. After the work is done, an investor estimates that the value added to the property will be $60,000:
- ARV = Purchase price + Value added through rehab
Using the ARV formula, if the home was purchased for $120,000 and the estimated value added is $60,000, the ARV would be $180,000.
Note that the cost of repairs is not the same thing as the amount of value added. As this article from Forbes explains, cost is the price actually paid while value is the perceived worth. In this example, the cost of repairs is $25,000, while the value added to the home by making repairs is $60,000.
After determining the ARV, the next step is to calculate the MAO. This is where the 70% Rule comes into play. According to the rule, the MAO is 70% of the ARV after backing out the actual cost of repairs:
- MAO = (ARV x 70%) – cost of repairs
- MAO = ($180,000 ARV x 70%) = $126,000 - $25,000 cost of repairs = $101,000 maximum allowable offer
In this example, the MAO of $101,000 is below the seller’s asking price of $120,000.
The question is: Why would someone sell for less than what they think their home is worth? Or to phrase the question another way: What would motivate someone to sell for less than what they think their property is worth?
There are 8 ways for buyers who want to pay as little as possible to motivate sellers, according to this blog post on Trulia:
- Find out what the seller wants, because it isn’t always about price.
- Offer cash (you can get a short-term, hard-money loan if needed), then obtain a loan after rehabbing.
- Rent the house back to the seller—a key component of the BRRRR method.
- Waive contingencies by buying “as is” for a fast close.
- Offer to buy the furniture.
- Write a heartfelt letter.
- Play hardball.
- Think outside the box.
Of course, every real estate deal is different, and there’s no guarantee that these negotiating tactics will work with every seller. But with the right seller in the right place at the right time, the odds are that one approach eventually will.
It’s important to calculate the potential return on investment (ROI) of the rehab work when using the BRRRR method. That’s because some projects add more value than others, and the last thing an investor wants to do is spend money that doesn’t increase potential returns.
With each rehab project, an investor should ask 2 questions:
- Does the rehab justify a higher monthly rent?
- Does the rehab add more value than the cost of the project when the time comes to refinance and turn equity into cash?
The answers to these 2 questions depend on the local real estate market, the neighborhood, and the type of tenant who will be renting the home. For example, a family or a couple working from home may see more value in a nice backyard, while tenants with roommates may see value in extra space.
The home warranty company American Home Shield (AHS) recently crunched the numbers to determine the updates that can help investors immediately increase the value of a home. According to the report, 10 home updates that quickly increase value are:
- Kitchen remodel
- Bathroom remodel
- Deck addition
- Basement finishing
- Window replacement
- Garage door replacement
- Exterior door replacement
- New siding
- Working fireplace
At this step of the process, try to speak with several contractors to compare and get the best price for your rehab expenses.
Choosing a good tenant is just as important to property value as doing the right rehabbing is. Dependable tenants who consistently pay the rent on time and take care of the property can help you keep net operating income (NOI) higher, which in turn may make refinancing easier and less expensive.
Once a rental property using the BRRRR method accrues enough equity, the home is refinanced. In order to obtain the best rates and terms, a lender will expect to see a good borrower credit score, a property that is generating consistent cash flow, a tenant who has been renting for 6 months or more, and remaining equity after the refi of at least 25%.
The following example illustrates how refinancing using the BRRR method works. We’ll use a home in Tampa, where Zillow reports typical home values increased by nearly 30% last year (through December 31, 2021), and assume that values will grow by another 10% over the next year:
|Year 1 (buy)||Year 2 (hold)||Year 3 (refi)|
|Cash pulled out||$64,400|
One important thing to note here is that the appraisal is one of the biggest risks when using the BRRRR strategy. If your appraisal comes in much lower than you were expecting, you won't be able to pull out all the cash you were expecting in your model at the beginning of the process.
Another thing to be mindful of: Seasoning periods. Many banks will require you to have held the property for a minimum period of time before they will accept a new appraisal of the property. Be sure to ask your lenders if they have seasoning period requirements and how long those periods are.
Based on the hypothetical example above, an investor is able to pull more than $64,000 in cash out by refinancing after a 2-year holding period. The cash is used as a down payment for another investment property, while the original property still continues to generate rental income.
It’s alright to fine-tune the BRRRR method from time to time. For example, property values may not increase as expected, which means an investor will need to hold longer before refinancing.
Pros and cons to the BRRRR method
As with any other investing strategy, the BRRRR method has its pros and cons. Here are some things to consider:
- You may be able to make money by buying low, adding value, and refinancing to buy another rental.
- There’s potential for consistent rental income and cash flow with a good tenant and local property manager.
- It’s an autopilot investing strategy to grow a rental property portfolio.
- Overestimating ARV or underestimating rehab costs can significantly lower or even eliminate short-term equity until home values increase.
- Financing and refinancing a rental property is more expensive than a primary residence, with higher interest rates and fees and a bigger down payment. There’s also a risk that the appraisal could come in lower than you were expecting.
- It may take longer than anticipated to accrue enough equity to do a cash-out refinance.
How to get started with the BRRRR method
There are several things an investor may wish to do before using the BRRRR method to purchase rental property.
Begin by reducing personal debt and getting personal finances in shape to have sufficient investment capital on hand for the initial purchase and repairs. Some investors choose to work with a business partner to raise money and share the workload.
Secondly, be prepared to walk away if a seller’s final asking price is higher than the maximum allowable offer. Paying too much for a property can reduce potential profits and may require waiting longer than necessary to refinance and pull cash out to purchase another rental.
Finally, know where to look for a home with BRRRR potential. On the Roofstock Marketplace, investors can search for homes owned by motivated sellers using criteria such as cash only, discount to valuation, and reduced price.