Why the BRRRR method may get your assets frozen

Question

The BRRRR method: Buy, Rehab, Rent, Refinance then Repeat.

This investment strategy attempts to maximize return while deploying the least amount of capital. The idea is simple, put as little down as possible in order to purchase and rehab, once refinanced you are able to pull the original monies out and invest elsewhere; in the end you have a property you have zero net dollars invested and a property that cash flows (the rent outpaces the mortgage). Investors are all different, while some look for a particular threshold to cash flow there is a growing number of investors that simply want to be in the black; these investors care about one thing, appreciation, after all once the 30 year mortgage is paid off it will be pure cash flow—right?

The financial crisis of 2008 was caused by systemic problems within the banking system as well as the undeniable moral hazard permeating throughout the housing market. Tabling those very real and serious factors for a moment, there is another issue that is often glossed over: the prevailing sentiment by the market that prices were always going to go up. The purpose of acknowledging this dangerous co-factor is not to shift blame rather, address the morbidity of such a speculative investment strategy. Are the underlying assumptions made by the BRRRR investment strategy at all different? I would argue, no.

The economic landscape in which we currently find ourselves is, without a doubt, fragile. The corona-virus was able to put on full display the inadequacies of our savings deficient economy; much like the moral hazard and problems within the banking institution that led to the collapse of housing market, lets table the economic impact made by the corona-virus and instead address the underlying problems that have since surfaced. Americans are devoid of savings and cannot withstand even a single month’s expenses if stripped of their income or purchasing power. To me, printing money into oblivion is not the answer—the complexities and differences of Keynesian and Austrian economics are worth multiple blog posts in and of themselves—stimulus will not save the economy, just delay the inevitable, the rise in prices are either attributed to an increase in demand and/or an increase in the number of dollars in the economy. Now look, this is a general overview and it may go without saying that the answers won’t be found in this article so harping on the problem isn’t useful but in recognizing the issue we may be able to gain some insight into how to more efficiently invest and deploy the BRRRR strategy.

Early adopters will most likely be able to escape scot-free as they were purchasing properties after the collapse of housing prices while rents stayed relatively stable. But those that are purchasing today are paying premiums for their investments and are leveraged to the hilt. This can certainly be view as a doom and gloom scenario or, for some, an inevitability as we continue to infinitely print money—it is food for thought especially for those of you who are looking to get into real estate and plan to have very little to no skin in the game. Your dollar is worth less so you’re going to have to spend more to secure your asset, when credit evaporates home prices will vanish with it; Assuming the rest of the world will reject the inflated dollar as the world’s reserve currency, as credit dries up and home values collapse rents will follow suit.

Welcoming all to let me know what you think below!

Neil Henderson · Answer

All that the BRRRR strategy is is value-add investing. It's not new, it's how Warren Buffet has built his fortune, buying distressed assets at a discount that can be "fixed" to return their value to a normal, market price, or better. It's not natural appreciation, it's forced appreciation. In the commercial real estate investing space, it's a double whammy of increased cash-flow, PLUS forced appreciation due to the income based valuation of commercial real estate.

With residential real estate, if I purchase an asset for $60,000 that's worth $100,000 if it's been fixed up, and I spend $15,000 forcing that appreciation to $100,000, I've just created $25,000 in value, not the market. If that property now rents for $1,000 a month, in most scenarios, it's going to be positive cash flowing, even after placing a long term mortgage on it.

Yes, there are risks. You could be in the middle of a refinance when a global pandemic hits that causes an economic catastrophe that causes your cash out refinance lender to balk at a cash out refi of 75%. Now it's 70% and you've just left more money in the deal. Living that right now.

In the time you purchased the property and rehabbed it, the market could soften and your appraisal comes in low. 5% lower? 10% lower? Is a market really going to soften that much in a 3 month period? Maybe, but that would be a pretty severe market correction, and you're still pulling most of your capital out of a deal at a 10% drop.

So, everything has gone reasonably well, but not great, now your in a deal for $10,000 that's worth $90,000 and it rents for $950 a month. Eh. Not great, but hardly catastrophic.

Ok, now your tenant stops paying rent. You need to evict. In a normal world, and assuming you didn't buy in a state with wildly tenant favorable laws, you evict. It takes 3 months? Maybe returning it to rent-able condition costs $6,000? Ouch. Again, not catastrophic...IF you follow the Three Immutable Laws of Real Estate Investing:

• Invest for cash flow
• Invest with long-term, low-leverage debt
• Have sufficient cash reserves.

It's all about creating multiple margins of safety. The first margin is buying low and forcing the appreciation.The second margin is positive cash flow. The third margin is good debt, not over-leveraged, not short terms. The fourth is your cash reserves that allow you to adjust and weather the unexpected.

Alex Bekeza · Answer

@Ryan Peep Interesting post! Inevitably, once exhausting conventional options whether it be for DTI reasons, entity vesting, or ideally, simply ending up with 10 + financed properties, BRRRR investors end up having to rely on Non Qm/Commercial/Portfolio loan products with guidelines that allow them to scale.  Since these loans aren't backed by the government sponsored entities like Fannie/Freddie they instead rely on secondary market investor buyers.  Obviously, loans based on DSCR when so much of the country is out of work make the loans much less appetizing than pre covid.  However, I'm seeing a lot of Non Conventional lenders work out deals with secondary market buyers that allow them to continue to offer loans.  That being said, we're finally seeing lenders offer 70% cash out again (still a huge wrench in the plans of BRRRR investors banking on that 75% exit strategy) and lenders who previously offered 90 day seasoning to cash out off of new appraised value now want 6 months.  And as you pointed out, Reserves, Reserves, Reserves.  Most of these loans used to require 6 months reserves and now were seeing lenders ask for 9-12 and only a small handful will count cash out proceeds.

I hope this adds a little color to the topic for folks who come across your post in terms of how the private mortgage industry is reacting.

I think it will be several months before we see 75% cash out again and some time before we saw the killer non conventional rates we saw in early 2020 pre covid. Fannie/Freddie rates will continue to stay near rock bottom for a while as means of propping up the economy.

The "BRRRR" or Fix and Hold strategy is still doable but investors need to have their pencils extra sharp in these much more restrictive times and be prepared to not necessary recoup their entire initial investment.  Luckily, there are options with very light prepayment penalties where you could come back in a 1-3 years and scoop out a little of the equity you initially left in there.

Seems worse to just sit on the sidelines and wait.

Ezichi Oha · Answer

Interesting Topic

Chris Lounsbury · Answer

I'm probably over-simplifying this, but I would think that the BRRRR method, when done correctly is not what you are suggesting.  In fact, it could be argued that it is significantly less risky than the alternative of purchasing a property and leaving your capital in it.  As Neil mentioned, when doing the BRRRR method properly, you are forcing appreciation, not relying on the market to create appreciation.  You then are locking in long term financing and pulling out up to 70% (sometimes higher) of the appraised value.  As inflation increases, this locked in rate, and locked in mortgage value becomes more valuable. Furthermore, your risk is defined by the amount of money you have in the deal.  So if you are able to pull out a large portion of your capital, you are in essence, de-risking yourself.  As Brandon always mentions, buying a property for 80k thats worth 100k with 0% down is the same as buying a 100K house with 20% down, but which situation allows you for larger mistakes? The one where you still have 20K for reserves or other purposes.

Of course COVID really scared a lot of investors.  And many had to pivot when banks stopped lending for a few months there.  I actually had to do just this.  I was in the process of refinancing in March when appraisers were deemed non-essential in PA, and all the banks backed out of refinancing the property.  But prior to buying the property, I ensured I had a large capital reserve, and that the property would cash flow even with the current hard money loan that I used to purchase, even if it was at 10% interest. I had to wait 3 months until I could start the process over again, but during that time, I made some more repairs, and called more and more lenders preparing for when we would be able to move forward again.  Ended up finding a lender that does 80% cash out refi, which is 10% higher than any other bank I had been in contact with, so COVID will actually end up helping me pull out an additional 10% of my money to reinvest in other deals.

In regards to your rents decreasing beyond a point of cash flowing idea, that is definitely something to always consider. You never want to be the top of market rents when you are analyzing, so if a market correction occurs, you still should be able to get the rents you want.  But I guess that comes with more experience and understanding that spreadsheet math should always be conservative to avoid any downturn effects.

Again, I am surely over-simplifying, and if you are not properly running numbers or doing things correctly, then just like all investments, the BRRRR method can be very risky.  But for someone just getting started, who may only have 20-30k, this is the fastest and safest way to scale in my opinion.

Why the BRRRR method may get your assets frozen

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