How to Finance a Property With Little to No Capital
The BRRRR Strategy is widely considered the most efficient form of investing in real estate, and has 5 distinct steps. Buy, Rehab, Rent, Refinance and Repeat.
Identify undervalued and distressed properties in an area with a strong rental market.
Ideally these properties will need fixing up, giving you excellent potential to add value to the property.
After selecting one property that fits your criteria, you will be ready to apply for a bridge loan.
Many real estate investors will use a specialized type of loan called a fix and flip loan to fund the purchase of the property.
These loans will often time also finance 100% of the construction costs.
Depending on the lender and the strength of the real estate market, you will need between 20% and 30% of the purchase price as a down payment and can find a hard hard money lender to provide the remaining capital.
Private lenders are commonly used to fund this strategy, but be sure to lookout for these hard money scams.
Once you have finalized the purchase, it's time to start adding value by fixing up the property. You must make the property livable and appealing to future tenants.
Having a great contractor is essential to completing this objective. A great rehab can substantially increase your rental prices and in effect increase the value of your property.
After the Rehab is looking spiffy, now is the time to put it on the rental market and advertise to prospective renters.
Be sure to screen your tenants to avoid problems such as damage, non-payment and vacancies.
Getting the units rented will stabilize the property and will help for the next step of the process.
Once the units are rented and you've owned the property for 6 to 12 months, it's time to transition from your hard money loan to a traditional 20 to 30 year fixed loan at a lower interest rate.
If you are a first time home buyer and your credit score is subpar you could consider using an FHA Loan.
Assuming you have good credit and the units are rented out and cash-flowing as expected, the bank should appraise the value of your property for more than the purchase price, due to your excellent rehab job.
The bank should give you a loan to value between 70% to 80% of the new appraised value, and at a significantly cheaper rate than your original hard money loan.
Since the bank has now appraised your property at a higher value due to your rehab, you'll now have more equity in the property that is eligible to be pulled out.
This is commonly known in the industry as a cash-out refinance. And you can now use this excess capital as a down payment on your next property.
As you become more knowledgeable of the market and establish stronger relationships with contractors, lenders and realtors, this process will become easier and more profitable.
5 Pros of the BRRRR Strategy
- No Money, No Problem
With limited capital required to implement this strategy, it is great for cash poor investors.
The main focus is on finding undervalued properties and adding value to them.
This can create a strong return on investment.
- High ROI
Since little capital is required, once the property is rehabbed and rented, the cash flow should supersede the debt service required on the property.
This will create an asset that generates a mostly passive monthly income, with little money invested, translating into a high ROI.
- Increased Equity
Through the rehab procedure of the process, the investor should be able to capture increased equity in the property since it will be in better condition and command higher rents.
Additionally, there is the added bonus of owning the property free and clear in 30 years, after the mortgage is completely paid off.
- Reliable Tenants
Since you recently remodeled the property, you have a higher likelihood of attracting a higher quality of renters.
These renters are less likely to mistreat or disrespect the property and will pay rent on time.
This in effect will allow you to meet your monthly mortgage payments.
As mentioned before, this process can be repeated over and over again, making it scalable.
You can also achieve economies of scale via owning a large number of rental units.
Spreading out the cost of your maintenance and management team across multiple properties will make your business more cost effective and efficient.
5 Cons of the BRRRR Strategy
- Over Estimating Rental Revenue
If you over project your rental income for a property it will delay the time in which you can pull cash out and start your next project.
- Expensive Hard Money Loan
When purchasing a property, if you don't sufficient funds a hard money loan will be needed.
These interest only bridge loans can carry a rate of 8% to 15% annually.
If you make mistakes along the way and the project is delayed it will be costly and ultimately have a negative impact on your ROI.
Therefore, it's in your best interest to transition out of this loan as quickly as possible.
- Appraisal Risk
If the property does not appraise well after the rehab process this will make it difficult to repeat the strategy, due to you not having extra equity in the property to cash-out and use for you next purchase.
Hence it is crucial to be well seasoned.
It could be advantageous to learn as an apprentice under another investor, helping to learn the ins and outs of the business before going it alone.
You will also gain invaluable business contacts.
- Too Highly Leveraged
One major advantage of real estate over other assets is your ability to leverage properties and gain access to more capital for additional projects.
However, a drop in the real estate market could create financial issues.
If your rental income is not able to service the debt, you will be underwater on the property and could be subject to foreclosure.
If there is a drop in the real estate market, you may not be able to achieve your desired rental income, therefore causing vacancies.
If this problem subsists, for a long period of time, it would create a risk for foreclosure on the property.
Hopefully this article helps to clarify the benefits and risks of the BRRRR strategy. If you have any questions or comments be sure to let us know.