The 5 Primary Risks of BRRRR Investing and Flipping Houses
Buy a discounted property, do the work yourself, force appreciation from the work, sell it off or refinance it, and the money’s in the bank—it’s the real estate investing dream, right? Yes! Of course it is. It’s one of the fastest ways to make some serious buck.
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But let’s not kid ourselves here. This isn’t easy work. Knowing what makes a property a good candidate or a bad one for flipping or doing the buy-renovate-rent-refinance-repeat (BRRRR) method takes some education. Negotiating deals takes some education. Knowing the numbers takes some education. Doing the renovation takes some education. Renting a property out and managing that rental, if you are BRRRRing, takes some education. Figuring out the financing of all of it takes some education. It’s not an easy gig! Once you get going in it, though, things can certainly smooth out and you can get the hang of it, but there are a lot of moving pieces.
Every real estate investing strategy comes with certain risks involved. Any time you begin to pursue a strategy, one of the best things you can do to help yourself is to be fully aware of where the risks lie in your chosen strategy and to know mitigation options. If you don’t have a handle on the risks, it’s likely that the risks will soon end up with the handle on you.
There will always be a wide range of risk potentials with any deal, but as I said, each strategy typically has its own standard set of risks. That standard set of risks is what I want to point out to you when it comes to BRRRRing and flipping properties. This list is not inclusive of every secondary risk or offset risk that may show up or a guarantee that all of these things will cause you trouble, but these are the big ticket items that everyone involved with either of these two strategies needs to be aware of. If you are aware of these major risk factors, you can make a more valiant attempt at mitigating them and possibly saving yourself a deal and putting a great amount of money in your pocket.
If you are thinking of BRRRRing or flipping properties, you should have an intimate understanding of the following five risks associated with both of those strategies.
The 5 Primary Risks of BRRRR Investing and Flipping Houses
1. Renovation Period
If you've ever hired a handy person or a contractor for a bigger-ticket repair or improvement to your own home or an investment property, you've most likely experienced at some point or another the job taking significantly longer than was originally anticipated. It can happen very easily, and it's not always anyone's fault in particular. I've seen several property renovations get put completely on hold because of winter storms, for example. It's very hard to replace roofs or do siding or outdoor painting when ice and snow are swarming a town.
Related: How to Take the BRRRR Strategy to the Next Level with a 198-Unit Apartment Building
I’ve seen several rehabs get severely delayed in places like Georgia, where I’m from, because of summer rain storms that last a week. Again, it’s hard to do roofs and siding and exterior paintings or any other exterior thing in the middle of monsoon-type rain that seems to never end. Those things certainly aren’t anyone’s fault. But then there are also handymen and contractors out there who will make timeframes unnecessarily painful. I’ve seen contractors disappear for seemingly no good reason, as if they’ve just decided to take a week-long lunch break or something. Either way, renovations and rehabs can very quickly take on significant delays. Reno delays can negatively impact your financing, they can tick off any investors you might have on a project and put the idea of distrust in their heads, and, of course, they delay the time to which you get to collect some profit.
2. Renovation Cost
We are all in real estate investing hoping to make some money, right? It’s kind of the point. One of the worst things that can happen to any investor who owns real property is to have an unexpected major expense. Major expenses can make the difference between a profitable real estate investment and an unprofitable one. Even if an investor is buying a rent-ready rental property, meaning no repairs are assumed to be needed, they should always hire an independent property inspector to thoroughly confirm the condition of the property so that the investor can be specifically aware of any impending major repair costs. Anything unknown before you buy a property could pop up later as a major or detrimental unexpected repair cost.
This goes for renovations and rehabs as well. When you first analyze a property to BRRRR or flip, it’s all about the numbers. You have to take the distressed property price, combine it with the anticipated rehab cost, and then compare those two with what the property is expected to appraise at once the renovation/rehab is complete. Where a lot of your profit is going to come from, if not all of it, is in those numbers. So what if you own this distressed property and all of a sudden the rehab is going to cost you more than you expected or planned for? Do you have the funds to cover it? That’s the first question. If you do have the funds to cover it, where does that leave you now in comparison to the after repair value (ARV) versus where you were before? Speaking of ARVs and appraisals…
One of the primary factors in a BRRRR or flip, if not the primary factor, is what the property will be worth after you put the work into it. Improving the property to force the appreciation on it is the whole point to putting the work in at all. So back to this numbers thing: If your property doesn’t appraise at what you expected it to, you could be looking at a heap of trouble in terms of your profit margin. You can probably get away with this easier in the BRRRR strategy as long as the property cash flows as a rental. This is assuming you didn’t do some kind of “creative” financing and/or you didn’t made promises to investors about a return.
But if you traditionally finance the distressed property, like with a conventional mortgage, and suddenly the new value isn't as high as you expected it to be, you're holding on to the property anyway so you can give it some time and see what happens and possibly do the refinance then. But if you are flipping especially, the new appraisal value or ARV is critical to the verdict on your profit margin. Plus, there's a good chance you're using a hard money loan of some sort, which doesn't have the timeframe on it that would allow you to wait to sell. As you do your initial analysis on a property for a BRRRR or a flip, there's no way to know for absolute certain what the property will appraise for after the work is completed. The best you can do is run a serious amount of comps, stay conservative with them and run several appraisal number scenarios, and try to stay within the predicted renovation time frame so you don't give the market enough time to introduce an unexpected correction of some sort.
4. Time to Rent (BRRRR Only)
Going back to the renovation period again, you obviously won’t be able to rent the property out until that rehab is completed. So for BRRRR properties, where your plan is to rent it out and then refinance it, a rehab delay of any sort will only prolong the time when you can go ahead and place tenants. This matters because the refinance depends on the tenants being in there (in most cases) and you won’t start getting cash flow until tenants are in there. So the longer the rehab gets delayed, the longer before you start getting any of your money back out of the project. If you have the financial means to sustain that, then the time to rent isn’t as critical. But for BRRRRing, it should be looked at. And not only does the time to get the property rented, but it also matters what you’ll be able to rent it for!
5. Rental Amount (BRRRR Only)
Yep, the rental amount matters. If you are BRRRRing, your initial numbers analysis should include the anticipated amount you can expect to receive in rent once you place tenants. This matters because it will tell you whether you’ll actually be cash flowing or not on the property. If you can’t expect to cash flow, you might want to put some thought into your strategy. The point of the BRRRR is to refinance the property after it’s been fixed up, but if you won’t cash flow on it if you put tenants in it, you might as well just flip it—sell it rather than hold it. Maybe not, and it depends on why you are doing it but the idea behind the BRRRR is to rent it out, rather than sell it off as a flip, and cash flow is part of that equation. Similar to the other mentions in this article already, the best you can do is run comps like crazy and try to minimize your rehab time so you are more likely to get what you initial expect for rents, as well as stay conservative with it and running a few different income scenarios. If you want a refresher on how to run cash flow numbers on a rental property, check out “Rental Property Numbers So Easy You Can Calculate Them on a Napkin.”
Are you starting to see the connection between the major profit players in BRRRRs and flips? The numbers, which directly determine your profit margin, involve the price of the distressed property, the rehab cost, the appraisal value or the ARV, and the rental income (BRRRR only). The only known number up front in these strategies is the price of the distressed property since nothing else starts until that is purchased, and you have none of your own money into anything until that is purchased. After that, everything else can change unexpectedly on you, and one of the major factors that can increase the risk of unanticipated changes is the timeframe of the rehab.
The fact that so many of the numbers involved are technically unknowns is really the crux of the danger of BRRRRing and flipping. While there is no official solution to the risk of having unknown numbers, there are ways to lessen and mitigate those risks as much as possible.
Also know that BRRRRing and flipping are not what I would consider beginner-level strategies! Beginners quite often do them, but in no way do I consider them easy strategies. If you want to know why—or you like snowboarding, or both—check out my full opinion on the difficulty level of these strategies in “What Snowboarding Can Teach Us About Real Estate Investing Strategy.”
One of the best things you can do is not try to go at it alone for your first deal. I can most definitely say that one of the best things I have ever done in real estate investing is to utilize the brains of those around me who have either already done what I’m trying to do.
I have found that I can read all I want from a multitude of sources, but until I actually try something for myself, I don’t usually get a full understanding of what everything is trying to tell me. This is another reason I recommend a real-time mentor. Absolutely read everything you can and try your best to get a solid education, but nothing could top off those efforts better than working with someone who is actually doing it.
Any experienced BRRRRers or flippers out there—do you have any helpful tidbits for readers to help them mitigate any or each of these risks?