What is the BRRRR Investment Method?
The BRRRR investment strategy stands for “buy, renovate, rent, refinance, and repeat”. Investors who wish to scale their portfolios tend to use this investment strategy most often.
The property that is purchased will be distressed and will require a certain amount of TLC to have it rent-ready and up to code. To note; the property will often be much cheaper to purchase given its’ existing condition.
Typically, BRRRR investors start by identifying distressed or otherwise undervalued apartment buildings. They then develop a value-add business plan that focuses on the most cost-effective ways to stabilize the property. The extent to which the property needs minor renovations vs. more extensive renovations will depend on its condition at the time of purchase.
Stabilizing requires two things:
- Renting the vast majority (i.e., at least 90%) of the units.
- You must rent the units at or above market rents.
This is why the owner’s must carefully consider their value-add improvements.
The BRRRR investment strategy stands for
“buy, renovate, rent, refinance, and repeat”.
Once stabilized (i.e. rented). The owner will then refinance the building. The assumption is that, upon stabilization, the net operating income (NOI) will have increased. A higher NOI translates into a higher property value. This allows owners to refinance and pull some equity out while still maintaining the same loan-to-value ratio.
With that equity in hand, the investor can then begin repeating the process of BRRRR. This is a common way investors grow their multifamily portfolios.
BRRRR vs. Other Value-Add Investment Strategies
How is this different than any other value-add investment strategy, you may wonder? The key difference is that the end game for BRRRR investors is to refinance. They harvest that equity to roll into the next BRRRR method apartment investment.
This is different from a value-add real estate investment strategy in which the owners renovate without refinancing. In situations like these, the owners simply accept that they have a higher value and therefore, lower leverage. In some cases, this appeals to more risk-adverse investors.
It is also different from value-add investors who make property improvements, then upon attaining a higher value, sell the property. Those who sell rather than refinance may be subject to costly short-term capital gains taxes. These can impact the amount of profit that will be distributed to investors.
Identifying Distressed Apartments for Sale
To use the BRRRR method investment strategy successfully, you need to be skilled at finding distressed assets. People often assume that “distressed” means the property is in poor physical condition. While this is often the case, properties can be distressed for other reasons as well.
For example, if apartment units are clean and habitable but have not been updated since the late 1980s. Owners will not be able to rent for market rates. The units may no longer serve the needs of that market’s demographics. Renovating each unit can be costly and therefore, something current owners may not have the capacity to undertake. Some long-time owners have such a low-cost basis that renovating the units does not seem worthwhile. They can charge below-market rents and still earn significant cash flow. Convincing these owners to sell is a great way to capture the loss to lease that happens on apartment buildings in need of renovation.
BRRRR investors will also find properties that are financially distressed. This typically happens when an owner is over-leveraged on an asset. For example, someone who purchased a property at a 70% loan-to-value has 30% equity in the deal. If market conditions change. As we’re seeing in a rising interest rate environment, and cap rates rise, property values start to come down. Let’s say a property was once worth $10 million and had a 70% LTV mortgage. If that investment property is now only worth $8 million, the owners will have lost two-thirds of their equity.
Now, getting a money loan to make property improvements (desired or required) will be nearly impossible. They are too highly levered. Any improvement, like a roof that needs to be replaced, will require the owner to put more equity in the deal. It’s what we call “throwing good money after bad”. In situations like these, it often makes more sense for the owner to sell the asset. That way they are able to maintain any equity they have left, rather than risk losing it all. If property values continues to fall, they will lose all of their equity. These financially distressed assets can be great buying opportunities for BRRRR investors.
Poor Operational Performance
Sometimes, a property will become distressed as a result of poor operational performance. This can manifest in several ways. For example, an owner might not be keeping close tabs on the market. As a result, rents may have fallen below market rates. The property management company may be slow to respond to repair and maintenance requests. This could result in more tenant turnover than would otherwise be expected. High turnover and slow re-leasing can quickly drag down revenues, which in turn, lowers the property’s value.
Key Considerations When Evaluating BRRRR Investments
Many apartment investors think they have what it takes to pursue the BRRRR method. In reality, this can be a risky investment strategy unless you know what you’re doing. A few key considerations when you’re looking to pursue BRRRR properties:
How much will it cost to make the necessary property improvements?
Be sure you have a clear handle on actual costs (hard and soft costs) when preparing your budget. People tend to underestimate how much it will cost to renovate an apartment building. This is especially true today as we face material and labor shortages which have driven up the costs of apartment construction.
Will your proposed improvements be enough to justify your asking rents?
You’ll want to do a thorough market analysis. This is to ensure you understand what improvements, amenities, etc. are needed to charge top-dollar for your renovated apartments. Be sure to scope out your expected competition and then underwrite your deals accordingly.
What building code requirements will you need to meet?
Many BRRRR investors overlook the constantly changing regulatory environment. Depending on the scale of the renovations, many apartment renovations will need municipal review and approval. This can add time and cost to any project. For example, some municipalities are needing renovations that exceed a certain dollar amount to meet new building and energy code requirements. Apartment investors will want to monitor these policies closely to be sure they’re in compliance.
How long will it take you to execute your business plan?
Keep in mind that most apartment buildings sit vacant while renovations are being made. Depending on market conditions, it could still take several months to fully lease the property once improvements are complete. The longer a property sits vacant, the more carrying costs the owner has to pay out of pocket.
Will the property be vacant or tenanted upon purchase?
This is another key consideration because renovating an apartment building with tenants in place is difficult. If tenants have existing leases, the new owner must honor those leases. Evicting tenants can be time-consuming and costly—in some municipalities more so than others. Be sure you understand any tenant protection ordinances that are in place at the state and local levels. Real estate investors may want to consider offering tenants a relocation incentive to move sooner than their lease expiration date. Buying a tenanted property often means holding off on renovations until those units turn over.
At larger apartment complexes, there may be an opportunity to renovate “wings” or sections of the building one at a time. This will likely require moving tenants from one unit to another until renovations are complete. Due to these complexities, many BRRRR investors will opt to buy properties that are fully vacant upon sale. These opportunities are harder to come by and result in no interim cash flow.
Refinancing in an Inflationary Environment
For the better part of the last two decades, apartment investors have benefitted from historically low-interest rates. It is likely that sub-3% mortgages may have already ended and may not ever return. This presents a potential problem for those following the BRRRR strategy.
Refinancing is one of the key components of
the BRRRR investment method.
Typically, a BRRRR investor would lock in low-cost debt. Then utilize similarly low-cost financing when they refinance upon stabilization. However, interest rates are currently on the rise. They have more than doubled since the beginning of 2022 alone.
The practical implication of this is that, while refinancing might result in a lower LTV ratio. The net impact on actual cash flow might be negligible. Depending on how much higher the interest rate is, the cash flow might not increase at all. Simply because higher interest payments will consume more of the cash flow.
Opting to take out a HELOC
Rather than refinancing. BRRRR method investors may want to consider taking out a home equity line of credit (HELOC) after they’ve completed renovations. They will have forced appreciation after stabilizing the property. In turn, they will have more equity in the deal.
They can harvest this equity by taking out a second loan (assuming they find a lender who will do so). This keeps their lower-cost original mortgage in place, with only the second loan being subject to the higher interest rates. This is one way to mitigate against rising interest rates.
In any event, “refinancing” is one of the key components of the BRRRR investment method. As such, BRRRR investors will want to pay close attention to the interest rate environment as they make their underwriting assumptions.
Value-add apartment investing is small undertaking. It is much more hands-on and intensive than most people realize. Rising costs (land, buildings, materials, labor, debt, etc) make it that much more challenging.
The BRRRR investment strategy is
most often used by apartment investors
who want to scale their real estate portfolios.
It is still possible to earn a sizable return on BRRRR investments. The key is developing a solid business plan alongside a team of seasoned real estate pros.
Interested in value-add investing? Contact us to learn more about Smartland’s value-add investment platform.