Is the BRRRR Strategy Entering an Ice Age?

By A.I. Lendberg, Edited by Douglas Katz – 03/06/23

The BRRRR real estate investment strategy has become increasingly popular among real estate investors in recent years. BRRRR is an acronym that stands for Buy, Rehab, Rent, Refinance, and Repeat. This strategy involves purchasing a distressed property, rehabilitating it, renting it out, refinancing the property to pull out equity, and then repeating the process with the profits generated.

The BRRRR strategy is particularly attractive to real estate investors because it allows them to build a portfolio of rental properties while leveraging their capital, but a lot of success with BRRRR depends on certain variables working in favor of the investor.  In the current market, many investors are finding that some headwinds could put a temporary deep freeze on the BRRRR strategy.

What is BRRRR?

BRRRR is basically a strategy for minimizing stranded capital by accessing it on e regular basis after a property is completed and stabilized and as you would expect, there are five steps.

  1. Buy: The first step in the BRRRR strategy is to find a distressed property that can be purchased at a discount. This could be a property that is in foreclosure, a short sale, or simply a property that has been on the market for a long time.
  2. Rehab: Once the property is purchased, the next step is to rehabilitate it. This could involve anything from cosmetic updates, such as new paint and flooring, to more extensive renovations, such as replacing the roof or updating the electrical system.
  3. Rent: Once the property has been rehabbed, the next step is to rent it out. The goal is to generate enough rental income to cover the monthly mortgage payment, as well as any other expenses, such as property taxes, insurance, and maintenance.
  4. Refinance: Once the property has been rented out and is generating a steady stream of income, the next step is to refinance the property. This involves taking out a new mortgage on the property to pay off the original mortgage and any other debts, while also pulling out some equity in the property.
  5. Repeat: The final step in the BRRRR strategy is to repeat the process with the profits generated from the refinancing. The goal is to continue to build a portfolio of rental properties, using the profits from each property to purchase and rehab new properties.
Benefits and Risks of BRRRR Strategy

There are several benefits to the BRRRR strategy. First, it allows real estate investors to leverage their capital, meaning they can purchase more properties than they would be able to if they were using only their own cash. Second, it allows investors to generate cash flow from rental properties, which can provide a steady stream of income over the long term. Finally, it allows investors to build equity in their properties, which can provide a source of wealth that can be tapped into at a later date.

Of course, there are also risks associated with the BRRRR strategy. The biggest risk is that the real estate market could decline, causing property values to plummet and rental income to dry up. Additionally, there is always the risk that the cost of rehabbing a property could exceed the expected budget, reducing the potential profits.

The Current Challenges

The biggest challenge for the disciples of BRRRR is the refinance step.  Much of the analysis of future and some current projects were based on historic values and rates.  The long low rate cycle and the unprecedented increase in values meant investors had the ability to fairly easily restructure debt in the past.  Now with rates sometimes double initial estimates and, values dropping by high single and sometimes double digit numbers and lender risk tolerance becoming less liberal with more restrictive guidelines, investors are needing to rethink what was a sound strategy.

Interest Rates

Rates are up which means the payment for investors increase accordingly.  While rents have increased in many markets, the growth is insufficient to offset the higher payment.  Even if the investor is content to wait out the market, they may not qualify for the refinance at the higher payment when the lender is less enthused with a property that just breaks even or is even in the red.

Values

Home values are the other half of the lender equation when evaluating the collateral.  In the case of refinances, the equity freed up from a refinance needs to be enough to cover the payoff and closing costs while being substantial enough to help with costs on other projects.  We are in a declining market in some areas and a cooling one in others which means values lower than predicted just months ago.  This has caught many investors with deals that are no longer viable or beneficial at the lower values.

Guidelines

In response to the changing market, lenders have adjusted.  Fannie Mae and Freddie Mac added fees and more restrictive guidelines as they pivot away from the investor market to focus on the residential market.  They are still lending on investment properties, but their offerings are less often the preferable option, especially with the added approval requirements and the onerous process that these programs bring.  Lenders in the non-QM space, like hard money and private money, have tightened their guidelines and adjusted their pricing, but less so than Fannie and Freddie.  The changes have been enough to mean investors still face lower LTV/LTC and tighter debt ratios.

Regulation

Finally, many municipalities are rethinking the rental landscape in their cities, towns and villages.  While most of the coverage has been regarding short-term rentals, the challenges could creep into the wider rental market.  In the former, restrictions to short-term rentals are making them too costly or even not allowed in some places.  For investors who cannot shift to a long-term strategy because they expected bigger returns from short-term bookings.  Even of they have planned to shift to long-term, investors are faced with affordable housing focus in some areas that limits what they can charge or they face  operational challenges such as tenants rights that place them at too high a risk to make the rental palatable.

Conclusion

In conclusion, the BRRRR real estate investment strategy can be an effective way for investors to build a portfolio of rental properties and generate cash flow over the long term. However, investors should be aware of the risks involved and be prepared to adjust their strategy if market conditions change and that the risks are compounded in unfavorable market conditions.  We may even see a pivot back to flips as investors need to exit renovation loans with shorter terms and requirements to refinance in 12-18 months from funding.  Flexibility and nimble reaction to changing conditions will be the hallmark of success for investors.  As with any investment strategy, it’s important to do your research and work with experienced professionals who can help advise you as to the lending environment and how the available options can support you.

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Disclaimer: This article was created with the assistance of multiple ChatGPT AI language models and has been edited and refined by Doug Katz. The information provided in this article is intended for general informational purposes only and should not be considered as professional or expert advice. The views expressed in this article are solely those of the author and do not necessarily represent the views of ChatGPT or OpenAI. Readers are advised to do their own research and consult with relevant experts before making any decisions based on the information provided in this article