Why BRRRR is not an effective strategy today...

[Alan Asriants]

Margins in the market today are extremely tight. The best deals I find are usually the result of an agent's lack of familiarity with the area or a very poor listing presentation. Even in those cases, it's difficult to create a significant gap between the purchase price, rehab costs, and ARV (After Repair Value).

Investing in today's market is incredibly challenging, and I've found that the BRRRR strategy is one of the least effective approaches right now.

Let's keep in mind that BRRRR gained popularity before 2020. Back then, the market was more stable, interest rates were below 4.5%, and distressed properties sold at significant discounts.

Today, distressed properties often sell at a premium, and cash-out refinance rates are above 8%.

The best BRRRR deal I can find today involves buying a property with cash, investing in the rehab with cash, pulling out 75% of the ARV and breaking even on rent and mortgage. However, even in these cases, you typically leave a small amount of money in the deal and only break even before accounting for vacancy, repairs, and other expenses. For example, you might leave $10,000–$25,000 in the deal, end up with a $3,000 monthly payment, and only collect $3,000 (or slightly less) in rent.

This applies to my local market and primarily to Class B or higher real estate.

You’re better off finding a solid property that needs only light cosmetic work (e.g., paint, flooring, or perhaps a kitchen or bathroom remodel), buying it at a decent discount, and putting down at least 25%. This approach gives you access to better loan terms and makes the investment more feasible.

In my market, the BRRRR strategy only works if you purchase an absolute steal from the seller—and deals like that are virtually nonexistent. Even if you do find such a deal, getting it to cash flow after repairs and a cash-out refinance is extremely difficult, especially for single-family homes. This is because there's a cap on how much someone is willing to pay to rent a home today.

For example, even if you own a solid property worth over $600,000, the maximum rent you can charge in my area is $4,000 per month. Even at that price point, you may struggle to find a tenant, potentially leaving the property vacant for months.

Here’s an example of a deal I’m currently working on:

• Purchase Price: $215,000
• Rehab Costs: ~$250,000
• ARV: ~$615,000
• Potential Rent: $3,600/month

Using a $615,000 ARV and 75% LTV on the cash out refinance, with taxes and insurance, my monthly payment would be $4,267 using an 8.5% rate. This also leaves me with $3,750 stuck in the deal (not including financing and closing costs, which could easily add another $20,000).

In total, if I had to include closing costs and financing costs, I’d have about $23,000 (if not more) tied up in the deal and lose close to $700/month before accounting for expenses. While I would have built $150,000 in equity, the cash flow simply doesn’t work.

Now, let's compare this to the market conditions when BRRRR was highly promoted (pre-2020).

• Interest Rate: 4.75%
• Monthly Payment: $3,057/month
• Rent: $3,600/month

In this scenario, I’d be making over $500/month with $23,000 left in the deal, resulting in a gross 26% cash-on-cash return—an excellent deal.

As you can see, rates and prices play a critical role in the viability of the BRRRR strategy. Even with a great deal, it's tough to make it work in today's market.

This is the reality we’re facing now.

[Drew Sygit]

The Real Estate Crash of 2008-2010 caused real estate prices to crash across the country - but didn't affect rent amounts. This caused a historically unique opportunity for investors - they could buy Class A properties and immediately cashflow when renting them out.

This couldn't last forever, and it didn't, as excited new investors drove up prices.

Eventually, Class A property values increased to the point that even increasing rents didn't allow them to cashflow upon purchase.

So, the flood of new investors switched to buying Class B properties.

COVID created a chaotic spike in both the sale & rental markets, attracting even more new real estate investors. According to CoreLogic, in December of 2023, almost 30% of home sales were to investors!

Investment also spiked in Class A Short-Term Rentals (STR) and investors started paying higher and higher prices based upon anticipated STR rental rates, that exceeded sustainability based upon Long-Term Rental rates (LTR).

Now we're seeing investors pouring money into buying Class C rentals - but, many are getting burned.

In our experience & opinion, the main determinant of property Class is not location or even property condition, those are #2 and #3. The #1 determinant is the Tenant Pool.

If you don't believe us, try putting several Class D tenants in Class A apartment buildings and watch what happens. Or try the reverse - rehab a property to Class A standards in a Class D neighborhood and try to get a Class A or B tenant to rent it.

Unfortunately, many newbie real estate investors are jumping into buying affordable Class C rentals - expecting Class A results. In our opinion, Class C tenants have FICO scores from 560 to 620 - where their chance of default/nonpayment is 15-22%. See the chart from Fair Isaac Company (FICO) below:

FICO Score	Pct of Population	Default Probability
800 or more	13.00%	1.00%
750-799	27.00%	1.00%
700-749	18.00%	4.40%
650-699	15.00%	8.90%
600-649	12.00%	15.80%
550-599	8.00%	22.50%
500-549	5.00%	28.40%
Less than 499	2.00%	41.00%

Source: Fair Isaac Company

According to this chart, investors should use corresponding vacancy+tenant-nonperformance factors of approximately 5% for Class A rentals, 10% for Class B and 20% for Class C.

To address Class C payment challenges, many industry "experts" are now selling programs to newbie investors about how Section 8 tenants are the cure. If only it was that easy. Yes, the government pays the Section 8 rent timely, but more and more tenants are having to pay a portion of their rent. Then there are the challenges with Section 8 tenants paying utilities and taking care of their rental property.

Investors should fully understand that Section 8 is not a cure-all for Class C & D tenant challenges, it's just trading one set of problems for another.

We see too many investors not doing enough research to fully understand all this and making naïve investing decisions.