What’s Special About a BRRRR Refinance? Here’s What to Know

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One of the best ways to build rental portfolios is through the BRRRR strategy: buy, renovate, rent, refinance, repeat. Because of the different steps involved, many factors are important to be successful at this. A source of capital is needed to fund the purchase and renovations, a reliable contractor needs to do your renovations, and a banking relationship has to be established to provide the financing.

Along with all of these things, the refinance phase can be a deal maker or breaker. The key to this phase is getting the right valuation so you can recoup your capital and repeat. Without a good value in this stage of the BRRRR model, you will be left with some of your capital tied up in the deal, which will prohibit your buying power on the next one. That’s not sustainable. At some point, you will run out of capital if you have to leave some behind on each deal.

When it comes to real estate investing, always look for sustainability. This means engaging in profitable activities that you can do continuously. The key is to get a good value at your refinance so you can have sustainability in your business, repeating the process over and over again with the same capital.

Once you have a banking relationship in place with a lender that will fund your deal, the pivotal point in the BRRRR refinance is the appraisal.

Options for BRRRR refinancing

Keep in mind that if you can pay cash outright for your BRRRR refinance, that’s always best. But that doesn’t mean you need a huge amount of savings to get started. Here are some options to cover purchasing the property and paying for the renovations.

1. Use a HELOC

If you already own property, whether it be an investment or your primary residence, a home equity line of credit (HELOC) can provide you with the money to get started.

With this option, you can close in about 10 days, depending on your state, and this means you won’t need an appraisal. But the downside is you need to be spot-on when determining your ARV, which is the acronym for after-repair value. Otherwise, you may lose your investment.

2. Try a conventional loan

This isn’t ideal for BRRRR, but it’s not completely unfeasible either. Start by talking with your current lender if you already own property. They can walk you through the ins and outs of rehab costs with a conventional loan. If you do own property, you can do a cash-out and take out a loan against it.

A few things to keep in mind: Conventional loans severely limit the types of properties you can purchase. And BRRRR works best when the property has big problems like a bad roof or HVAC system. Additionally, conventional loans close much more slowly, which eliminates one of the major advantages of BRRRR.

3. Use hard money or a private lender

The right hard money lender will finance up to 90% of the purchase price and 100% of the construction. And when you’re buying, these loans are treated like cash—which keeps you competitive.

At times, a hard money loan, sometimes called a private money loan, will require an appraisal, which decreases your competitiveness. The lender will also pay close attention to potential rents, and may have requirements for how much the property should bring in. And then there’s the biggest downside: rates. These are typically much higher than standard mortgages, so calculate your holding costs carefully.

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Timeline for BRRRR refinancing

No matter how you’re doing it, the key to maximizing your BRRRR refinance timeline actually begins during the purchase phase for the property. Here are steps you can take during each point on that timeline.

Before you buy

• Find out how much your property will really be worth post-rehab. Before you even put in an offer, but especially before you submit a down payment for rentals, work with a realtor to get a solid sense of what the market will say your ARV is.
• Find your refinance lender before you close. This way, the lender will be involved in the project from the beginning. They can help negotiate the best rate and terms for the carry-out loan. It’s best to secure a lender at least two months before you want to refinance.
• Get prequalified for the refinance loan. Depending on the type of loan you secure, the lender will want to review your credit score, debt-to-income (DTI) ratio, and property equity. Be sure to give them any documents they need to get you prequalified.

If you are working with shorter BRRRR timelines, you can get prequalified for the refinance loan during your purchase phase.

If you are working with longer BRRRR timelines, think about holding off and applying for your refinance about 30 to 45 days prior to the time you want to actually close.

During rehab

Look at the refinance as project management, with the central question being “How can I collapse timelines?” In this case, you can pick up two to three weeks during the construction phase of the timeline with these steps.

1. Gather your documents. When you are about two months out from when you want to have a completed refinance and have applied for the loan, begin gathering your documents. Believe it or not, being super organized and quick during this phase can help shorten your timeline, with the bonus of impressing your lender. Depending on your loan, documents to gather may include:

• W-2s
• Pay stubs
• Taxes (last two years)
• Bank statements
• Copy of your license
• For commercial lending, you may need:
  • LLC articles
  • LLC operating agreement
  • LLC certificate of good standing
  • Business banking reserves

2. Schedule your appraisal. The appraisal phase can be the longest and most nerve-racking part of the refinance process. Be sure to schedule the appraisal immediately after applying for the loan.

Because this step can take so long, it’s best to start your refinance about three to four weeks prior to when you plan to put the property in service. That way you can get the appraisal scheduled without a tenant in place.

3. Prep for the appraisal. Get the property in order ASAP so it shows well. Ideally, you want to get the appraisal completed prior to the tenant moving in. The belongings aren’t supposed to influence the appraisal, but tenants can be very hard on properties.

If you have to complete the appraisal after the tenant is in place, incentivize the tenant to keep the property super clean and organized and make sure all repairs are done before this step. It may be a good idea to have it professionally cleaned the day before the appraisal. Spending $350 in cleaning fees to get another $5,000 or $10,000 in value is money well spent.

If you can, try to be present for the appraisal just in case they have questions. Either way, it’s best to prepare a package for the appraiser to help them understand what you have done with the property. This might be:

• A one-page document of the interior and exterior updates you’ve made since close. (Bonus for before and after pics and the budget!)
• A one-page document of closed comps in the area. Be sure you don’t include the value of the comps you provide. Many appraisers don’t like it and will not look at the file if you include a list of values.
• A file with proof of the upgrades just in case the appraiser wants to see it. This can include documents like permits and receipts.

4. Follow up with your lender post-appraisal to ensure things are on track. Getting the appraisal done is one thing. Getting it back from the lender is an entirely different thing. Touch base with them three days post-appraisal to understand when the appraisal will be back and what else is needed to close the deal. People get busy and refinances don’t have a hard and fast closing date, so they tend to get pushed to the side in favor of purchases. Staying top of mind can help the process along.

Be sure to ask about seasoning requirements. Some banks will lend at appraised value as soon as a property has been rehabbed and rented, but many want it to “season” for a certain period of time—perhaps a year or so. Before then, they’ll only lend on 75% of the cost you have in the property. This won’t cut it for the BRRRR method, so you need to make sure the lender is willing to do what you need them to do ahead of time.

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Tips for successful BRRRR refinancing

At the end of the day, always keep in mind that you have a huge impact on whether the refinance goes through. The lender is underwriting you if you’re using conventional lending and the home if you’re using commercial lending. This means there are a few things you can do to increase your odds.

Things like having a good FICO score and reserves will help you get approved for any loans. Avoid any big changes that would affect your income during the refinance process. That means no large purchases. And don’t change jobs, quit a job, and so on before everything is finalized. Here are a couple of other things you can do.

Make sure the income approach is used

Most appraisers use what’s called the market approach on an appraisal. This is when they look at the local real estate market for completed sales within a specific time frame to determine value. Real estate slang for this is “running comps,” or comparable sales. Things like distressed sales and bank auctions can pull down the market value unfairly. The sales they are comparing your investment property to may also not be as profitable.

On the other hand, the income approach factors in the profitability of the deal, looking at the net operating income (NOI) and applying a cap rate to come up with the value. If your deal is a good one, this approach will typically show a higher value than the market approach.

Break out your construction costs

As a real estate investor, you want to make sure the bank and appraiser see that you did significant work to fix up the property to increase its value. The best way to convey that is to show them a detailed scope of work for your renovations—especially since this is only going to increase the worth of your rental property and, as a result of that, your cash flow.

A bid from a general contractor with pricing and lots of details included is a good start. If you did any work on the property yourself, be sure to show some value for that. We also include a construction management fee on our deals to compensate us for our oversight. This fee could be taken as a payment or contributed as equity in the deal, but we make sure to show the dollar value in our budget.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.