Welcome to Everything About Wealth podcast 6, What Investors Should Know About BRRR Investing!
On this episode Denny and I will be going over the BRRR investment strategy. The BRRR strategy has been gaining traction in the real estate industry so we want to make sure you are in the loop.
So, what does BRRR stand for? It stands for Buy, Repair, Refinance, and Repeat.
Here is a simple example. For an active investor, an investor buys a property for $100,000. The property needs $25,000 in renovations. The market value of the property is $200,000 after renovating it. Once the property has been renovated, the investor refinances the property at 75% of the value. Meaning they get a new loan for $150,000 more or less and receives $25,000 in cash (not including closing costs). The investor keeps the original property and uses the additional funds to purchase another investment property to repeat the process. The original property the investor refinanced produces $250 cash flow and now a second property he/she purchases produces another $250, adding a total of $500 to their pocket on a monthly basis.
Purchase - $100,000
Renovations - $25,000
Total Costs - $125,000
New Loan - $150,000
Total Costs - $125,000
Cash after Refinance $25,000 (Closing Costs not Included)
As a capital investor, there are a couple of ways to be involved with the BRRR strategy. First, he/she may act as private lenders to lend money to active investors who are implementing the BRRR strategy and will be refinancing the capital investor out with a traditional loan. Let's say an investor contacts you about a single-family home they want to buy for a $100,000 plus $20,000 for repairs, but the property after repair value is $200,000. A capital investor may lend the investor $100,000-$120,000 with an interest rate around 12% and maybe even some points. The agreement was for six months which means after that the buyer will need to refinance or sell the property within that time to pay off the private lender.
If you choose this strategy, be sure to analyze the deal property to ensure the numbers make sense by reviewing comparable properties sold in the area. The terms of the loan should be competitive in the market to make sure you find enough lending options as a lender and the investors you lend to will be successful. Additionally, verify the investor can refinance the property with a prequalification from the bank of their choice. Lastly, consult professionals such as accountants and attorneys to verify how to structure the business the right way. There are new rules capital investors lending their funds to investors must follow — be sure to follow them to stay in compliant.
A popular way capital investor uses this strategy are with commercial real estate properties using partnerships. Typically, with commercial real estate properties a capital investor will partner or do a joint venture with a sponsor to purchase a property. They are also known as a syndicator in commercial real estate. Instead of charging an interest rate and points, the capital investor will be part of the company ownership. Ownership is typically held in Limited Liability Companies. The capital investor will receive part of the monthly cash flow and profits at the sale of the property. This is how our own business model is structured for buying and selling apartment buildings with capital partners. This is called syndication. Basically, it is when a group of people put their resources together to achieve a common goal. The goal in this case is buying an apartment building investment and the resource is capital. In this arrangement, we would be considered the sponsor. The sponsor is like a conductor of an orchestra, their job is to create great music by managing all the musicians. The musicians would be acquisitions, investors, property and asset management, due diligence, reporting and more. Our great music would be a successful investment that meets projected investor returns.
As the sponsor, we manage the asset of the property ensuring the property managers are handling the day to day operations of the property efficiently and making sure any renovation projects are on time and under budget. Additionally, the sponsor sends monthly reports to capital partners with updates on property’s operations and handles the future disposition of the property. The capital investor for the most part is passive, just reviewing the monthly reports and being present at quarterly conference calls with the sponsor. And of course, receiving their distribution checks.
In commercial real estate, the sponsor will perform similar duties as the investor of a residential home, in the sense of renovating the property as needed for a sale or refinance depending on the structure of the investment. If the property plan is to stay within the portfolio, the syndicator will refinance the property when necessary. The funds from the refinance will be used to first pay back funds from the initial investment and then split any remaining funds among the partners. Partners can then use their funds to buy another property and repeat the process over and over again.
One of the benefits of owning commercial real estate with this strategy is continued depreciation. This allows a capital investor to reduce their taxable income while they still own the property. In addition, both investors and sponsors will have extra capital to invest in other deals to build additional income opportunities.
Now, let’s cover some items to decide if the refinancing part of BRRR will be the best strategy for your deal. One of the most important items to look out for is over leveraging the property. That means refinancing the property at a loan to value rate in which the property can continue to operate efficiently. A good rule of thumb is to refinance at around 70% of the property’s value. Remember, in these examples when an investor refinances a property, the loan amount is now higher than before which means the cash flow will typically be lower. Not all properties can support a refinance due to the drop-in cash flow.
As with any partnership, it will be a good decision to discuss the refinance of the property with all partners in the deal to ensure everyone is on-board with the decisions. As the capital investor, it will be a good idea to ask for the projected numbers of the property after it has been refinanced to ensure the numbers make sense. Just because the syndicate says it’s going to be a good deal, it doesn’t mean turn a blind eye.
Many investors inquire why an investor would implement the BRRR strategy instead of selling the property? This is a great question. One of the main reasons an investor implements this strategy is to own a passive income stream. Most people are buying properties to increase their income without having to work as many hours — thus the term passive income. Another reason is investors want to maintain diversification in their portfolios to reduce risk. When one investment is down, the other is up and vice versa. This creates a healthy average return over time. Experts recommend investing 20% of your funds in real estate. Lastly, everyone has different goals. One investor may want a return on their money within a short timeframe such as 6 months and go on to the next deal. While another investor would want a deal with a longer timeframe of 10 years. This will prevent the required search of a new deal which takes considerable time especially in the current market.
We have been implementing BRRR in our investment strategy and this is how it has worked for us.
The first multifamily property we purchased with capital partners was a 24-unit apartment building in Florida. If you have been following us online or taken our courses, you may have heard about this investment. We completed a value-add strategy with this property which means, an investor adds value to the property by either increasing the income or reducing the expenses. We purchased the property with high expenses which ate up about 50% of the operating income. This was a bit high for the condition and age of the property. So, we found ways to decrease expenses to around 40%. We also found ways to increase the income by 10%. In return, the net operating income increased by 20% or $60,000 a year.
We decided to follow BRRR and refinance the property, we got a loan for 70% of the value to keep the loan-to-value low. At refinance, we were able to take out close to $300,000 in cash from the property. At the initial purchase of the property, the capital investors and ourselves originally invested $192,000. So, all of us got our money back that we invested and then we were able to distribute another $100,000 or so as additional profits. Using the Repeat part of BRRR we used those funds to invest into other apartment buildings as well as to complete certain updates at the property.
Remember the following items when using BRRR. One, consider the amount of loan to value ratio to use when you're refinancing a property to avoid overleveraging the property. Two, make sure to keep the capital reserve account funded with enough money for short term and long-term repairs and updates to keep the property competitive. Three, as a capital investor be sure to understand the fundamentals of any deals prior to investing to be sure your projected target returns are met. Four, BRRR includes an invisible R that you must learn about— it stands for rent. The true acronym looks like this BRRRR - Buy Repair Rent Refinance Repeat. This is may apply for single family homes and commercial properties. We will discuss rent as its own topic on a future podcast.
All information is for educational purposes only. We recommend hiring professionals prior to making any investment decision.
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