The Empire Goes BRRRR
Christopher Shank NMLS 2562885
I witnessed quite the real estate survival story earlier this month and, with the subject’s permission, I am now going to share it (with some details obscured for privacy concerns).
Bob is not your traditional fix and flipper. After spending half a decade as a drone operator, Bob loaded up on some IT certifications and is currently making every one of his friends jealous when they learn how many digits his salary is comprised of.
Anyway, a few months ago, Bob made friends with a real estate agent who specializes in identifying prime investment properties. After a decent search, he was made aware of a property set to go into foreclosure and, at the advice of his realtor, he offered to buy the homeowner out of their mortgage, an offer that he was readily taken up on.
Now, the home wasn’t in the best shape, but when you accept the fact that Bob purchased it essentially on clearance, there’s not too much to complain about. Over the next two months, Bob immersed himself into the world of real estate investing, making friends with contractors, and pumping about 20% of the home’s worth into it in the form of an updated kitchen, new carpets, a couple of renovated bathrooms, and a whole new coat of paint.
Two months ago, Bob had his property reappraised and was stunned. Because of how property values in Clarksville have risen over the years, despite pumping a mid-size SUV’s worth of cash into this house, he was still looking at doubling his total investment in his first foray into the world of real estate investing.
There was only one problem- he couldn’t liquidate his investment. As I mentioned before, this summer was quite the opportunity for investors. Slow market conditions put stress on sellers, many of which took deals under asking price simply to offload a property that was slow to sell. Many investors, such as Bob, found properties at fantastic discount. Unfortunately, as the summer wore on, even though the rates did gradually drop, there wasn’t enough of a buyer pool to tip the scales in Bob’s favor. Case in point- of the two months that his property was on the market, the only purchase offers he received were from other investors, and those were low-ball offers similar to the one he had made to snag his property in the first place.
Finally, after doing some research online, Bob decided to attack his problem another way. Instead of trying to liquidate his rehabilitated property for an immediate cash return, he put it on the market as a rental. Then, he refinanced his property as a DSCR, pulling out enough equity to cover the down payments on two more investment properties, one of which already had a paying tenant occupying it!
I love this story because it provided me with the perfect example to write about one of my favorite real estate investing concepts, the B-R-R-R-R process, otherwise known as Buy, Renovate, Rent, Refinance, Repeat. As an added benefit, Bob’s story gave me the perfect excuse to pay homage to one of my favorite memes, which, if I’m being honest, motivates me a lot more than I’d normally give it credit.
Who goes BRRRR?
If we were to sort your traditional real estate investors into two groups, those groups would be short-term and long-term investors.
Short-term investors are your fix and flippers and ground up construction gurus. These types of investors operate on tight margins to maximize the profit they earn at a single point – the sale of a property. I’m working with a few of these clients at the moment, and right before I wrote this article, I had a meeting with one of them to discuss the profitability of a particular venture. The math was pretty simple (it was all subtraction); at the top of the equation, my client put what he planned to sell his particular fix and flip for. Subtracted from this was the price he could buy the property for in an off-market deal. Additionally on the list of subtractions was the cost of materials that would go into the rehab (new appliances, paint, carpet, etc.), the cost of labor, interest on his short term loan, etc.
Now, don’t get me wrong – this guy is going to be making a fair profit when all is said and done, but should things go awry during the fix and flip process (for example, a lumber shortage a la 2022), that profit margin will get thinner and thinner until he’s invested more into the property than he can expect to get back when said property is liquidating. Done properly, I’ve seen a fair number of short term investors complete several of these projects over the course of a year.
On the flip side, you have your long-term investors. Like the short-term investors mentioned above, long-term investors are comprised of property rehabilitators and even a few builders. The big difference, however, lies in the fact that long-term investors aim to retain their investment properties for years before liquidating them, if they end up selling at all.
Long-term investors are certainly sensitive to the margins on their properties, but as there is no immediate cash influx from the sale of the property (at least, not in the sense of an impending property liquidation), they understand that their investments may take time to become realized.
The draw of long-term investing comes from the idea of stacking residual income in the form of rent. While it is by no means an industry standard, most of the long-term investors that I work with do not expect to see a return on investment on the average property for the first three to five years.
Now, that’s not to say that there isn’t any money in long-term investing. Actually, far from it; like every other investing methodology, however, you need to ensure that you properly understand the logic behind your particular strategy.
B-R-R-R-R – More than a Meme
As I mentioned above, BRRRR stands for the process of buying a (oftentimes depreciated) property, renovating it to bring it up to current market value, renting it out to generate passive income, refinancing it to liquidate the equity you’ve built into said property, and repeating as needed.
In Bob’s example above, he embodied the BRRRR methodology by-
- Purchasing a house under market value.
- Renovating it to a standard comparable to other houses on the market.
- Finding a tenant to live inside said house.
- Refinancing the house, establishing a mortgage that is paid with proceeds from the rent collected in the previous step.
- Repeating this process by leveraging the liquid equity tapped in the previous step to finance the acquisition of two additional rental properties.
Personally, I love this investment strategy. Bob’s goal (and the goal of every true BRRRR’er) is to charge a rent that is, at minimum, able to completely cover the expense of that structure’s financing. This way, at absolute worst, the property is gaining a trickle of equity each time that mortgage bill is paid, and an extra bit of equity each time the property assessor confirms that the property has increased in value. Eventually, one of two things happens. If the property is paid off in its entirety, it is still an income-generating asset that can be liquidated for a substantial influx of cash. On the other hand, once enough equity is built up, secondary financing such as a HELOC or a second mortgage can be used to tap that equity and start the cycle over once more on a different property.
Can you go BRRRR?
If you’ve read any of the articles I’ve published so far, you know that I believe it in my heart that anybody, given enough support and dedication, can use real estate investing to generate a lasting income for themselves and their family.
I also believe that real estate investing is a serious business. Take the above method- you’re not only playing around with staggering amounts of cash, you’re also embarking on the journey to become someone’s landlord. If you err, you’re not only hurting your family’s financial future, you’re also putting your tenant(s) in a bad spot.
That said, I encourage you, dear reader, should you find yourself contemplating becoming an empire builder, to find yourself a trusted mentor, be they an experienced realtor, trusted Mortgage Advocate, or even a really awesome financial advisor (or heck- why not all three?). Whoever you do decide to surround yourself with, study extensively upon different investment methodologies and decide what kind of empire you want to run. As the rise and fall of civilizations have proven century after century – only those empires founded on strong foundations survive the test of time.
