THE BRRRR MODEL: PROS, CONS & WHAT RENTAL INVESTORS SHOULD KNOW
It’s a classic model for buying rental properties: you buy a property in need of repairs, renovate it, rent it out, refinance it for cheaper long-term financing, then rinse and repeat.
Among real estate investors, it’s acronymized to BRRRR. And it can be incredibly effective; I’ve used it myself many times. Sometimes more successfully than others.
What are the advantages? Disadvantages? Risks, rewards, pros, cons… What do real estate investors need to know about the BRRRR strategy of investing in rental properties before laying out thousands of dollars?
Advantage 1: You Get Your Cash Back
One of the great advantages to the BRRRR model is that once the renovations are complete, you can refinance based on the after-repair value (ARV) of the investment property, rather than what you paid for the property.
This means you can not only pull out all the initial cash you put in, but sometimes you can even pull out more cash.
That makes it a lot easier to buy your next rental property!
Advantage 2: You Can Finance the Renovation Costs (Usually in Full)
Most hard money lenders or fix-and-flip lenders will finance 100% of your renovation costs.
That’s the good news. The bad news is that it’s usually reimbursed on a draw schedule. That means you have to put up the initial money for each phase of the renovation, then the lender will reimburse you for the costs of that work.
So, you do need some operating capital, but you don’t have to cover the entire cost of renovating your investment property yourself.
Advantage 3: Forced Appreciation & Equity
Many real estate investors like renovation projects because they can buy at a discount, put in the renovation work, and create “forced appreciation” and equity by improving their investment property.
There’s an elegant simplicity to it: you buy a property for $50,000, spend $25,000 in repairs, and end up with a property worth $100,000.
The numbers are predictable, to an extent. You know your purchase costs, you know your renovation costs (assuming there are no surprises), and you have a strong sense of the ARV (especially with Mashvisor’s market research data!). That doesn’t mean that nothing can go wrong, but it’s far easier to predict the returns on an investment property and renovation project than, say, a stock’s returns.
Advantage 4: The Final Product Is a Long-Term Investment Property in Excellent Condition
When real estate investors finish renovating a property, they know the exact condition of every component in the property.
Because they’ve replaced or updated many of these components, they know they can expect a long lifespan from them. A brand new furnace is far less likely to stop working than a 15-year-old furnace!
Still, real estate investors who follow the BRRRR model should set aside money for capital expenditures, maintenance, and repairs just like any other landlord. There’s nothing worse than a $5,000 repair bill and only $500 in your operating account.
Disadvantage 1: You (Probably) Have Two Rounds of Closing Costs
Notice that the third “R”, which stands for “refinance”?
That means the second round of closing costs with a second lender, who will charge another round of fees, require another round of title work, etc.
In other words, thousands of dollars in fresh fees.
Real estate investors don’t have many ways around this second set of financing costs. A few lenders offer a single loan with two phases: a higher-interest renovation phase, and then a lower-interest long-term renter-occupied phase. When possible, rental investors should use loans like these.
Disadvantage 2: The Temptation to Overleverage
I’ve been guilty of this, early in my real estate investing career.
If you invest $75,000 to buy and renovate an investment property, and a long-term lender offers you $90,000 when you go to refinance, it’s hard to say “No thanks, I’d just like the $75,000.”
Especially when you’re low on cash for your next rental investment property.
But where does that cycle end? It doesn’t – you just end up with a series of overleveraged rental properties with poor cash flow.
When you first buy a property, you buy it with cash flow projections in mind. Honor those original cash flow projections, so that each property in your portfolio generates strong cash flow on its own.
Disadvantage 3: The Rush to Refinance Can Lead to Hasty Leasing
Often long-term lenders like to see a signed lease, with tenants occupying the rental property before settling on the refinance loan.
Even when it’s not driven by the refinance lender, many real estate investors feel so pinched by the high-interest renovation financing that they leap to sign a lease with the first applicant with a pulse and a job.
The quality of landlords’ returns is determined by the quality of their renters. Thorough tenant screening often takes patience and the discipline to say “no”, even with a high monthly payment hanging over their heads.
Disadvantage 4: The Risks Inherent in Relying on a Refinance
What happens if the investment property doesn’t appraise enough to secure the refinance?
Short-term renovation financing is not only expensive, it’s also (ahem) short-term. Real estate investors can find themselves in hot water if their renovation loan comes due, but no long-term financing is forthcoming.
Some lenders impose seasoning requirements or other requirements that the rental investor may not have anticipated. Fortunately, it’s easier than ever to secure long-term financing as a real estate investor, with the rise of online investment property lenders.
The Bottom Line on BRRRR
The buy, renovate, rent, refinance, repeat model is a classic for a reason: it works. But that doesn’t mean it’s without its drawbacks.
Double-check that your short-term renovation lender will allow you to use the contractor you have in mind for the project. They may need to be licensed, insured, bonded, or meet some other requirement.
If the project requires permits, make sure you’re comfortable with the process of pulling them. Budget extra time and money for each permit – dealing with local zoning and permitting board is usually more trouble than most new real estate investors realize.
The earlier in the renovation process that you can start showing the rental property and collecting rental applications, the better. Remember, every month that goes by, you’ll incur hefty carrying costs!
Most of all, make sure the numbers work, even with a buffer for unexpected expenses. Use our rental market data to ensure you’re getting a good deal on your purchase. Just as important, triple check the expected after-repair rents, so your cash flow projections will be accurate.
While you’re at it, make sure you’re confident in the investment property’s after-repair value. Your long-term financing depends on it!
If you’re a new real estate investor, consider lighter, cosmetic updates for your first couple of deals. Full renovations have the potential for better equity but also come with more opportunities for something to go awry.