Risks with BRRRR for a newbie?

Question

Hello BP,

I am a newbie looking to buy my first real estate investment in the high-cost area of Maryland between DC and Baltimore. On paper, the BRRRR strategy seems to make perfect sense for this type of area. I am considering obtaining an FHA 203K loan to rehab a property, live in it with roommates for some time, move out and rent the entire property, and then refinance to expand my cash flow.

However, online you will find videos such as this one of Brandon Turner or this by the Kwak Brothers which explains the significant risks and unsustainability of BRRRR. The major issue that these videos explain seems to assume that the investor is using a short-term, high-interest loan to fund the rehab. Since I am looking into using a 203K that I could (if I was unable to refinance) amortize over 30 years, do I clear this major concern?

I understand that there are other risks involved with underestimating rehab costs but these videos seem to focus in on the refinancing aspect. My questions for you all are:

1) What do you think of this strategy overall for a new investor in a high-cost market?
2) Does using a 203K where there is still cash-flow even before refi cut down on the major risks?
3) Are there any other major risks that I am missing here?

Kris Mann · Answer

@Brad Fallon, I am also from MD. I almost exclusively invest in PG county, though I live in Howard. What do we really mean when we say BRRRR "works" vs. "doesn't work"? In lower cost markets, you may be able to get all of your money out after refinancing. But not in our market. That doesn't mean BRRRR doesn't work. You have to enter with the right expectations and make sure the outcome works for your financial situation and goals. I have completed over 25 projects in PG/HC/MC, and maybe 5 of them resulted in recouping all of the cash. Usually I have anywhere from 10k - 50k left in each property, but I don't mind. Here are my approx average numbers over 25 projects, mostly in PG: Acquisition cost: $200kRehab + carry cost: $50kARV: $300kRefinance 75% LTV: $225kAmount of my money left in each property: $25k ($200k + $50k - $225k)Equity in each property on outset: $50k ($300k - $250k)Average cashflow (after debt service and operating costs): $700 For my situation, I am happy to own a cash flowing property for 25k out of pocket, where I have a built-in equity of $50k right off the bat. The type of financing, who lives in the house, when you rent it, how you buy it are all just variables within the model. You living in the property with room mates just adds more variables to the equation, maybe you should not tie the investment to your personal situation. But that is your call. When you evaluate a deal, your goal is to maximize X, where X = ARV - Acquisition Cost - Rehab costs - Carry Cost Think of all the ways you can maximize the ARV while minimizing the other three variables. And think of all the ways each of those components can go wrong. That should answer all of the questions you asked in your post. On the other hand, minimizing rehab costs by doing fewer renovations and finishes could result in a lower rent, which will impact you negatively over the long run. So you have to figure out the optimal rehab that gives you the best ARV and rent combination. The moral of the story is: you can go into an analysis paralysis trying to optimize the end result :) In our market, if your total cost is 80% - 85% of the ARV, I would say it is a stellar deal and you will come out way ahead over the long run. You may be able to do better in Baltimore county (I would avoid the city as an initial investment). Feel free to PM me if you need any help. Cheers!

Kenneth Garrett · Answer

@Brad FallonI’ve done many BRRRR projects. There is risk in any type of investment. Calculating your rehab numbers and ARV are critical. You will need to have a backup plan in case the rehab goes way higher or your appraisal comes out low. I would stay away from high cost markets. Class B and C markets are best. I tend to lean towards C+/B-/B areas.

Stephen Kehoe · Answer

That is what I suggest.Honestly I wouldn't get too caught in trying to find a 203 property either. If there are none close to your work in the next month or two I would just get into that house hack and do the 203 later.

Mark Cruse · Answer

You have to buy right in order to recoup most of the cash out. If the numbers are not right going in you will never make it work. Just like anything else in the game, you have to find the deals where the numbers line up for the BRRRR in the first place. When you get in, yes things can go wrong which is why you need exit strategies. However, going in you should have it all worked out on paper and try your best to run in as close to those numbers as you can.

Brian Garrett · Answer

The BRRRR method does not typically work well in high-cost markets as the rents don't justify the prices.

Stephanie P. · Answer

@brad FallonLots of great responses on this thread.I wholeheartedly believe in house hacking, especially when using 203k on a multi family property. It's unfortunate there aren't more multis here in MD. Brrrrr works using this financing because you defray your own living expenses with your tenants or in the case of a a sfr, your roommates. Going forward, you'll have to put more down, but this is just a stepping stone to the next property that allows you to get started with the least out of pocket.Best of luckstephanie

Sue Hough · Answer

@Brad Fallon if you would like to message me I am happy to share a spreadsheet I use to assist my analysis of buy and hold properties. It can give you a good idea of where you will be financially month to month. It does not take into account property appreciation, which you can add in simply enough. I like using spreadsheets to quickly analyze an opportunity.One piece of advise I would offer for your new venture; make sure you have a trusted contractor evaluate all of the construction expenses and on your part, when looking at a property always look for the construction concerns which will cause big trouble in the future. There is no benefit to playing down construction disasters, as I see so many people do because they get excited about the project and want to make it work. If you look for potential pit falls before you buy and calculate for their expenses your chances of success are much higher.Good luck!

Whitney Hutten · Answer

@Brad Fallon BRRRR carries several risks:1. Buying right (asset type, location, class, price, etc. here is an article for you.)2. Rehab (construction costs, timeline, contingencies)3. Rent (tenant quality, rental market pressures, etc)4. Refinance (this is probably the trickiest part to success. here is an article for you).Here is also an article on how to use other people's money to scale once you get the hang of things. PM me with Q's!

Brad Fallon · Answer

@Stephen Kehoe I think you hit the nail on the head on this - I have been stalled finding the right property. You would suggest that I focus primarily on a househack model using a 203k that does not take into account refinancing? As I've moved along (and need to find a place to live soon), I've put more consideration into buying a property to serve as my primary residence with roommates to at least cut my housing costs way down and help me save up for a future investment. If I can't cashflow off the property but could get my cost of living down to $600 or less/month I may still consider it.

Stephen Kehoe · Answer

@Brad Fallon Combining a BRRRR with a 203K loan with a primary residence with a first investment sounds like a recipe for analysis paralysis.I would concentrate on the fact that you’ll be able to cash flow your primary residence. If you don’t refinance and pull out some of your money to make this a BRRRR your ROI will suffer. However, having any ROI on a primary residence without appreciation is exceptional. Additional pros: Long term low owner occupied interest rate of 203K. This is better than any investment loan you can get.You’ll learn a lot in the rehab process. Things to note: The 203k loan is a pain. Eg. you will have to have contractors prepare bids to get the mortgage amount approved.