You’ve probably heard of the famous BRRRR method which describes a strategy and framework used by investors who wish to build passive income over time.
The BRRRR method involves five steps:
It’s a new name for a time-tested strategy to create wealth through real estate. Whether you know the acronym or not, all seasoned real estate investors understand the concept. First you buy a property cheap, renovate the property to make it presentable and then rent it to create cash flow. Finally, you refinance to get all your cash back and go do it again!
While the concept does indeed sound straightforward, investors often struggle to obtain the financing (loan) needed. Traditional banks and conventional lenders won’t lend on these types of real estate investments.
In fact, traditional loan programs will not help you BRRRR your way to wealth in real estate. Investors need to align themselves with a lender that understands the method itself.
Here’s what that looks like in two steps:
Step 1: Fix/Flip Bridge Loan: A short-term fix/flip loan will give you the financing you need to buy and fix the property. These loan programs are designed to allow you to buy a property “as is” and renovate it. The programs typically provide 80-90% of the funds to buy the property and 100% of the construction funds needed to renovate it. This type of loan allows you to act fast and close quickly, making you the next best thing to a cash buyer.
These loans are usually referred to as fix/flip loans, , but in regards to the BRRRR method, the true plan will be to fix/hold. It’s very important to let your lender know the plan is to buy/fix/hold because they will look at the deal differently than if the plan is to buy/fix/flip.
Most lenders focus on ARV, or “as repaired value,” but if you let your lender know the plan is to hold, they will analyze the deal differently and may lend a higher percentage of ARV. When flipping, lenders typically won’t lend you more than 70% of ARV. If the plan is to hold, you may get more flexibility based on your potential rent cash flow.
Step 2: Long-term Landlord Loan/DSCR Loan: DSCR stands for Debt Service Coverage Ratio, referring to the cash flow of a property.
On DSCR loans, lenders are basing their lending decision more on the rental income and cash flow of the property and focusing less on the personal income of the borrower. Another benefit of a DSCR loan is that many lenders will allow you to close the transaction in the name of an LLC or corporation. This is highly beneficial to investors. Holding a property in the name of an LLC offers potential tax benefits to investors and reduces exposure from a liability standpoint.
By using a short-term buy/fix loan and a long-term DSCR loan, you can now buy a distressed property, renovate it and then refinance into a 30-year fixed-rate loan. The best part is most DSCR loans allow you to “cash out” on the new property value without a long waiting period. Most traditional loans will make you wait up to 12 months before lending on the new or renovated value. With a DSCR loan, you should be able to “cash out” as soon as the work is done and the property is renovated.
Here is an example to demonstrate how this really works:
Buy a single-family home: $100,000
Construction costs: $30,000
ARV (As Repaired Value): $175,000
Step 1: Fix/Hold Bridge Loan:
$85,000 to buy the property (85% of purchase price)
$30,000 to renovate (100% of construction costs)
Total Loan Amount: $115,000
Step 2: DSCR 30 Year Fixed Loan:
New Value (ARV): $175,000
Cash out refinance (75% of value): $131,250
You now have most or all of your cash back in the bank, and you have a property that cash flows completely. Your tenant is paying down your debt and, long term, your asset is expected to appreciate in value.
Obviously, this example keeps it very simple and many other things still need to be factored into the equation (e.g., closing costs of each loan, carrying costs, loan qualification parameters, etc.). But my point is to get you thinking! You can make this happen and most likely with not as much cash as you think. Start building your real estate portfolio today with the BRRRR method.