How Vacation Real Estate Investors Can Leverage This Time-Tested Strategy to Scale Rapidly and Boost Returns
The BRRRR method is a powerful tool for real estate investors. It allows you to buy, rehab, rent, and refinance a property, using the equity you build up to fund further rental property investment. This strategy can be used to build a portfolio of income-producing properties without relying on loans or other forms of financing. And, because you are recycling your capital, the BRRRR method can be a great way to build wealth through real estate investment.
What is the BRRRR method?
The BRRRR method is a fantastic way to finance your next vacation rental property. BRRRR stands for Buy, Rehab, Rent, Refinance, and Repeat. This method allows you to buy a property, rehab it to make it rent-ready, rent it out, and then refinance the property to get your initial investment back. You can then repeat the process with another property.
One positive about the BRRRR method is that it allows you to finance your property without using any of your own money. You can use the equity in the property to finance the purchase and the rehab. It can be a great way to get started in the vacation rental business without having to come up with a large amount of money upfront.
How does the BRRRR method work?
The BRRRR method is a RE investing strategy that can be used to purchase, renovate, and rent out properties. The acronym BRRRR stands for Buy, Rehab, Rent, Refinance, and Repeat. The BRRRR method can be used to build a portfolio of rental properties and achieve financial freedom.
The BRRRR method is a good way to quickly build up a rental property portfolio. The key is to find a property that you can buy below market value and then use the equity you've built up to buy more properties. The beauty of the BRRRR method is that it allows you to leverage your money. Instead of having to come up with the full purchase price of a property, you can use the equity you've built up in your first property to help finance the purchase of your second property.
This technique can be used to buy multiple properties in a very short period of time, which is great for those who want to build up a rental portfolio quickly.
Here are the steps of the BRRRR method:
1. Buy a property below market value.
2. Rehab the property to add value.
3. Rent out the property.
4. Refinance the property and pull out cash.
5. Repeat the process.
BRRRR Method Example
Step 1: Buy a Miami beach property with value-add potential
If you can pay cash- great, move on to Step 2. If you don’t have the entire purchase price on hand, there are several other ways you can take your first step on the BRRRR ladder.
-Secure a loan from a bank or other traditional lender.
Since you generally can’t use an FHA loan for a vacation property you won’t be living in, you’ll probably need to put somewhere around 20% down to secure the property.
To keep things simple, let’s say you’re looking at a $600,000 condo overlooking the sand and sun of Florida’s Miami Beach. You’ll need to put $120,000 or 20% down to secure a conventional loan. You’ll be financing 80%, or 480,000 Keep in mind that terms and down payment requirements will vary from lender to lender. We’ll also assume you’ve got $5,000 in closing costs.
Total Loan Amount: $480,000
Total Invested Out of Pocket: $120,000 down payment+$5,000 in closing costs
Your financing and loan program will vary from deal to deal, but for the purposes of this exercise, we’re going to assume you’ve got a 6-month interest-only loan with an interest rate of 6%. This means you have to pay back the loan within 6 months, either through a property sale or via the funds you get from your next loan.
Interest Rate of 6%
Monthly Interest Paid for 6 Months: Total Loan Balance x Interest Rate/ 6 Months= $480,000 x .06/ 6 months= $4,800/month
Other Financing Options
Get a short-term hard money loan
A real estate hard money loan is a type of real estate rental financing used to purchase real estate. Private investors or companies typically issue hard money loans, often used by investors who cannot get traditional financing. Hard money loans are typically shorter-term loans, and they are secured by the property that is being purchased.
Because the property secures them, hard money lenders are often more willing to lend to investors with poor credit or who are otherwise considered to be high-risk borrowers. Hard money loans typically have higher interest rates than traditional loans, and they are often due in full within a year.
Secure private money financing
A private money loan is a loan that’s not from a bank or traditional financial institution. Instead, it’s from a private individual or company. Private money loans are usually shorter-term loans, with terms of one to five years. And they often have higher interest rates than loans from banks because they’re considered higher risk. But there are also some advantages to using private money.
For one thing, private lenders are often more flexible than banks. They may be willing to work with you even if you have bad credit or a complicated financial situation. And because private money loans are shorter term, you can use them to buy properties that you couldn’t get a traditional loan for. That’s because you won’t have to worry about making payments for as long, so you can put more of your money into repairing and flipping the property.
Step 2: Renovate and rehabilitate the Miami condo
In this step, you’re going to add value to the property via a rehab project. You have the option to hire a contractor or perform the work yourself, but you want to be careful unless you’ve got significant renovation and construction experience under your belt.
Replacing some appliances, slapping on a new coat of paint, and replacing doors is one thing- fixing a cracked foundation, replacing a roof, or refurbishing wiring is another thing altogether. Just make sure you don’t bite off more than you can chew.
Regardless of whether you’re handling the work on your own or using a contractor, you’re going to have to create a budget for the project. This budget should include all labor and materials costs, as well as a look at your expected return after completion. Create a conservative estimate of both your costs and your expected return from the rehab project- both in terms of additional rents collected and property appreciation.
Let’s say you added a new Sub-Zero Freezer and a Viking Range, in addition to other little tweaks to turn the place from good to great. The project took you a month to finish and $10,000 out of pocket.
Total Renovation Costs: $10,000
Monthly Interest Payment: $4,800
Total Rehab Cost to You: $14,800
Step 3: Rent out the property to guests in need of a short-medium term rental in Miami
After you’ve added value via a renovation project, it’s time to start cash flowing! You can find eligible vacationers and renters via several different methods, including online vacation sites like Airbnb and VRBO, you can work with real estate agents or other firms to provide stays to traveling nurses, contractors, or others in need of a short-term place to live while they work.
Now let’s assume you’re able to rent out the property for $300 a night, or about $9,000 a month. Remember that you’re almost certainly not going to have the property rented out every single night- you will have vacancies- but for the purposes of this example, we’re going to assume you’ve got 100% vacancy.
Monthly Rental Income From Vacationers: $9,000
Step 4: Refinance the property.
When refinancing your vacation property via the BRRRR Method, there are a few things to keep in mind:
- Your vacation property is likely worth less than your primary residence, so you'll need to take that into account when refinancing.
- You'll need to find a lender who's willing to work with you on a loan for a vacation property.
- You'll need to make sure that you're getting a good deal on your loan.
Moving forward, you’re going to refinance the initial loan into a term loan by using a cash-out refinance. You take the cash from that loan and use it to pay off the initial interest-only loan and any out-of-pocket expenses you might have incurred along the way.
Getting an Appraisal
Before securing that loan, the bank is going to require an appraisal. They’ll look at comparables, or “comps” of nearby recently sold properties to help determine the value of your home. For instance, let’s say the major upgrades you made to the Miami Beach condo raised your property value from $600,000 to $750,000- a gain of $150,000 in value- that’s a pretty good deal for just $10,000 in repairs.
New Appraisal Valuation: $750,000
Getting a New Loan
You’re then going to get a new long term loan from the bank or lender. They’ll base this loan on a percentage of the total appraisal valuation, also known as its LTV or “Loan to Value.” In most cases, your LTV will range between 75% and 80%.
Now, let’s assume the bank is going to give you an LTV of 75%- creating a loan of $562,500. Let’s say it’s a 30-year mortgage loan with an interest rate of 6%.
New Loan Details:
Loan Balance: $562,500 (75% of $750,000)
Refi Closing Costs: $2,000
Loan Term Length: 30 Years
Interest Rate: 6%
Step 5: Repeat the process all over again.
This step is pretty simple- go back to Step 1 and start all over again, with minor adjustments depending on the deal in question, your needs and goals, and underlying market conditions.
The Pros and Cons of the BRRRR Method
There are several advantages- and drawbacks- offered up by the BRRRR Method:
- It allows investors to buy properties at a discount because they are usually in need of repair.
- The rental income can help to cover the mortgage payments, making the investment more cash flow positive.
- By refinancing and taking out cash, investors can use leverage to buy more properties and grow their portfolios at a faster clip.
Of course, like any investment approach, this strategy has some potential drawbacks:
- It can be time-consuming and expensive to renovate a property.
- There is always the risk that the property will not rent for as much as expected or that it will take longer to find tenants.
- If the market crashes or interest rates rise, it could be difficult to refinance the property and get the cash out that was originally invested.
Overall, BRRRR investing can be a great way to build wealth through real estate, but it is not without its risks. As with any investment, it is essential to do your research and understand the potential pros and cons before getting started.
How much money do you need for the BRRRR method?
So, how much money do you need to get started with the BRRRR method? The answer is, it depends.
If you're going to be buying and renovating a property on your own, you'll need enough money for the down payment, closing costs, and renovations. Depending on the property and the scope of the renovations, this could be a few thousand dollars or even tens or hundreds of thousands of dollars.
If you're going to be partnering with someone else or using financing for the purchase and renovations, you'll need to have a down payment and closing costs, as well as enough money to cover your portion of the renovations. In either case, it's important to have a buffer of extra cash on hand in case of unforeseen expenses.
The bottom line is that there is no set amount of money you need to start using the BRRRR method. It will depend on the individual property and the scope of the project. However, getting started with a relatively small amount of money is possible if you're careful and strategic about it.
How To Finance BRRRR Properties
BRRRR investment generally requires you to use one of three loan types, fix and flip loans, rental loans, or single-close loans. When you initially purchase the property, you take out a fix and flip loan that is interest-only. That covers the cost of the property purchase and any renovations.
After, you'll refinance to a long-term rental loan, with full amortization and, most importantly- a lower interest rate. Below are some examples of common loan programs- but terms, interest rates, and fees will vary from lender to lender.
Fix and Flip Loans
These loans can cover as much as 90% of the purchase price of the vacation property, typically with a term of around 12-13 months. Many lenders offer loans for the after-repair value or ARV or 75%- meaning you can finance roughly 75% of the estimated value of the home after your project is complete.
Rental Loans
After you refinance your vacation rental, you’re going to take out a long-term rental loan. In most cases, these are 30-year, fully amortized loans with a max LTV of 75-80%. Your rental loan is based on the current value of the property, so you’ll need to do a new appraisal that looks at all the upgrades you’ve made.
Single Close Loan
You also have the option to use a single close construction-to-permanent loan to finance the property rehab. With this loan type, you only pay interest on the balance of the loan during the rehab project, then the loan gets converted to a 30-year note for holding the property. You save out on costly closing costs and fees by only doing a single close, hence “single close construction loan.”
Refinancing a BRRRR Property
The BRRRR strategy is a powerful tool for real estate investors. It allows you to buy a property, renovate it, and then refinance it to pull out your equity and use it to buy more properties. The key to successful BRRRR investing is finding good deals on properties you can add value to through renovations.
Once you've found a property that you think has potential, you'll need to get it under contract and start the renovation process. After the renovations are complete, you'll need to refinance the property to pull out your equity. This step is where many investors get tripped up. They don't understand the different types of loans available or how to structure their financing correctly.
The good news is that there are a variety of lenders who specialize in financing BRRRR properties. These lenders understand the strategy and can help you structure your financing in a way that maximizes your equity.
Is the BRRRR method risky?
The BRRRR strategy is a popular real estate investing strategy, but it's not without its risks. Here are 4 risks of the BRRRR strategy that you should be aware of before you try it.
1. The most significant risk of the BRRRR strategy is that you could end up owning a property you can't rent out or sell.
If the property is in the wrong location, is in poor condition, or if there's something else wrong with it, you could take a not insubstantial loss. If you can't rent it out or sell it, you'll be stuck with the property and will have to pay the mortgage and other expenses on it yourself.
2. Another risk is that you could end up over-improving the property.
This can happen if you spend too much on renovations and increase the property's value more than you should. If you can't sell it for a profit, you'll be stuck with the property and will have to pay the mortgage and other expenses on it yourself.
3. You may also end up with a tenant who doesn't pay rent or causes damage to the property.
Bad tenants can cause nightmares for investors and landlords- guests can create significant damage or cause other legal liability issues- beyond your standard non-payment issues. The wrong tenant can cause you to lose money on the property and could even cost you more than you invested in the first place.
4. The property could end up being foreclosed on.
Foreclosures happen if you can't make the mortgage payments. It’s just how it is. You’re also at risk if the property value decreases and you can't sell it for enough to pay off the mortgage.
Final Thoughts
BRRRR real estate investing can be a great way to make money in the real estate market. By buying properties at a discount and then refinancing them at a higher value, you can make a profit while also building equity in the property. This strategy can be beneficial in markets where values are rising, as you can take advantage of the appreciation while also getting the cash you need to reinvest in other properties. As always, you should obtain professional advice as is appropriate to protect your interests, including any legal, accounting, financial or other relevant advice to make an informed decisions based on your circumstances.
