BRRR or “Buy, Renovate, Rent and Refinance (and sometimes Repeat)” is a real estate investing strategy that has increased in popularity over the last ten years.
The strategy is “sold” as a way for investors to recapture their down payment to purchase additional properties and to build a bigger real estate portfolio faster.
How the BRRR Real Estate Investment Strategy Works in Theory
The B, Buy a Property With Potential
Buy a rental property that is in need of renovations or has a value add potential (IE add a basement suite) – You purchase a property for $250,000
The First R, Renovate the Property
Renovate the property – You spend $75,000 renovating the property to add a basement suite to the property for a total cost of $325,000, $75,000 and $250,000.
The Second R, Rent the Property you Purchased
Rent the property – You now rent the property for $1500 for the main unit and $1000 for the basement suite. A total of $2500 in rental income.
The Third R, Refinance your New Rental Property
Refinance the property – You appraise the property for $425,000 and secure a mortgage for $340,000.
The Fourth R, Repeat the BRRR Process
Repeat the process – If you bought the property for $250,000, spend $75,000 in renovations and end up with a mortgage for $340,000 you would end up with no money in the deal.
This would then allow you to take your original funds and purchase another rental to repeat the process. (Total cost is $250,000+$75,000 = $325,000 and total mortgage is $340,000) Net gain of $15,000 and no more money in the deal.
Now you might be thinking “Keaton, that sounds great, how do I do this?”
Well I have bad news for you. Above is how the strategy is often “presented or sold”. I am here to break down the reality of the numbers and the challenges you will face. (BRRR’s can be great but they often do not work out as perfectly or simply as they are presented).
What to Look Out For In BRRR Real Estate Investments
Here are six things you need to look out for, the last one is where most investors get caught.
1) Are your Costs Accurate?
In the example above the numbers were missing nearly $10,000 in costs such as carrying costs (utilities, mortgage payments and insurance), closing costs (appraisal and legal fees) and potentially mortgage penalties (there are ways to avoid mortgage penalties but they require upfront planning).
2) Can you Actually Refinance?
Some lenders will not allow you to refinance a property until you have owned the property for at least one year. Always wise to check in with your mortgage broker for this reason alone.
3) How are you Paying for the Renovations?
If you are borrowing on credits cards or personal lines of credit (this also relates to the last and most important point) you need to know that $13,000 of unsecured debt consumes the same borrowing power as a $100,000 mortgage.
Likely you will need to have the refinance proceeds (from the BRRR) pay down these renovation debts.
BEWARE many lenders will require you to close any unsecured debts you pay out with a refinance.
4) Do you Need Rental Income to Qualify?
Many investors want to refinance the property as soon as they are done renovating (before securing tenants) to minimize carrying costs and to speed up the process.
A few things you need to know – if you are relying on a “Market Rents Appraisal” appraisers will no longer provide market rents for illegal/unauthorized suites (they also contact the city to inquire if its legal which could put the city onto investigating your non authorized suites).
One of the major banks in Canada will not consider market rents on a refinance and for any bank to recognize a lease they also require three months rent deposits to support the lease. This could delay your refinance 3-5 months and cost you thousands!
5) Trapped Equity
If the same appraiser is used for the purchase and the refinance you may only be able to pull out your cost (rather than your sweat equity).
This could result in thousands of trapped equity. This can also happen if your refinance happens too quickly after the purchase. Lenders can ask for a breakdown of your costs and lend based on the lower of appraised value/total cost.
Each lender will have a different policy on how long before they will refinance the market value.
6) Will your Strategy Drop your Credit Score by 150 Points Right Before you Refinance?
If you use unsecured debt to cover your renovation costs your credit utilization will be very high. Never heard of credit utilization? It makes up 25% of your total credit score and any revolving balance (credit card or line of credit) that reports over 40% of the limit will start dragging your credit score down. We explored your credit score in more detail in an earlier blog. Often below the minimize credit thresholds to refinance.
This is the number one trap that catches real estate investors using the BRRR strategy. You need to refinance to pay off the debts, you can’t refinance due to low credit score because of the debts. Next thing you know you are refinancing using a private lender at 14% interest with thousands in fees.
There is good news, every single one of these challenges can be completely avoided with the correct planning. All it takes is someone who is experienced with both the lending environment and real estate investing world, as well as experience in costing out renovations.
Over the last eight years I have invested in multiple BRRR projects (as joint ventures in a corporate structure), worked with and spoken at dozens of real estate investing groups and ran one of the top real estate investing focused mortgage teams in Canada.
If you are considering a BRRR, or maybe you belong to realtor or investor groups that periodically send you these opportunities, please reach out to me and I can help you plan out what this strategy would look like for you with those specific properties in mind.