Tip Tuesday: Don’t Forget to Do This When Buying Under-Market using the BRRRR Method!

[Robin Simon]

Many real estate investors feel ecstatic when they secure a great deal—purchasing a property way below market value. Whether it’s a grand residence in disrepair, picked up at an estate sale or an off-market listing from a desperate seller, finding such bargains requires hard work and perseverance. However, one good find can pay off significantly. Nevertheless, there is one crucial step to avoid turning your successful deal into a disaster down the line. Document the property’s condition and obtain an independent valuation report. Even after securing the purchase, spend the extra time and money to run comparative market analyses (comps) and ideally get a Broker Price Opinion (BPO) or even a formal appraisal. You want rock-solid documentation of the true value. Why is this so important? Is it merely to feel smart about snagging a great deal or to see your net worth increase on paper? The reason is far more significant.

Avoiding Pitfalls in the BRRRR Method: The Importance of Proper Valuations

The BRRRR method (Buy, Rehab, Rent, Refinance, Repeat) is an increasingly popular wealth-building strategy. Essentially, when you buy an undervalued property and fix it up, instead of flipping it for a one-time profit, you rent it out and refinance, cashing out based on the property's new value. The catch? Your lender will scrutinize the property's value when you seek to cash out. If the lender sees a dramatic increase in value over a short period, they may become wary. For example, say you bought a single-family residence (SFR) for $1,000,000 at an estate sale. You invest $150,000 in rehab, and ten months later, the property is rented out, cash flowing, and valued at $2,000,000. Forced appreciation is a real estate investor's bread and butter. However, an $850,000 (85%) value jump in ten months can raise eyebrows.

In this scenario, the lender may become skittish and back out. How can you prevent this? If, despite paying $1,000,000, you had obtained a BPO at the time of purchase indicating it was actually worth $1,500,000, with solid comps to back it up, the lender could see a more reasonable progression: $1,500,000 in value, plus $150,000 rehab, resulting in a $2,000,000 valuation with forced and market appreciation over time. This is much more plausible. By documenting this from the start, you can ensure your cash-out refinance proceeds smoothly. This allows you to lock in long-term, low-rate financing and recoup your capital to continue building your portfolio.

If you are a BRRRR investor, use this tip to ensure your refinances execute smoothly on your best buys!

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