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Do you ever ask yourself, “How do I grow my real estate portfolio while spending as little money as possible?” Well, I ask myself that A LOT. Who wouldn’t want to add a property to their portfolio, build up their equity, and pull out their working capital – their cash money – to roll into another project? Let’s walk through a strategy that lets you do that, known by the acronym BRRRR, and then I’ll give you my thoughts.
The first thing you need to do is build up enough capital to make that first purchase. You’re looking for an undervalued rentable property, one that’s within your budget to renovate. With this strategy, the property you’re looking at shouldn’t require any major upgrades. The bones of the house – its foundation, walls, roof, electric, and plumbing should all be in good useable condition. The point of a BRRRR is to retrieve all of the money that you put into purchasing the property, while building yourself some equity in the property. A popular rule investors use when executing the BRRRR strategy is called the 70% Rule:
(After Repair Value x 0.7) – Repairs = Max Purchase Price
The After Repair Value is something that you make an educated guess on once you’ve added the value your renovations will bring. The ARV is the goal – the number you want your property to be appraised at. You might gain some insight on what your ARV could be if you take a look at sites like Zillow or RedFin. Search in the area of your prospective property and look at homes that have the similar numbers in terms of square footage, beds, and bathrooms, however are listed at a higher cost than your property. Ideally you’re buying in a market where newly renovated properties are selling for a greater value, so when you are appraised, your market value soars above your purchase price. The Max Purchase Price is the total you’re willing to spend on the purchase. Once you’ve found a property that matches your criteria, its time to grab the deal. Many investors use hard money loans, private loans, seller financing, or even straight cash. Its okay if your interest rate is a bit high with the initial purchase, one of the following steps is a refinance.
Alright, now you’ve purchased the property and you know what improvements you need to make. If you have the skills you can start making those changes yourself, or you can begin hiring out people to make them. View properties in your area that look similar to your purchase but include additions such as a renovated kitchen, a renovated bathroom, or finished flooring, improvements that justify them being listed at a higher value. If you have the extra space in your home such as an office that can turn into a well-sized bedroom, or a basement that can be finished with a bed and bathroom, then these are improvements that, if allowed by the town, can increase your homes value. Spend some time on sites like Zillow and RedFin and look at the cost per square foot of properties similar to yours. If a renovation costs $100 per square foot, but its estimated to add $200 per square foot in value, than its worth it. Ask local investors and Real Estate Agents what they think your property needs to appraise at a higher value. Essentially, you want to make sure your renovations push an appraiser to estimate the value of your property 15% to 25% greater than your purchase price.
Now, you rent it out. Take well lit pictures of your rooms, advertise anywhere prospective tenants might search, and get a great tenant to occupy your property. Getting a tenant during a BRRRR offers two advantages, the first is that it now gives you a rented property paying down its mortgage, and the second is that you can impress banks on having created an investment property, potentially raising its value upon appraisal. “Why would I need an appraisal once I have a tenant?” you might wonder. Well, renting is an important step in the BRRRR process, by getting a tenant you create an income producing property, this is attractive to banks. The reason you want to be attractive to banks is because the next phase in this strategy involves getting a new loan from a bank. The process of getting a new loan, involves getting a new appraisal, and the appraisal can be increased if your property is already rented. Once you have a tenant, make sure your tenant knows you are getting the house appraised. Ask them if they would clean or tidy up the interior, and kennel their pet if they have one. Make sure the landscaping is groomed as well. You might even go as far as hiring a cleaning company to take care of the interior and a local landscaper to handle the outdoors. Make sure that you know your tenant laws and your tenant is well informed of the inspection, even give them a reminder call the day before. You want to make sure you have a happy tenant, and you also want to make sure your property looks great!
Here is the key to the BRRRR strategy, search out a lender that will refinance your loan at an appraised value greater than what you spent on it. You can try major banks, however many have found success with local banks, those that are centered within the community you bought in. Here’s what you need to know from the bank:
- Will they give me a cash-out refinance? This is when the bank pays off the amount on your existing loan and gives you the rest in cash. If your loan was for $100k and your property appraised for $120k, you get out of your original $100k mortgage, get a new mortgage (hopefully at a lower interest rate), and you get $20k in cash. This is money for your next purchase!
- Do they require a seasoning period? Here’s when the bank requires you to wait a year or so until they are willing to refinance a property based on its appraised value. You a want to find a lender that will refinance once a property is rehabbed and rented, much quicker than waiting for the seasoning period.
Make sure you look at a variety of banks, and find one that gives you the best deal, the lowest interest rate, and the best value from an appraisal. Once you decide on a lender make sure that you go in with all the information you’ll need. The easier you make it for them, the quicker you can close your deal.
Great! You pulled out all the money you used to purchase the property! Its like you didn’t really spend anything but your time and you got a rented property with some equity. Now with your money back, a bank you’ve formed a relationship with, and your newfound knowledge, all you have to do is repeat the process and build a monumental portfolio.
This is a great strategy for those well versed in various areas of real estate, such as raising capital, estimating rehab costs, working with contractors, and working with local banks. However, that’s not to say its impossible to do for someone starting out. However, it would be wise to spend a little time learning about these areas of real estate and jump in once you’ve built some knowledge and made some connections. While it might be true that with this strategy, you can build yourself a perpetual system to fund an unlimited number of properties, you’d need to make sure that your estimates are consistently accurate and you’re always retrieving enough for a down payment on your next purchase. Do a couple deals with local banks, get to know private lenders, build relationships with contractors, and once you’ve locked down the right pieces, find properties and start up your BRRRR machine!