The BRRRR method is foolproof! Right?

Question

I wrapped up the week having a conversation with an out of state investor interested in purchasing a few properties that would fit the BRRRR criteria. I have found myself having the same conversation time and time again with investors who are in search of these dilapidated properties in which they can go in and add a bit of value to pull all of their cash out and then some. While in theory this sounds great, I have now come across multiple investors in the last couple of months who have lost their shorts to say the least.

I share this because as a local I know how hard it is to find decent labor at this time in the market. Not only are individuals having issues, but larger property management firms are struggling with the labor shortage as well. I am witnessing out of state investors purchase "BRRRR properties" for tens of thousands of dollars over what they should be purchased for. Just because a property is being bought "off market" does not always mean that you are getting a deal. Make sure you do your due diligence and get a few bids on the project prior to pulling the trigger. Don't be the guy/gal that has to throw together a sloppy remodel and complains to your contractor(s) that the final figures are too much simply because you made a mistake on the front end by paying too much.

That said, there is nothing wrong with purchasing buy and hold properties to get your foot into the market. Upon gaining some confidence and learning who some of the reliable vendors are, then perhaps take a stab at doing one.I am not saying that I am completely opposed to the BRRRR method, but I would suggest having all of your ducks in a row before doing so. Get a great team behind you so that you are not shooting in the dark. If you are in the Indianapolis market reach out to @Ross Denman he will shoot it with you straight, similar to how I do.

Cheers,

Zach

Harvey Levin · Answer

@Zach Hoereth excellent point. I will add a situation that I am currently involved in. Investor purchased a property I advised him was not going to be a good purchase based on price and estimated rehab cost.  Investor hired a cheap contractor based on a well know wholesaler recommendation. I advised the investor to make sure the contractor had all the proper insurance. The quote came back at a VERY competitive price.  Turns out the contractor had liability insurance only. No workman compensation insurance but since the contractor was a individual with no employees he had a Indiana State Wavier releasing him from needing to have WC insurance but it was expired. I asked the investor how he thought the contractor could preform the rehab all by himself.   Long story short... contractor  hired "1099 " workers who also had no insurance and no waivers. 1099 fell off the roof and broke his back. Investor is now liable for potentially over 1 million dollars.   Yes contractor is as well but the contractor has no assets. The investor does. Since investor did not require proper insurance  his insurance company is NOT responsible.  The LLC is not going to protect the investor as the investor has not acted as a corporation as most investors do not. Based on current negotiations Investor will not only lose the house but also several others as well as he may need to sell his personal home to pay off the agreement.   Make smart informed decisions.

Ross Denman · Answer

@Zach Hoereth thanks for the shout out.

Caveat: I have not read the new "BRRRRR" Book. This is just based on my understanding and experience of working the BRRRR method for my properties and our clients.

BRRRR can be very tricky. Here's my honest opinion, if you can BRRRR a home with a long term-investment of less than 20% of the cost you're in a better position than conventional financing. Of course, as @Jay Hinrichs mentioned, it's a lot of risk to get there.

Infinite rate of return... is a lie. Unless you can cash-out refinance with enough money to fill reserves (I like 6-12 months of rent in reserves) and still cash flow beyond the debt coverage and through the next vacancy... but that deal really is a Unicorn.

Leverage is the investors most powerful tool. We leverage money, people, technology, machines, time, and whatever else we can come up with. Leverage is also very dangerous. It would be the equivalent of taking a smaller boat in to the deep ocean. Every move can become very overwhelming because volatility and lack of cash flow.

Here is some food for thought for anyone looking to BRRRR.

• Don't worry about refinancing all of your money out, but try to leave no more than 20% of your capital invested long term. That puts you in a leveraged position of 5:1. This means that instead of 3%-4% equity growth every your, your COC equity ROI will be 15%-20% annually.
• Consider the rental income when determining how much you want to refinance. I am an advocate of the 50% rule. While your NOI should be higher than this on years without a vacancy, it will average somewhere between 40%-60% over time if you turn tenants. If that holds true, then your mortgage break-even amount for cash flow is 50% of the rental income. I recommend shooting for a mortgage of 40%-45% of the rental income.
• Keep reserves. I can't tell you how many big ticket items I see come up every year. Two trees fell on homes last year. Fire two years ago. Lots of wind and hail damage this year. Car ran into a house 3 years ago. This doesn't even consider the more normal expenses. Appliance, mechanical, or structural repairs or replacement. Evictions or other legal issues.
• Rental increases. Be sure to let the property manager know that you want some kind of rental increase every year if the market allows for it. Many of these homes will only cash flow $1,000-$2,000/year. A $10/mo rental increase is a 1.2% increase on your COC ROI. For instance, if you have $10k tied up (long-term) and cash flow $1,000, that's a 10% COC ROI. If it's $1,120, it becomes an 11.2% COC ROI.

There are other considerations as well, but these are some of the more important concepts. I highly recommend working with a team familiar with the BRRRR strategy or have investing expertise. There are lots of ways to make money in real estate... and one of the most profitable ones that I tend to see is sell poor deals to out of state investors at a profit. Education, deal evaluation, and due diligence are vital.

I hope that people take note that there are a lot of experienced investors here who are advising to be cautious with the BRRRR strategy. I believe it's a great model that can work in the real world, but there are lots of moving pieces to be managed and a lot of ways to leak capital while doing it. That's investing in general, but with the limited cash flow to offset some problems. BRRRR is like a flame thrower. Awesome weapon... but if used poorly, you'll get burned. (Sorry, watched "Once Upon a Time in Hollywood" this weekend.)

Sathish Sekar · Answer

Zack, you touched on an important point:There is no way to fix a high purchase price. If one pays too much to acquire a property, then no amount of rehab or strategy will make the numbers work. You make your money when you BUY the property. The rehab and resale/refinance are a byproduct of a prudent purchase price.

Jay Hinrichs · Answer

@Zach Hoereth  the reason your all of  a sudden seeing this is there is a book on BP touting this.

while in theory it works in practice its by far the most risky thing and investor can do and a beginning investor takes HUGE risks.. as we are now seeing since it became a soup d jour.

not only the buying and rehabbing of he asset but the frustrations of getting the refi.

this is an old strategy its nothing new and certainly a great one for locals who have their go to contractors and get the better buys..

Lots of folks taking on risk just to try to have zero money in a rental that throws off 100 or 200 a month..  Not sure the juice is worth the squeeze for many.

Melissa Parrella · Answer

My husband and I are looking to BRRRR in Indianapolis, thank you all for the comments, there is a lot of good info here!

Jay Wu · Answer

Thanks for posting this, @Zach Hoereth As a new investor I will definitely take your word of advice and evaluate each deal with caution. BRRRR isn't the only way to invest especially for starters.

Frank Lin · Answer

@Jim K.

As an OOS investor who is not paranoid about OP cornering the market, I welcome all to dive into the BRRRR method and to call me when they need to quickly liquidate! LOL

Chris Seveney · Answer

@Zach Hoereth

There are a lot of people who think they are investors watching to much HGTV thinking they can flip properties. Unfortunately most do not do well and you only here success stories as people don’t talk about their failures. Case in point look at someone who has a 9-5 job and their resume - they brag about their successes or failures ?

If your buying to hold I recommend having boots on the ground and being local. If you are trying to invest out of state in a hot market it will be more difficult to find the better value properties as those areas have local investors who know someone on every street corner. Not to say you cannot find deals but a lot that are presented have already been picked over by others and a reason why they are still available

Henry Kaldenbaugh · Answer

BRRRR involves lots of work and real savvy about the actual costs.  It will cost more, take longer, and consume more of your energy than you will calculate in your presumptive analysis.  You can bet on that

Jay Hinrichs · Answer

YUP common thread locals make it work.. out of state investors while it can work take huge risks in rehab and refis..

in theory most things work.. even warp drive !!!

The BRRRR method is foolproof! Right?

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