There's some good news and bad news about the BRRRR method of real estate investing, or what most people would call buying a house, rehabbing that house, renting out the house, refinancing the house, and repeating the process.
The good news is the BRRRR method really works. I know because, while I don't use this method exclusively, I have had success using it, as have many other real estate investors.
The bad news is both houses and supplies to rehab houses have become more expensive post-pandemic, as you might have noticed, and that affects both the buy and rehab aspects of BRRRR by cutting into your profits. Let's further unpack this.
The traditional formula
BRRRR investors look for as-is properties and try to never pay more than 70% of the after repair value (ARV) of the home minus the cost to rehab. The formula works like this, based on an asking price of $300,000 for the home:
- You figure you need to put in $35,000 to make it ready for renters to occupy.
- After repairs, the home is now worth $375,000, which would be its ARV.
- In this case, you would have spent $35,000 to add $75,000 in house value. (House value is what buyers are likely to pay for the house based on what comparable homes have recently sold for.)
- The goal for BRRRR investors has been to pay 70% of the ARV minus the cost of repairs, which in this case would be $227,500. ($375,000 x 70% = $262,500 - $35,000 = $227,500).
A new formula
It might not be possible for you to get a house in today's market at 70% ARV. Therefore, you would need to determine whether it would still be profitable to buy a home at a higher price. Also, supplies and labor will probably cost you at least 25% more in today's inflationary times. So here's how this deal might look now:
- The asking price is $300,000.
- You need to put in $44,000 to make it rent ready.
- After repairs, the home is worth $375,000.
- In this case, you would have spent $44,000 to add $75,000.
- You don't reach the BRRRR investor goal because the seller won't go below $300,000. So instead of spending $227,000, you would now be spending $344,000.
Should you still do the deal?
Maybe, because there's also some more good news to consider -- the rent and refinance portion of BRRRR.
Rents are up 17% from 2020, more in some areas and less in others. Look to see what rents are going for in your area for homes in the $375,000 range. You could likely get $3,000 a month in rent on a house you spent $344,000 to buy. That's a good ratio.
Figure cash flow
Let's say you put down 25% on the home, or $75,000. Your mortgage loan is for $225,000 at 3% interest. Your mortgage, including taxes and home insurance, is $1,350. And let's say your operating expenses total 40% of the rent, which would be another $1,200 a month. You still come out with positive cash flow.
Consider cap rate
What about cap rate (your rate of return on your investment)? In this case, it would be 7.2%, which is quite good. The formula is as follows:
- Subtract operating expenses (excluding mortgage payment) from gross annual rent to get net operating income (NOI).
- Divide NOI by purchase price to get cap rate.
For example: $36,000 (annual rent) - $14,400 (annual operating expenses) = $21,600 / $300,000 (purchase price) = 7.2%.
But since you put in $44,000 into rehab, let's say you really bought the house for $344,000. Would the cap rate still be good? It would be 6.2%, which is still decent.
Icing on the cake: house appreciation
Homes are still appreciating in 2022, maybe not as much as they did in 2021, but most housing experts expect some appreciation to continue through 2022. So you should be able to refinance at some point in the near future when you consider rental income and house appreciation. When you can refinance, you repeat the process -- if you desire. BRRRR still works, but you might need to wait longer to refinance and repeat this way than you would if you were to pay 70% ARV.
Also keep in mind that while foreclosures are down currently, largely because of the increased equity in homes, we might start to see more distressed properties on the market in the future. If and when we do, you can dust off that 70% rule.