Fix-and-flip investors take great care in buying properties. The BRRRR process involves some math. To ensure a profit on the back end, you have to buy right on the front end. That means calculating purchase price and rehab costs to figure out the total investment and comparing that to the expected sales price at the completion of the project. Investors generally look at loan-to-value (LTV) ratios and after-repair values (ARV) to determine whether a project is a good investment or not.
Another strategy called Buy, Rehab, Rent, Refinance, Repeat (BRRRR) is emerging in the real estate investing marketplace. It’s not new, but it does offer some advantages to a straight fix-and-flip strategy. Let’s discuss those.
Buy the Right Property at the Right Price
There are two types of fix-and-flip projects that fit into the BRRRR strategy. One is where the investor goes into the project knowing in advance that he will rehabilitate the property and convert it into a rental property, adding it to his buy-and-hold portfolio. In that case, the investor must calculate expected rents and determine if it will lead to cash flow, or determine if there is potential equity after holding for a few years. If property values go up, he can sell the property later for a nice return.
The other type of fix-and-flip project that might end up in a buy-and-hold portfolio is one that was intended to be sold immediately after repairs, but a change in market conditions has caused the investor to change his strategy to buy and hold mid-stream.
In either case, buying the property at the right price is essential to getting the return on investment expected.
Rehabilitate the Property
Whether you intend to flip the property or convert it to a rental, the rehab part of your project is very important. You don’t want to spend too much money on the rehab or it will eat into your profits. On the other hand, you want to ensure the property is functional after the repairs have been made. If possible, you want to focus on repairs that also add some value to the property, which is very important if you intend the sell the property later.
Rent to the Right Tenant
In a typical fix-and-flip project, immediately after the rehab phase of the project you’ll move into sales mode and try to find a willing buyer as soon as possible. Holding properties cost you money. However, if you are transitioning to a buy-and-hold strategy, then you’ve got to turn the property into a revenue generator as soon as possible. That means you need to find a tenant as soon as possible.
You want to do this before you refinance because most banks don’t want to refinance a property that isn’t occupied. Having an occupant will increase your chances of refinancing.
Refinance to More Favorable Terms
In order to refinance, you need to ensure you have some things in place first. For starters, you’ll need an appraisal.
As soon as you have tenants in place, make sure they know an appraiser will be stopping by to look at the property. You don’t want to surprise them. After you get your appraisal, interview a few banks and compare terms. Find out if the bank offers cashouts. If not, you want to find another one. The cash out is very important in the BRRRR strategy because it reduces your risk. Secondly, find out how long the bank’s seasoning period is. In other words, how long do you have to own the property before you can refinance it?
Seasoning periods are important because if you get stuck in a high-interest loan for long, it will slice into your profits. You want to get your interest down as soon as possible.
Repeat and Profit
When you find a strategy that works, you want to repeat it. Many buy-and-hold investors find that they like the BRRRR strategy and continue to implement it into their portfolios. There are several ways to do this:
- Go all-in – Some fix-and-flip investors convert to the buy-and-hold strategy completely. There are advantages and disadvantages to doing so. If you go all in, you’ll have a large portfolio of properties in your inventory that could be difficult to sell later if the market turns. It could also lower your liquid cash reserves as your capital will be tied up in properties. On the other hand, flipping produces short-term returns and higher capital reserves, which translates into more money for buying properties.
- Half and half – More popular than going all-in is the half-and-half method. Some fix-and-flip investors convert every other property into a buy-and-hold property. In effect, they flip one and then hold one. That way, they can keep the short-term returns coming in while building their buy-and-hold portfolio.
- Create your own mix – Maybe you’d prefer to flip 60 percent of your portfolio, or one-third buy-and-hold matches your risk tolerance better. Creating your own strategy can also make you feel like you have more control.
The Benefits of the BRRRR Strategy
In a rising market, it’s usually better to buy and hold. The downside is, it is difficult to time the market. There is no fail-safe way to know the best time to sell. That’s why many BRRRR strategy investors use a 5-year benchmark. They buy, rehab, rent, refinance, and repeat, and in the fifth year, they put the property up for sale.
Using this strategy means you’ll always have properties on the market after the fifth year. If you buy your properties wisely, even in a market hostile to sellers, you could see returns on these transactions.
It’s still important to buy right. Using the same LTV formula you use for fix-and-flip properties will keep you on the right track. If it works for flipping properties, it should also work for your buy-and-hold strategy. The snag will be if you can’t find a renter during the rent phase. If that happens, you can still flip the property and aim for buy-and-hold on the next one.
Since real estate investing often means buying properties at a discount and selling them at full market value, the buy-and-hold strategy gives you an advantage, especially in a market where property values are on the rise. If the rental market is up and home sales are down, it’s also a good time to take advantage of the monthly cash flow that owning rental properties brings. However, you don’t want to get yourself in a bind by holding onto too many properties at once.
Be sure to calculate the costs of refinancing before you make a purchase. Lenders generally finance no more than 75 percent of a property’s value. If you aim for a 70 percent LTV, that gives you some wiggle room. Sixty-five percent is even better.
Banks also charge a refinancing fee. On top of that, you’ve got to pay for the appraisal, title work, and loan processing. It will be worth it if you can cash out your initial investment. That way, you have none of your own money tied up in the project while earning residual income. In the meantime, you can build equity. If you start with 25-30 percent built-in equity, you could be sitting on a gold mine.