In this post, I wanted to give an introductory primer on how to approach this investment strategy, from beginning to the part where you repeat it over and over and over again.
B — Buy
They say you make your money when you buy, and that’s definitely true. Although, to paraphrase Tolstoy’s opening line to all good deals involve a good purchase, but each bad deal is bad in its own way.
The key to remember when buying property you intend on holding, is that there isn’t a great feedback mechanism. Yes, you will get an appraisal, but you can always disagree with an appraisal and who is to say whether you or the appraiser is right? I’ve seen some absurd appraisals, and I’ve seen homeowners believe their houses are worth some absurd price (never myself, of course).
When you are flipping, you will always know how well you did because you will be able to look at what your profit or loss was after the sale. With holding properties, you can always deceive yourself into thinking the appraisal just wasn’t any good. In other words, there is a tendency for buy and hold investors to get lazy.
Don’t get lazy!
The goal behind a BRRRR strategy is to pull all of the money you put into a property out when you refinance it so that you effectively bought a property for nothing, but still have 25 percent built-in equity to reduce risk. So while you may be looking for a different type of property (flippers will usually buy more expensive properties than holders), you still want to get the same equity margin.
Flippers often use the as a rule of thumb. In short, the rule goes like this:
(After Repair Value X 0.7) – Repairs = Maximum Purchase Price
Most lenders will finance 75 percent the value, so you could say that holders can aim for 75 percent. We generally do this, but that’s because we have some money we can leave in the deals and are looking for volume. If that doesn’t describe you, I would argue you should stick with the 70 percent guideline for two reasons:
1. Most banks charge a point and there will be an appraisal, title work, and loan processing fees that eat away at your margin.
2. People will go over budget more often than under budgetso building in a bit more of a margin is a better idea unless you are going for volume. Again, we are focused more on volume and so we aim for 75 percent, but overall, when I ran the numbers on our portfolio, our all in price came out to 80 percent.
Now, to purchase the property up front you can use cash, a hard money loan, seller financing, a private loan, etc. The upfront financing is outside the scope of this article, but what’s important to note here is that different upfront financing options will result in different acquisition and holding costs, and you need to account for those when analyzing a deal in order to hit your 70 or 75 percent goal.
R — Rehab
There are two key questions to keep in mind when rehabbing a rental:
1. What do I need to do to make this house livable and functional?
2. Which rehab decisions can I make that will add more value than their cost?
Unless you are doing luxury rentals, generally speaking, things like the following are not necessary and will cost much more than either the rental or property value they will produce:
§ Granite Countertops
§ Brazilian Hardwood Floors
§ High-end Stainless Steel Appliances
§ Bay Windows
§ Hot Tubs
It’s also rarely worth finishing a basement or a garage when it comes to rentals. But on the other hand, two-tone paint, refinishing hardwoods, and adding tile are very often worthwhile.
And, of course, the house needs to be in good shape and everything needs to be functional. Being a slumlord will hurt you in the long run as well as all of our industry’s reputation. We want to rent good properties, but luxury items will cost you more than get back. That being said, there are plenty of value-add rehab ideas that are great for rentals.
And as noted before, a little more attention being treated to the front of the house is important.
A bad first impression can sink an appraisal because appraisers are, like everyone else, human. A first impression effects them in the same way it does a prospective tenant. So make sure the front of your houses are appealing.
R — Rent
Banks rarely want to refinance a property that isn’t occupied so renting usually needs to come first. I have talked about the importance of screening before, and it’s critical to screen diligently so you get tenants that will pay each month. But it’s also important on the financing side. While appraisers shouldn’t take too much into account about how clean and pleasant the tenant is, as noted above, everyone is human and such impressions can make a difference. It’s important not to forget this.
It is also worth noting that you will need to notify the tenant that you are doing an appraisal beforehand (I always recommend you request interior appraisals versus drive-bys as appraisers will be more cautious and likely downgrade your property unfairly with drive-bys). Just send out or post a note on your tenant’s door about the date and time and then give them a reminder call the day before (unless your local laws require something else in addition to that). They don’t need to be present, but you should ask them to sweep and clean up as well as to kennel any pets if they won’t be home.
R — Refinance
Not too long ago, it was extremely hard to find a bank that was willing to refinance single-family rental properties. Now, however, it has gotten much easier. Still, when looking for such banks, there are a few things that you will need to ask:
1. If they won’t offer cash out, you will probably want to move on.
2. A “seasoning period” is how long you have to own a property before the bank will lend on the appraised value instead of how much money you have into the property. For the BRRRR strategy to work, you need to borrow on the appraised value. These days, some banks are willing to lend on the appraised value as soon as a property has been rehabbed and rented. These are the best banks to find.
The most effective way to find such banks is to ask around. Ask any investors you know which banks they use or go to your local real estate club and ask there. If a bank is lending to another investor, there is a good chance they will lend to you, too.
Another way to find such banks that we’ve used is a bit odd, but it has been quite effective for us. First, pick a market you are investing in, for example, I would pick “Tamuning, GU”. Then pick your loan range, i.e. “$40,000-100,000.” Then go to a website such as ListSource or DataQuick and search for every loan made in that city and that price range in the last year or so to non-owner occupants. It will probably cost you a couple hundred dollars.
Once you have the list, go through it and pick out all the banks. Right off the bat, you know this bank is at least willing to lend to investors in the area and price point you are looking for since they’ve done it before. So there is a good chance they will do it again.
Finally, make sure to provide the lender with as much information in as clear a way as possible to 1) impress them (remember, these are human beings, not computers making decisions) and 2) help them make a decision quickly. The same should go for whatever information, if any, an appraiser requests.