BRRRR Your Way To Unlimited Real Estate Returns
Updated: Jan 30, 2019
When you begin your real estate investing career, you will be tempted by several different shining objects. Each one of these shining objects are different acquisition and exit strategies. While each one of these strategies can definitely prove to be profitable, it is very easy to become overwhelmed, take on to many strategies and not be successful in many.
Although there are several different acquisition and exit strategies available to the investor, once you learn the basic concepts of real estate investing, you will learn that several of these strategies are a play off of these basic fundamentals. The concept that we are going to talk about today is a combination of several strategies that real estate investors tend to be interested in.
To successfully execute the BRRRR strategy, you will have to market to find a deeply discounted property, purchase the property using your own cash or other peoples money, strategically add value through renovations, place a qualified tenant and then work with a traditional lender to get financing on the property.
As you can see this is more of an advanced strategy, but if properly executed, can be a great wealth building tool for you and your family.
Our goal throughout this post is to relay the basics of this strategy as well as the details you will need to understand in order to get from start to finish.
The Basics Behind the BRRRR Strategy
Before we begin talking details to implement this strategy, I want to go over the basics of each stage of this process to give you a high level understanding of how this process works.
The end goal of executing this strategy will be to place a long term tenant in a renovated property that produces unlimited income through a refinance that allows you to pull out your initial capital invested into the deal.
Buy – The first step of the BRRRR strategy is the buy. However before we buy a property, we have to find a deeply discounted property that fits on our model. We can find a deeply discounted property either through direct to seller marketing or working with an agent. Once we find a deeply discounted property, in order to execute this model we will have to purchase this property using our own capital or raise money using other peoples money to fund the transaction.
Rehab – Once we determine how we will fund our deal, we will close on the transaction and begin our renovations on the property. The renovation process is the usually stage of this strategy that causes several trying to execute to fail. When it comes to the rehab process we have to be organized and have a great plan going into the project to ensure that we have a good idea of all of renovation costs. When planning our renovation, we want to make sure that we make strategic renovations, so that we do not over rehab the property but maximize the value of the appraisal when it comes time to refinance. Investors often times over renovate a property and put to much money into the property and are unable to get there capital back when it comes time to refinance.
Rent – Once we are completed with the renovation stage of the strategy, it is now time to begin marketing, qualifying and placing a tenant. By placing a tenant, you will prove to your lender that you are producing income on the property. This income will cover the debt obligations on the property, and this is a variable that a lender looks at to see if they will lend on the property or not. The income generated from the property will also increase the value of your property, hence increasing the appraised value during the refinance step. It is very important to place a well-qualified tenant who will take care of your property and pay the rent on time.
Refinance – Once we have stabilized the property, we will begin the refinance process. We recommend that you begin interviewing potential lenders as early as possible to begin building a relationship and portraying to them your exit strategy. During the refinance process, traditional lenders will allow you to cash out up to 75% of the appraised value. When you decide to refinance a property, lenders will typically have 6 month seasoning period, meaning that you have to own the property for more than 6 months in order to refinance. Check with all of your local lending institutions to ensure that this is there requirements. We recommend that you choose a lender and begin starting the process by month 4 so that you can refinance your property the 1st day of the 6th month to pull all of your invested capital out of the deal.
Repeat - You have officially completed your first BRRRR deal, at this point in time, if completed successfully, you have just built unlimited cash flow for you and your family. It feels good. The reason that we can repeat this strategy is because we are going to pull out all of our initial capital through the refinance and start the search for our next buy. If you are using OPM or have lots of capital saved up, you will be able to implement this strategy more than once at a time.
The Details Behind the Execution of BRRRR
We hope that the information that we have given you thus far has given you some high-level insight as to how the process works and all of the different parts of the process. In order to successfully implement this strategy, we must be able to execute all the parts of this process to get the end result that we are looking for. In this part of the post, we will explain the systems within each of the parts of the process to give you some more detailed insight into what you need to do to successfully execute this strategy.
Before we purchase a subject property, we must have already done all of our due diligence to ensure that the numbers work on paper. By thoroughly completing the analysis on the subject property, we will know the exact price we need to offer on the subject property. When running our numbers to purchase the property, we have to make sure that we stay under the 75% threshold (75% of the appraised value) for the purchase, repairs and other costs associated with the deal.
1) ARV / After Repair Value / Appraised Value
The first number we will need to know when running our analysis on the BRRRR strategy is the After Repair Value. For this article, we are going to be referring to the ARV as the appraised value. The appraised value is going to be the value that the lending institution places on the property when it comes time to refinance. For our due diligence, prior to purchasing the property, we will have to know exactly what the property will be worth after we strategically add value through our renovations. There are 2 different ways that we can obtain this figure. The first being, running our own Comparable Market Analysis on the property and determining it’s value though comparing similar properties that have sold, listed or are pending in the past 6 months. The 2nd way would be to utilize a broker/agent to generate the appraised value for you. We suggest using the 2nd solution because agents/brokers have more data to compare when it comes to generating a value.
2) Repair Estimate
One of the most difficult aspects of value-add investing for new investors is accurately estimating repair costs. Understanding the labor and material costs on a project and properly estimating them can sometimes be difficult. However, we have specific documents that we can utilize to streamline this process and increase our odds of accurately forecasting these costs.
· Scope of Work
· Material Lists
We will further elaborate on the details of these documents in the next section. We just want to reiterate the importance of producing an accurate figure for these costs, so we ensure that we offer the correct price when purchasing the property.
3) Closing Costs (Purchase)
In real estate, whenever you purchase or sell a property, you will incur additional closing costs. When we purchase a property, we will incur more costs than when we are selling. The amount of your purchase closing costs will depend on if you are using OPM or you will be using your own money. If you are using your own money, your closing costs will be far less expensive. If you are raising money for the purchase, you will incur additional closing costs that we will talk about next.
· Taxes paid in advance
· Abstract/Tax update
· Closing document preparation
· Attorney fees
· Government Recording Fees
Other People’s Money
· All of the above costs
· Origination Fees/Points
· Daily Interest Charges
· Title Insurance (if required)
If you are using Hard Money to acquire the property, make sure you review all of the hidden costs that they typical charge at closing and make the buyer pay for. These costs can really accumulate if you are not aware of them prior to closing.
4) Holding Costs
For some reason these are the costs that are always excluded when watching those HGTV shows on television. Your holding costs are the costs that you will incur throughout the life of owning the property on a monthly basis. For our analysis, we will only look at the holding costs during the time the property is vacant since what we place a tenant, these holding costs will be absorbed by the revenue from the rental income. When executing this exit strategy, your property, should only be vacant for the period the property is under renovation and the time you are marketing and placing a tenant. Here are some of the holding costs that you will incur after the purchase of your property.
· Lender Interest (if you are using OPM and paying monthly)
5) LTV & Refinance Closing Costs
As previously stated, when it comes time to refinance your loan, your lending institution will typically refinance your loan at an LTV of 75%. This means that the lending institution, will issue you a loan on the property for 75% of the appraised value, which will either pay off your existing debt or return your own capital invested into the deal. Instead putting a dollar amount in for the refinance costs, we typically run our numbers at a 70% LTV or threshold to give us some extra cushion just in case we missed any other costs in our analysis.
Determining Maximum Offer Price
Appraised Value = $100,000
LTV (including closing costs) = 70%
Repair Costs = $20,000
Purchase Closing Costs = $4,000
Holding Costs = $1,000
$100,000 x .70 = $70,000
$70,000 - $20,000 = $50,000
$50,000 - $4,000 = $46,000
$46,000 - $1,000 = $45,000
Maximum Purchase Price = $45,000
When preparing the analysis to execute this strategy, you will need to have a good understanding of your renovation budget before the renovation begins. We will talk about different tools and documents that you will use to ensure that you put together an accurate estimate and produce a correct purchase price to offer. We are also going to talk about some documents you will need to assemble to ensure the execution of the construction project. As previously discussed, when renovating a property to execute this strategy, it is both an art and a science. We will not be renovation the property as if we were flipping the property but we are going to be renovating the property to strategically make repairs to maximize the appraised value. During the renovation project, you can not get emotionally attached to renovation but we need to stick to the plan that we have in place and ensure that we include contingencies so that we can account of any unknowns that may arise during the renovation.
We also want to make sure that we are making material choices based on durability and longevity since you will be placing tenants in the property to live in it while you own it. These material choices will cut down on tenant turnover costs as well as maintenance requests throughout your time as a landlord. For example, when we are choosing our flooring, you should always go with a plank board, LVT or ceramic tile over carpet since this flooring will hold up much better for you.
1) Pre-Acquisition Scope of Work
Before we purchase a property, we have to have a good understanding of all of the tasks that we want to perform during the renovation. We document these tasks using a pre-acquisition scope of work. This is basically a high level scope of work that we put together prior to the purchase so that we can use for our estimate when running our analysis to determine our maximum purchase price. This pre-acquisition scope of work is assembled prior to the purchase and when you walk the property for the first time. When you go out and take a look at the property prior to offering, we want you to take a bunch of photos and video, so you have some content to review when assembling to scope at home.
2) Professional Home Inspection
No matter your experience, we always recommend a professional home inspection be performed on a property that you are interested in purchasing. We always get what is called an “investor inspection” on our properties, just so that we can get a second set of eyes on the property to ensure that we did not miss any major issues during our walk through. They will issue you a detailed report of any of the capital ex items for your review.
3) Scope of Work
Since we have already put together a pre-acquisition scope of work to produce our repair estimate for our purchase price, we will utilize that information to create a formal scope of work. We will add on to our original scope of work through the professional home inspection and also during our due diligence period. Typically, we include a 7-10 home inspection contingency, so that we can view the property during this period to add to our scope of work and it also gives us a way to back out of the deal if there is something large that we missed when producing our offer. Our scope of work will be a final look at all the tasks associated with this project. We will generate several documents utilizing this scope of work such as: schedule, material list and budget.
Our estimate for the project will consist of the labor and material costs associated with the scope of work that we created. We will utilize our scope of work to bid out specific tasks to contractors as well. Your estimate is going to give you a high-level look at the renovation costs associated with the project. Our final estimate will be place into our budget and our total budget number will be the number we have to stay under during our renovation. If you are unfamiliar with estimating a project, we recommend that you build a relationship with a General Contractor to help you put together material and labor costs for your project.
Every construction project needs a schedule to ensure that you do not go over budget, tasks are performed in the proper order of operation and you have a good grasp as to where your project stands at all times. Once again, we will utilize our scope of work to produce our schedule to show how long each of the tasks on our scope of work will take to complete. Having an accurate schedule will help you limit and forecast your holding costs as well. If you are unfamiliar with the order of operations of a construction project, just reach out to us and we would be happy to share.
6) Material List
Just like the labor on a project, we will have to account for the material costs on a project. In order to determine which material is going to be needed within a project, we will utilize our scope of work to assign material to each labor task. Everyone has different relationships with material vendors, so the pricing varies. However to get a high level determination of pricing, simply determine the material that you want to use and go on (Home Depot or Lowes) website and look up the pricing for the material that you will need for the project. There is a much more extensive system that we use to produce our material list and gather our pricing but this is outside the scope of this post.
Your budget will be the final costs that you determine for your material and labor allowances on the project. This is where you will get final pricing on all of your material costs as well as the labor portion of the project from your general and subcontractors. Within your budget make sure you always include contingencies to capture all of the unforeseen work that accumulates during a renovation project. It is nearly impossible to account for all of the tasks that will need to be completed on a project, that is why contingencies are very important to be added to your budget.
All of the documents that we just spoke about will help you to stay organized before and during your construction project and will allow you to produce an accurate rehab figure prior to construction beginning.
The next piece of the puzzle that we will have to execute on is the marketing, showing, qualifying, accepting and onboarding of a tenant. As a landlord, it is very important to realize that your tenants make or break your success in this industry. So, it is your responsibility to supply them with a great product, take care of the maintenance requests and set expectations as to how you want their tenancy to play out. It is very easy to accept any tenant and have them be late on rent or destroy your property.
The first step is placing a great, qualified tenant is the marketing aspect of your property. Hey, you just completed a great renovation, so you mine as well show it off. When it comes to marketing your property, we want to try and get as much exposure as possible for our property and also to ensure that we have our unit properly price to garner the necessary interest that is needed. Here are some of the platforms that you can market your property on to get the exposure discussed.
· Facebook Groups
Be sure to track and store all of your inquiries so that you can respond to them through email to set up showings.
2) Property Showings
Once we gain the interest from our possible tenants, we will have to schedule showings for our prospective tenants to view the property. When showing a unit, you can do it 1 of 2 ways. The first way being individual showings and the second way being open houses. Through our experience, we recommend that you schedule open houses. We feel that this is a better use of time and also builds a sense of competition between potential tenants when they are viewing the property. Be sure bring a sign in sheet for your showing so that you can gather interested parties names, emails, phone numbers and if they are interested in the property.
Once we show the property and we feel that we have some good interested applicants, we will email these potential tenants over an application. If this is your first rental property, you probably are not signed up for a rental management software. These software’s allow you to send out online applications and receive application fees directly online. We recommend that you charge an application fee so that you can order a credit report, criminal background report and eviction report. We will use this information to vet our interested tenants to ensure that we make the best possible decision for our property. Here are some rental management software’s that you can look into to streamline this process.
· Rentec Direct
· Rent Manager
4) Tenant Acceptance/Onboarding
Once we have reviewed all of the applications from our tenant base, it is time to make a decision on the tenant that we will choose. Once we have made the decision, we will send out a tenant acceptance letter to the prospective tenant and let them know that they have been chosen. In this acceptance letter, we will explain the funds needed and our expectations in order to take occupancy of the building. You will also schedule a meeting at the apartment to collect the initial funds, hand off the keys and work through an onboarding packet that you put together that will explain how rent is to be paid and how maintenance requests are to be submitted.
This is the fun part. You made all the right moves, if you purchased the property with cash and made the repairs in cash, this step will be just that much more gratifying. Before you reach the standard 6 month seasoning period in order to refinance, you must do some preliminary work to ensure that you will be approved and your plan is justifiable. This preliminary work starts when you begin searching for properties to implement this strategy with. Now some of you may have a great relationship with a lending institution while others are just getting started. If you are just getting started, you have to get out there and network with different lending institutions. You have to find a lending institution that is investor friendly and that is a fit for the goals you are trying to accomplish. Early on you may get turned down by a lot of banks, but I promise you there are investor friendly lenders that will be willing to work with you.
Also, if you have little money or poor credit, you want to ensure that you meet all of the regulations and qualifications in order to successfully be able to refinance when the time comes. The last thing that you want to happen is to be unable to pull your money out or worse unable to pull your private money lenders money out.
Make sure you complete this preliminary work, build some relationships with lending institutions and get approved for a refinance for the estimated amount on your subject property. By taking these preliminary steps you will feel much more comfortable going through the process. To complete your refinance, begin the process with your lending institution on month 4. This is where you fill have to complete the tedious application process and provide your financial documents to the bank. These documents will include:
· Last 2 week pay stubs
· W2's (Last 2 Years)
· Credit Report
· Federal Tax Returns
· Checking Statements
· And sometimes more
The reason that we want to start this process in month 4 is because banks work slow. They process paperwork slow and do not really have an intention of moving fast. This process typically takes about 2 months to run your reports, collect all of your documents and ensure that you will be capable of refinancing.
Congratulations, you have successfully executed the BRRRR model and created unlimited wealth for your family. Once the refinance process is complete, you will get your initial capital back and be able to execute the model again. The more times that you execute the strategy, the more familiar you will get. It is now time to get back on the hunt for your next deeply discounted property to fit this specific model.
We hope that this post gave you some detailed insight into what it takes to execute the BRRRR model.
In the simplest form, we will be buying a property at a deep discount, making strategic repairs, placing a qualified tenant and refinancing with a traditional lender to pull our initial capital and repeat the process.