BRRRR - How this 'cold' strategy leads to HOT returns

BRRRR - Looks like a character response you'd read in a children's holiday book about snowmen and sledding. But to many an experienced real estate investor, this acronym is the gateway to creating substantial passive cash flow through real estate investing.

There are many great articles, books, blog posts, video's, etc., that discuss this strategy in detail. It's a favorite of mine, because it's exactly how I got started (and before I knew it was an actual strategy with a name). 

The strategy stands for Buy, Rehab, Rent, Refinance, Repeat. If executed appropriately, when you get to the Refinance stage you will own a cash flowing rental property with $0 of your own money in the deal. If executed exceptionally, when getting to the Refinance stage you will have the opportunity to even pay yourself to own a cash flowing rental property.

B - BUY

Step one. Buy a property. Makes sense, right. But you have to be very diligent in your selection. Knowing your market is key when it comes to the BRRRR method as you'll have to know, within a small margin of error, not only what the property will be worth when you are finished with the rehab stage, but also what you'll be able to lease the property for. What you're striving to do is purchase a property that has an ARV (after rehab value) of 25-30% more than the summation of the purchase price + rehab costs. The reason being is because most CREM (commercial real estate mortgage) lenders will have an LTV (loan to value) limit of 75%. Although it is not unheard of to find multiple lenders who will provide an 80% loan to value. However, by assuming the need for an equity position in the ARV of 25-30% you leave yourself with multiple financing options, and also some room for cost overruns.

When purchasing a property, there are several financing methods that are often utilized; your own cash, Joint Venture where a partner brings cash, hard money loan/private financing, seller financing, etc. Typically, with this strategy you don't see a lot of buyers obtaining traditional bank financing during the Buy phase. Why? While traditional Commercial Real Estate Financing can be great, lenders often see this as speculative investment (which it is if you have little to no experience) and to obtain the financing can be cumbersome and expensive.

R - REHAB

When rehabbing a BRRR vs. a flip there is one thing that you must remember: that when the rehab is finished this place is for tenants, and not a homeowner. It is what it is; tenants just do not treat a home as well as a homeowner will. Therefore, you probably don't need to go with granite countertops, glass enclosed shower's, top of the line cabinetry, or $8/SF flooring.

Focus your rehab on two things:

1) Making sure the property is safe, meets your rental target market needs, and is up to code

2) That you budget accordingly, and do not spend over the 75% of projected ARV

You want to find a way to deliver a product that appeals to the eye, but is easy on the wallet. You will have to be willing to put in the time to shop around on appliances, flooring, cabinets, countertops, faucets, shower heads, light fixtures, etc. I always try and deliver a home that I would live in with my own family, it just may not have the exact finishes I would put in my own home.

Last but not least during the rehab stage, make sure that you account for and calculate the financing and holding costs. Things like utilities, taxes, insurance, loan fee's, etc. You must have an estimate for these and subtract them from your rehab budget.

R - RENT 

You've purchased the property and finished the rehab - time to fill the property with a qualified tenant. It's crucial to secure a tenant with a lease prior to refinancing because most Bank's will want to see that the property is producing income.

TIP: 

Qualifying a tenant is an entirely different topic, so I'll leave that out completely, however I would suggest you look into the possible tax incentives that are available for marketing your property PRIOR to rehab. This may allow you to categorize your rehab costs in a manner that benefits you come tax time - see your accountant/CPA for clarification.

R - REFINANCE

When looking for a lender to refinance your rehab and purchase costs you'll want to find out two things:

1 - Do they have a seasoning period - is there a length of time you must own the property before the Bank is willing to lend against it

2 - What is their max LTV for cash out re-fi's on rental property 

Technically you should've sat down with potential lenders prior to this point so that you know exactly who you're going to do your refinancing with. The last thing you want to have happen is get to this point and struggle to find a lender that will provide the financing you request.

(actual deal of mine with actual numbers)

Purchase Price - $32,000

Financing & Holding Costs - $1,650

Rehab Costs - $18,300

Total Money in before the Refinance Step: $51,950

ARV - $73,500

- Now when I was doing my market analysis, I had figured an ARV of $70,000 - but to be sure, I went one step further and ordered an appraisal to be performed with an " as competed " value. It cost me $350, but it also eliminated much of the doubt of what the ARV would be once the rehab was completed. Additionally, it allowed me to structure my rehab costs as well so that I knew exactly what my limit was. That value came in at $73,500. I was lucky here, as I was able to get the Bank to accept my appraisal as it was performed by an appraiser that was on their approved vendor list.

ARV - $73,500 X 75% = $55,125

This means that I was able to refinance and pay myself back the $51,950 I had in to the project PLUS cash out $3,175.

Now I wouldn't always recommend doing this but if the increase in the debt service is nominal and you can still have a solid CF ratio (I prefer 1.50X Debt service coverage or better) then I say pay yourself!

Rent - $885

Mortgage - $360/mo

Taxes - $162/mo

Insurance - $73/mo

Misc. $50

Reserve $35

Total monthly CF after expenses and debt service = $205

DSC ratio - 1.57

When all said and done after the Buy, Rehab, Rent, Refinance I had paid myself $3,175, had a 25% equity positions, and a property that CF over $200/mo.

Once you do find a lender that will provide what you're looking for, be sure to build a relationship with them so that they are familiar with your business plan and will be willing to continually take on the financing of future properties. Which leads us to our last R.

R - REPEAT

This last step needs no explanation. Go out and find yourself another property to BRRRR - 

This process is a great way for newbies to break into real estate investing and will allow you to build both your balance sheet and your monthly passive cash flow.