How BRRRR Increases Your ROI (and Why You Should Be Using It)
If you spend any significant period of time on BiggerPockets, you’ve no doubt heard of the BRRRR strategy to investing. If you aren’t quite sure what it means, that’s OK. It’s an odd name, created by the infamous Brandon Turner, to describe a method of buying an investment property, fixing it up, and then refinancing it instead of selling it.
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In spite of his gigantic frame, Brandon is actually a pretty smart guy. He’s come up with a signature term to help describe an investment method that’s been in place forever. Thanks to Brandon’s clever marketing, more people have become familiar with what is, in my opinion, the best way there is to buy rental property. BRRRR allows you to increase your ROI in big ways while also preserving your capital. For those of you unfamiliar with the method, follow along and I’ll explain how it works.
BRRRR stands for: Buy, Rehab, Rent, Refinance, Repeat.
It is a method of acquiring an asset, improving it’s value, stabilizing it, then pulling your money out on a loan. While most investors tend to take out a loan when buying a property, experienced ones know this isn't the most efficient way to do so.
Consider this: if your crush asked for a picture of you, would you take the picture, send it, then put on your makeup and fix your hair? Of course not. You would want to look your very best before you presented yourself to the person you wanted to impress.
Real estate investing works that way too. Before you go to the bank to ask for a loan, you want your property in it's best condition, so that t's worth it's absolute most. Taking out the loan and then fixing it up afterward is like taking and sending the picture before you look your best. This post should help you understand why this matters, how it helps your bottom line, and why the best investors all understand this.
(If you’re doing this for your Instagram, you’d better be doing it for your business!)
How To Calculate ROI
ROI (return on investment) is the rate of return you can expect on your investment. When someone claims they earned a 10 percent return on their investment, they are usually referring to ROI. In real estate, we also refer to this as “cash on cash.”
Brace yourself, I’m about to introduce a little math (I’ll keep it brief). To calculate ROI, you take your yearly profit and divide it by the amount you’ve invested.
For real estate, you would take your monthly cash flow, multiply it by 12 (to convert it to yearly profit), then divide by your down payment.
(Cash flow x 12) % (down payment)
That’s it. It’s really simple. Two different numbers in the formula, both very basic. It’s important to understand this because our goal as investors is to both increase our ROI. If you don’t understand something, you can’t improve it. This is why we say knowledge is power.
How To Increase ROI
It’s not enough to just understand ROI. We want to improve it! Because there are two numbers involved in the equation, there are two ways to increase your ROI (yearly profit and the down payment). Knowing how to manipulate these numbers gives us the power to control our ROI.
The first way to increase ROI is by increasing the yearly profit. This is also the method most people focus on, because it’s easier to control. If you think about it, once you’ve put a down payment on a property, it’s hard to get that money back. It’s much easier to make the property more profitable, so that’s what most people will work on.
There are several ways to increase the yearly profit. The obvious ones are to raise rents or decrease expenses. Learning to do these are fundamental to becoming a good real estate investor. Because rents usually rise faster than expenses do every year, it’s not uncommon to see your ROI improve as time passes. Most investors expect this and underwrite it into their pro forma.
The other (and less common) method of increasing ROI is to decrease your down payment. This will be what we focus on in this blog post.
How Loans Work
Most people consider a down payment to be a “fixed cost,” meaning, it can’t be reduced. The bank requires a down payment of 20-25% for most investor loans, and there’s nothing that can be done about that.
This is because most people don't understand that you don't have to get the loan when you're buying the house.
By becoming a student of real estate investing, you learn the down payment exists so the lender ensures it isn’t funding 100 percent of the asset’s value. This is how they protect their investment. The lender will let you borrow a portion of the asset’s overall value. If we can buy a property, then increase it’s value, we can borrow more money than we’d be able to when the asset wasn’t worth as much.
You buy the property with a loan. A bank is offering a 75 percent LTV. Your property is worth $100,000 in it’s present condition. The bank will let you borrow $75,000. This means a down payment of $25,000. You spend $20,000 on the rehab, and your house is now worth $150,000. You added $30,000 of equity to the property after rehab, and you left $45,000 of your money in the investment ($25,000 down + $20,000 rehab).
You buy the property with cash for $100,000. Then you spend $20,000 on the rehab, increasing its value to $150,000. The bank will allow you to borrow 75 percent of the home's new value, which means you can borrow $112,500. This means you left $7,500 in the deal ($120,000 (purchase and rehab) â $112,500 (recovered on the loan refi)).
That means $37,500 more in your pocket, folks. All because you BRRRR’d.
Why BRRRR Is So Efficient
I need to clarify something before I continue. Thus far, we have been calling the amount of money we invest the “down payment,” but that’s a little misleading. I’m only calling it that because most properties are purchased that way. To be more precise, the amount of money left in a property that you’ve invested in isn’t always the down payment. It can be money you left in the deal after you refinance, too. Basically, as long as it’s capital you didn’t get back, we will refer to it as the “down payment.”
BRRRR works so well because (when done correctly) it reduces the amount of money you leave in a deal. When buying a property with a loan, the bank will lend against the value of the home at the time of the loan. When taking a loan out against a property after it's been fixed up (and it's value is increased), the bank will let you borrow against the new, higher value.
Buying a property under value, making it more valuable, then taking your money out is a much better way to lower the amount of money you have left in a deal, and therefore increase your ROI.
Remember how in the above example we ended up with more in our pocket if we BRRRR’d? We only left $7,500 in the property. Compare that to the $45,000 we left in by using the traditional down payment model. To put this in context, let’s plug these numbers into the ROI formula. (Option two will have slightly less cash flow because we borrowed more against the property, so our mortgage is higher).
(Cash flow of $500 x 12 = $6,000) % (down payment – $45,000) = 13.3% ROI
(Cash flow of $310 x 12 = $3,720) % (down payment – $7,500) = 49.6% ROI
In option two, we used a 4.5 percent interest rate on the additional loan balance of $37,500, which reduced our cash flow by $190 a month.
If you are stuck considering only cash flow, borrowing the additional money would seem unwise. If you’re focusing on ROI, however, it’s very apparent a nearly 50 percent ROI is much better than a 13.3 percent.
Even though our cash flow decreased by a whopping 38 percent in option two, our ROI still skyrocketed. Why?
Because leaving less money in a deal has a bigger affect on ROI than just increasing cash flow.
Why Most Investors Don’t BRRRR
This seems like a no brainer, right? Why isn’t everyone doing this?
Well there are a few good reasons that deserve to be mentioned.
It takes time to save up the money for a property. It takes even more time to save up all of it. Some people don’t want to wait to start buying, others just don’t believe they can ever save up enough money to buy a place with cash.
There are many articles written on borrowing money from family or friends, getting hard money loans as bridge loans, etc. I would encourage everyone to look into their options in order to buy and rehab a place with all cash.
I know this well, because I used to be this guy. Working my butt off to save every dime I could, and buying three houses a year. It seemed impossible to scale, because I was dropping large amounts of cash as the down payment and then spending large amounts of cash on the rehabs. Once I started to BRRRR, I stopped buying three houses a year and started buying three houses at a time.
The process can be unfamiliar for some, and requires learning some new requirements. For one, banks won’t always allow you to refinance a place you bought with cash until a few months have passed. This throws some people off. Secondly, BRRRR works best when you buy something significantly under value that often needs major rehab work. This can intimidate some investors. Third, BRRRR requires you to do a little more work on the front end in order to determine a property’s ARV. Investing is much simpler when you’re just buying something at market price. It gets more tricky when you’re trying to gauge the moving target of a properties ARV.
Many people don't realize you can actually get a loan for a property after you own it. Because it is so ingrained in our minds that we get loans in order to buy something, we assume that’s the only way to do it.
Lenders don't usually care if you already own something or are just buying it. They only care what the loan-to-value ratio is. When we borrow money and make a "down payment," we aren't giving that money to the lender. We are giving it to the seller, so that the lender doesn't have to. From a lender's perspective, the less money they have to give you in order to buy something, the better. It makes sense.
If you ask me to borrow $50 to buy a pair of Air Jordans and promise to pay me back with interest, the first question I may ask is what the interest rate is. But that wouldn’t be the wisest.
The first question I should ask is, “How much are the shoes worth?”
If you are borrowing $50 to buy a $50 pair of shoes, I’m in trouble if you don’t pay me back. By the time I’ve confiscated the shoes as collateral, you’ve worn them and they’re worth less than $50. That means I won’t be getting my investment back. However, if the shoes are worth $150, (and you put the other $100 “down”), I could still confiscate the shoes and sell them for a decent profit, regaining my investment.
The amount of money you borrow verse the value of the asset you are borrowing for is referred to as the LTV. The LTV is one of the things the bank considers when deciding if the loan will be risky or not. The bank (or lender) doesn't care if you don't own the asset yet, or if you have already owned it. They just want to know that you're borrowing less than what it's worth.
Once you understand this, it makes sense why we BRRRR. Why borrow against the value of an asset (the house) before it’s been rehabbed, when we can wait until after it’s rehabbed and worth more? When it’s worth more, we can get more money back out.
This is what increases our ROI.
Why The Best BRRRR
The best investors are looking to do several things with their portfolio:
- They want to add as much equity as possible
- They want to increase the “velocity” of their money
- They want to increase their ROI as much as possible
- They want to buy deals others can’t buy
- They want to capitalize on using OPM (other people’s money)
Wealth is built fastest by increasing the value of an asset. Period. Whether it’s rehabbing a house or turning around a failing business, the best wealth builders are looking for opportunity to add value. When talking about real estate, that means adding equity through buying right and rehabbing right.
BRRRR incentivizes you to add as much value as possible before you refi so you can recapture as much equity as possible. There is really no reason to do it if you aren’t adding value to the property. The best understand this and it’s one of the reasons they love to BRRRR.
Increase Velocity Of Money
The velocity of money is the rate at which you can buy something with it, make a return, recapture that capital, and then increase it by buying something else. If you are able to add $30,000 in equity to every property you buy, you obviously want to buy property as quickly as possible. The faster your velocity of money, the more equity you can build in a shorter period of time. This adds up to really, really big returns over significant periods of time.
When you BRRRR, it allows you to build equity and also get your money back out. The more money you get back out, the more you have to invest in the next deal. If spending $120,000 on a property nets you $30,000 in equity each time, you want to get as much of that $120,000 back as possible to invest in the next deal. BRRRR makes this much, much easier.
As we’ve already discussed, a successful BRRRR can have a ridiculous impact on your ROI. While beginners focus on improving their cash flow to improve their ROI, experienced investors and wealth builders limit the amount of money they have left in the deal to do so.
Now, it’s also important to be sure the property still cash flows once you pull your money out of it. Keep in mind that the more you finance, the less money you keep in the deal, but the higher your debt service becomes. For me, I need a deal with enough meat on the bone that I can recover 100 percent of my capital and still cash flow positively. I’m not advocating you lose money every month just to get your cash out. For the majority of investors, that is a bad idea.
BRRRR is a great strategy because it allows you to recover your capital and increase your ROI. The more you can buy, the higher your ROI, and the more equity you can capture or build, the faster your new worth will grow.
Buy What Others Can’t
When you’re buying something that needs major rehab work with all cash (the best way to buy something with the BRRRR strategy), you can buy houses other investors cannot. This reduces your competition and strengthens your position when negotiating for a low purchase price.
I purposely target houses that will not qualify for conventional financing. If the house needs a new roof, is missing appliances, has drywall ripped out, etc. I know the majority of my competition won’t be able to buy it because a lender cannot underwrite it.
This removes the majority of other buyers and makes my all-cash offer that much more appealing to the sellers. I’m able to buy what other investors and primary home buyers cannot.
Looking for strategies like this is how you can find success in “hot” markets when there is “nothing to buy.” Establishing partnerships with others to pool your money can give you a big advantage when you can buy properties others cannot.
OPM, or other people’s money, is one of the core tenants of successful full-time investors. Having money is great. Using OPM is even better.
OPM provides the ultimate leverage. It opens doors you couldn’t walk through without it. It cuts down on the amount of time you have to wait before you can scale up your investing. It allows you to get in the game sooner, and bigger, so you learn faster, and more often. OPM provides you the boost to go to a professional level, quick.
In real estate investing, it’s what and who you know that determines what you make. The more you learn, and the more connections you make, the quicker you’ll find success. The best investors use OPM, and the experience it helps them gain is what drives them from beginner level to expert. The best BRRRR, and they use OPM to do so.
If you want to BRRRR but you don’t have the funds yet, this can force you to start working on how to use OPM, which is another great investing strategy. Developing these skills, while painful and frustrating at first, produces huge dividends in the end.
Are you interested in real estate investing but there is nothing to buy that makes sense where you live? Are you tired of seeing the amazing success of others investing in markets better suited for buy and hold real estate and wish that could be you? Do you want to take advantage of wealth building opportunities but are frustrated by the fact there just isn’t any way to do that until the next market crash?
In Long-Distance Real Estate Investing, real estate investor and police officer David Greene shows you exactly how he’s built a multi-million dollar portfolio on blue collar wages buying out of state rental property without ever even seeing it. Check out this read, available today!
Have you tried BRRRR? How have you gone about about?
Let me know below!