Your Guide to Understanding BRRRR Method Risks and Rewards
Fix and flip transactions have been a reliable money maker for real estate investors for more than a decade.
While the profit margins on fix and flip projects depend on multiple variables, including everything from location to the general state of the economy, recent data shows that the average profit for a single sale was around $70,000 in 2022.
The BRRRR method is a system that allows real estate investors to build and scale a pipeline of fix and flip transactions that continue to generate profits beyond a single transaction.
The BRRRR method at a glance
BRRRR stands for buy, rehab, rent, refinance, and repeat. Before diving in for your first BRRRR money maker, it’s crucial to understand how the process works so that you can take advantage of its rewards.
- Buy: The first step is to locate and buy a distressed property to renovate. Distressed properties have the most potential to sell at a profit after renovations and can often be purchased at a discounted rate allowing investors to maximize profits from the initial sale.
- Rehab: Renovations include everything from cosmetic improvements — like new paint and flooring — to structural and safety upgrades to the plumbing, heating, electrical, and ventilation systems.
- Rent: Rather than selling the property once the renovations are complete, BRRRR properties are put on the rental market and generate ongoing residual income in rent payments.
- Refinance: Leverage your equity in the property to refinance your mortgage for cash (known as a cash-out refinance) to purchase and refurbish a new investment property.
- Repeat: Once you’ve refurbished and refinanced the first property, repeat the process to grow your portfolio (and profit margins).
Potential risks associated with the BRRRR strategy
Like any investment strategy, there are a few potential risks associated with the BRRRR method that savvy real estate investors should know before they jump into their first “buying” opportunity.
The biggest risk is the ever-fluctuating real estate market, including property values, interest rates and renovation costs that can all impact the profits of your investment.
While some of the factors that increase the risk profile of a BRRRR investment are beyond your control, understanding the risks allows investors to make contingency plans.
Price fluctuations in property market
The BRRRR method hinges on finding distressed and undervalued properties with renovation potential. However, as more investors flood a market, finding properties in this category can be challenging depending on factors like your location and the state of the property market at the time.
Cost overruns and rehab challenges
Even the most meticulous budgets and renovation plans can go off schedule and over budget. These overruns could impact your cash flow as well as your application for a real estate loan.
Rental market snags
The rental market can be unpredictable, especially in times of economic uncertainty. There are also additional costs associated with keeping up the property’s occupancy rates, from marketing and administrative costs to maintenance, repair, and management fees.
Financing challenges
Real estate investors often find it challenging to secure funding for investment projects like BRRRR properties through traditional lending options. The nature of BRRRR projects, where acting quickly to acquire a new property and beat out the competition, can make or break a project, making it more difficult to secure financing on short notice.
Facing these challenges is why it’s essential to find a hard money lender who understands your goals and opportunities and can act quickly and easily to provide the capital needed to get to the closing table.
Securing the right financing is a critical component of the BRRRR method, impacting both your ability to act quickly and your investments' overall success. To better understand your options and choose the right loan type to mitigate risks in BRRRR, it's important to familiarize yourself with various loan products and how they can benefit your investment strategy.
Advantages of the BRRRR method for real estate investors
The great news is that the BRRRR method creates several avenues for profit. Whether from recurring income through rent to equity you can leverage, BRRRR success allows you to repeat the process again and again with new properties.
Earn more equity
BRRRR properties are generally purchased below market value because they’re distressed and require considerable renovations to get them rental-ready. Once the property is refurbished, its market value increases, and the accrued equity can be used to purchase a new property or make further investments.
While the equity and rental income aspects are crucial, it's equally important to understand the overall profitability of your BRRRR investments. To gain insights into this, calculate the profitability of your BRRRR investments. This will help you make informed decisions about your investments and ensure they align with your financial goals.
Boost ARV with renovations
ARV (after-repair value) is an essential metric for real estate investors using the BRRRR method. In addition to increasing property value, renovations make a BRRRR property more attractive to renters and allow you to charge market rental rates depending on the property, location, and extent of renovations and amenities.
Hard money lenders also consider the property’s ARV to calculate real estate loan amounts and terms.
Boost cash flow with rental income
Unlike standard fix and flip transactions where the property is sold after the renovation, BRRRR properties allow investors to continue to earn income and increase cash flow through rentals. Maintaining a healthy cash flow is essential to managing your debt load, investing in property renovations and ongoing maintenance, and securing the financing you need from outside investors and lenders.
Leverage equity to buy new properties
The last step in the BRRRR method — repeat — allows investors to jump right back into the market with a new property to renovate and rent by leveraging the equity from the previous property to secure new financing.
Making the most of the rewards
Hard money lenders offer short-term real estate loans designed to meet the needs of investment property owners who need fast closing and cash disbursements. These lenders provide a streamlined application process that factors in the property’s income-generating potential and investor experience for flexible repayment terms like interest-only payments.
Cash-out refinancing and fix and flip loans (also known as bridge loans) can be used for property acquisition and refurbishing costs, making them ideal for BRRRR projects.
Always check out the terms of any loan you choose and conduct a thorough market analysis for each investment to mitigate your risks and secure the best financing options for your needs.