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Many investors have fast-tracked their real estate business with the BRRRR real estate strategy. BRRRR stands for buy, rehab, rent, refinance, repeat, and it is a great way for investors to earn passive income. It’s a method by which real estate investors buy distressed properties, but the difference is the intention to keep them as rental properties instead of selling them.

In BRRRR real estate investing, the property is treated like a fix-and-flip, using short-term financing such as private money, hard money, a home equity loan, or cash to acquire and rehab. Then, after the property has been finished, it is rented out to a tenant instead of sold. The owner then obtains a refinance on the property to pay off the short-term loan and turn the property into a stable, long-term, cash-flow-positive property that continues to build equity. And then, the investor does the whole process over again with a new property.

In a nutshell, this is how it works.

1. The investor looks for and purchases a distressed property with potential.
2. The investor fixes up the property, building its equity.
3. The investor finds a tenant for the property.
4. The investor secures a loan to cover the purchase price and rehab cost.
5. The investor finds another property and builds wealth.

Of course, as with all investments, the math has to work for the strategy to work, and there are many BRRRR pros and cons to consider. When a person goes to refinance such a property, a bank will typically only refinance up to 75% of the new value. Therefore, for an investor to get enough to refinance the entire short-term loan and possibly recoup the rehab money, the property needs to be worth significantly more than what it was purchased for.

For example, let’s say a property sells for $100,000. The property needs a $25,000 rehab to be rent-ready, for a total cost of $125,000. An investor could use a short-term loan to buy the property (like hard money) and their own cash to rehab the place. Then, they would refinance the property with a new loan from a lender. If the new lender’s appraisal came in at $160,000, the bank might give 75% of that amount in a new loan, which is $120,000. This would pay back the investor’s entire short-term loan and most of the rehab cost. The big bonus is that the investor now has a stable, long-term rental property with $40,000 of equity at the start.

Of course, this example only works if the after repair value (ARV) comes out at the $160,000 level. It wouldn’t be as nice if the ARV were to come in at $100,000, and the bank would only loan for $75,000—not even enough to pay back the short-term loan. This is where the math has to work for the strategy to work.

Let’s summarize some of the BRRRR pros and cons.

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Pros to the BRRRR method

Potentially no money down

The BRRRR method is one of my favorite strategies for investing without needing a lot of cash. If the numbers work out right, an investor could get into a deal for very little money out of pocket. Of course, the better the deal, the less money will ultimately need to be provided. And some investors have figured out a way to do this without using their own personal cash!

High return on investment (ROI)

Because of the low out-of-pocket cash needed for this strategy to work, the ROI should be astronomical. In other words, if the investor ends up having only $10,000 in the deal, but the cash flow is $2,500 per year, that’s a 25 percent cash-on-cash return, and that doesn’t account for all the equity built during the rehab stage. And as long as the investor owns the property, the ROI could be infinite!

Equity

BRRRR real estate investing allows investors to build some serious equity right off the bat. Rather than owning a rental property worth what was paid for it, wouldn’t it be better to own one with $40,000 of equity?

Renting a rehabbed property

After the full rehab has been done and the property is rented, the investor owns and leases a property in Class A condition.

A property can bring in more rent if rehabbed, even if it’s an older building. For example, in Lufkin, Texas, two properties are worth $93,000. Property A was built in 1949, but it has a higher rental rate; the tenants pay $1,000 monthly since it has been updated. Though built in 1956, Property B has a lower rate of $750 monthly since the property hasn’t been recently renovated.

Aside from a higher rental rate, a rehabbed property can be rented out faster and attract better tenants. It also reduces the maintenance budget on the property, making landlording even more hassle-free.

Fast-track scalability

After that first house, it’s easy to use the BRRRR method as an investment strategy. The investor already knows the drill and can easily go through the steps to build their portfolio of properties. Of course, investors need to do their part and find a great property, make a budget that covers everything, get through the project, and find the right financing. The BRRRR model is no walk in the park, but it can work very well under the right circumstances.

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Cons to the BRRRR method

Short-term loan

The short-term loan needed initially can be expensive with high interest rates, especially if it is a hard money loan. Also, the short term on these loans can make the carrying costs expensive, possibly resulting in negative cash flow during the time the investor is paying on the loan. For this reason, many people use a home equity loan or cash to fund the first phase of the project, then refinance to get their cash back so they can rinse and repeat.

Over budget

When making the budget, investors need to identify which parts of the property need to be fixed. The first thing to consider is what is needed to make the house livable and functional before upgrades that add value to the property. But the project could easily go over budget with unexpected expenses and necessary repairs that can lead to a longer rehab time. Many factors can cause setbacks, so investors need to anticipate as much as possible at the beginning when they are putting together the budget.

Low appraisal

If the home doesn’t get a high enough appraisal after the rehab, it will be a big headache for the investor. A bad appraisal is a worst-case scenario for a BRRRR property. This is why coming up with the correct math and budget going into the deal is imperative.

Seasoning

The refinancing bank will likely require the investor to wait six months or maybe even 12 months after the original purchase before they will refinance the property. This period of time is known as “seasoning,” and most conventional and portfolio lenders require it. If the end-lender requires a 12-month waiting period, and the short-term loan is only good for nine months, that will be a problem.

Therefore, when I use this hybrid real estate investing strategy, I try to make sure my short-term loan is for no less than 18 months. This gives me the time I need to refinance, and if something goes wrong after month 12 and the refinance won’t work, I still have six months to sell the property or hunt for a new refinance.

Two potential closing costs

The BRRRR method usually involves two loans—one at the beginning when the property is purchased and another when the property is refinanced. Of course, each transaction comes with its own set of fees and financing costs. There are lenders out there who will finance the whole project with higher fees at purchasing and lower fees for the refinancing stage. Investors need to do their due diligence when finding the right lenders for the project and shop around.

Problems at the rental stage

The clock is ticking, and investors are often in a rush to get a property rented out. Aside from the investor’s need to start earning money on the rental property, having tenants is usually a requirement for refinancing. Lenders like to see that the property has tenants and will be a safe bet for the loan.

But rushing through finding a tenant and acting hastily may prove to be unwise for investors. Investors need to thoroughly vet the tenant first—get their credit report, do a background check, even ask for references. After all, they will have to deal with the tenant and rely on them for their income for a number of years.

Dealing with a rehab

Finally, the biggest part of the BRRRR strategy is dealing with the complications of a large rehab project. Rehabbing a property is not easy. It’s no fun dealing with contractors, unknown problems, mold, asbestos, theft, and the rest of the headaches that come with a rehab.

BRRRR real estate investing can be a powerful way to build wealth through real estate and is one of my all-time favorite strategies. Capitalizing on the forced appreciation the way a house flipper would while acquiring a great rental property that will provide years of cash flow and passive income is truly getting the best of both worlds. However, the strategy is not a simple undertaking, and there are numerous BRRRR pros and cons to consider. It requires exquisite math, planning, and the ability to find a great deal. But for those willing to take on the challenge, BRRRR real estate investing can supercharge a business and set investors on a path to great success.

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.