The BRRRR method—Buy, Rehab, Rent, Refinance, Repeat—has become a beacon for real estate investors looking to generate rental income and expand their portfolios efficiently. But there are some BRRRR method risks you should be aware of!
By recycling capital from one property to another, the method promises growth without continuous capital injection. However, every promising strategy comes with pitfalls. While BRRRR can pave a golden path to financial success, missteps can lead to setbacks. This article will spotlight the key risks of the BRRRR method, arming you with knowledge to navigate potential challenges.
First, here’s a 7-min video from Ryan Dossey about how following the popular BRRRR formula could have cost him $97,000…
BRRRR Method Risk #1. Over-Leveraging
One of the most enticing aspects of investment strategies using the BRRRR method is the potential to grow using leverage. But with great potential comes great risk, particularly when it comes to over-leveraging.
Danger of Borrowing Too Much: It’s tempting to stretch borrowing capacity to snag that next deal, especially when the market is hot. However, borrowing too much money can strain your cash flow. Let’s be practical: ensure you have a comfortable buffer. Real estate is full of unforeseen expenses, from sudden maintenance needs to longer-than-expected vacancies. If you’re too stretched, one unexpected bill could disrupt your entire operation.
Market Downturns with High Leverage: Markets are cyclical, and while the upward climb can be rewarding, the descent can be punishing, especially if you’re heavily leveraged. When property values dip, and you owe more on a property than it’s worth, you’re in a negative equity situation. This can lead to challenges refinancing, or even worse, an inability to cover the mortgage if rent prices also drop. A good rule of thumb: Don’t base your strategy on continual market growth. Instead, make sure each investment property make can stand on its financial feet, even in a downturn.
Action Steps:
- Regularly Review Debt Levels: Monitor your portfolio’s debt-to-equity ratio. Aim for a balance that allows for growth but also safeguards against market unpredictability.
- Stress Test Your Portfolio: Regularly run scenarios to see how your investments would fare in less favorable conditions, like a rise in interest rates or a dip in rental income.
BRRRR Method Risk #2. Underestimating Rehab Costs
Getting into a BRRRR deal often means buying properties in need of a little (or a lot of) TLC. This rehabilitation phase can significantly boost the property’s value, but only if costs are kept under control. Here’s the real deal about the risks of underestimating those costs:
Common Causes of Cost Overruns: Most seasoned investors will attest to renovation projects seldom going precisely as planned. Whether it’s discovering mold behind walls, outdated wiring requiring a full overhaul, or just plain inaccurate initial estimates, costs can quickly spiral. Avoid this by:
- Getting Multiple Quotes: Always source at least three estimates for any significant work.
- Building a Relationship with Trusted Contractors: A reliable contractor can make the difference between a project that stays on budget and one that doesn’t.
The Importance of a Contingency Budget: Never, and I repeat, never dive into a rehab project without a contingency budget. Typically, a 10-20% buffer of your initial estimate is a good start, but adjust based on the property’s age and condition. This isn’t being pessimistic; it’s being prepared. The older or more neglected the property, the higher the likelihood of unexpected issues arising.
Action Steps:
- Regularly Inspect During Rehab: Instead of waiting until the end, regular check-ins can catch problems early before they escalate in cost.
- Educate Yourself: The more you know about the renovation process and common issues in properties of the era or type you’re buying, the better you can anticipate and budget.
BRRRR Method Risk #3. Overestimating After-Repair Value
The ARV plays a pivotal role in the BRRRR method, determining the success of your refinancing and overall profitability. Misjudging this value can set your project off course. Let’s dive into the practicalities:
Risk of Being Overly Optimistic: Enthusiasm can be an investor’s best friend, but also their worst enemy. Just because you believe a property will be worth a certain amount after rehab doesn’t make it so.
- Use Reliable Comps: Instead of cherry-picking the highest-valued properties in the area, aim for a mix. Look for homes with similar square footage, features, and location proximity.
- Seek Neutral Opinions: Get a professional appraisal. While there’s a cost involved, an unbiased perspective on potential value can save you from costly misjudgments.
Market Volatility: Local real estate markets can be surprisingly volatile. A sudden influx of new properties, changes in local employment rates, or shifts in local infrastructure can all affect ARV.
- Stay Updated on Local News: Know what’s coming down the pipeline in your investment area. New schools, businesses, or transport links can boost value, while factory closures or increased crime can decrease it.
- Be Conservative in Your Estimates: Instead of banking on the top-end value, be conservative in your ARV projections. If the market surpasses your expectations, it’s a bonus, not a necessity for your investment’s success.
Action Steps:
- Regular Market Analysis: Make it a habit to regularly review local sales data, keeping an eye on how actual sale prices compare to your predictions.
- Network: Join local real estate investment groups. Networking can offer insider insights into where the market might be headed next.
BRRRR Method Risk #4. Tenant Risks
At the heart of the BRRRR method lies the ‘Rent’ phase, where cash flow starts pouring in. But with tenants come certain inherent risks that can impact property value and profitability.
Vacancy Periods and Loss of Rental Income: Every month a property sits vacant, you’re losing potential rental income. This not only affects cash flow but can also influence refinancing terms.
- Effective Marketing: Have your rental adverts ready to go as soon as renovations are nearing completion. Use high-quality photos and compelling descriptions.
- Price Right: While it’s tempting to set rents at the higher end of the scale, competitive pricing can reduce vacancy periods.
Dealing with Problematic Tenants: Late payments, property damage, or even legal disputes over rental properties can be both time-consuming and expensive.
- Thorough Screening: Don’t rush the tenant selection process. Conduct credit checks, verify references, and meet prospective tenants in person.
- Clear Lease Agreements: Ensure your lease terms are explicit. Detail responsibilities, penalties for late payments, and property care expectations.
Action Steps:
- Regular Property Checks: Implement a routine of checking the property, say bi-annually. This not only helps in spotting potential issues early but also ensures tenants maintain the property well.
- Build a Good Landlord-Tenant Relationship: Foster open communication. When tenants feel respected and valued, they’re more likely to reciprocate with timely payments and good property care.
BRRRR Method Risk #5. Refinancing Challenges
The refinancing stage is crucial in the BRRRR method, allowing investors to pull out funds for their next investment. However, this phase can sometimes be riddled with unforeseen challenges.
Not Being Able to Secure Favorable Refinance Terms: Securing good refinance terms is pivotal. If the terms aren’t favorable, it can strain your cash flow.
- Build Strong Relationships with Lenders: Start by creating strong ties with multiple banks or credit unions. The better they know you and your track record, the more inclined they might be to offer you favorable terms.
- Maintain a Healthy Credit Score: Your personal financial health plays a role. Regularly check your credit score, and work on improving or maintaining it.
Challenges Due to Market Fluctuations: Sometimes external factors, like a downturn in the property market or economic conditions, can affect the terms or even the possibility of refinancing.
- Stay Informed: Continually monitor the economic indicators relevant to the real estate market. Being ahead of the curve can allow you to time your refinancing optimally.
- Diversify Lending Sources: Don’t rely on just traditional banks. Look into credit unions, private lenders, or even peer-to-peer lending platforms as alternative options.
Action Steps:
- Professional Financial Review: Before embarking on refinancing, consider getting your financials reviewed by a professional. They might offer insights or strategies you haven’t considered.
- Flexibility in Strategy: Sometimes, it might be beneficial to hold off on refinancing until conditions improve. Having a flexible approach, rather than being fixated on immediate refinancing, can be advantageous in the long run.
BRRRR Method Risk #6. Lack of an Exit Strategy
Every other investment strategy should come with an exit plan. While the BRRRR method inherently revolves around holding and renting properties, circumstances might force or entice an investor to sell. Here’s why not having an exit strategy can be risky:
1. Being Unprepared for Market Shifts: The real estate market isn’t static. Events, ranging from economic downturns to changes in local regulations, can drastically impact property values or rental potential.
- Stay Informed: Regularly evaluate the property market’s health. Understand local zoning laws, potential infrastructure developments, and general economic conditions.
- Maintain Property Condition: A well-maintained property sells faster and often at a better price. Regular upkeep means you can act quickly if you decide to sell.
2. Emotional Attachment: Becoming too attached to a property can hinder objective decision-making, leading to missed selling opportunities for distressed property or holding onto a property that’s underperforming.
- Keep Business Separate: Remember, this is an investment. While taking pride in your properties is essential, avoid letting emotions dictate your investment decisions.
- Regular Portfolio Review: At least annually, assess the performance of each property in your portfolio. It helps in making informed decisions about holding or selling.
Action Steps:
- Develop Exit Scenarios: Plan for different exit strategies. Whether it’s a long-term hold, sale after a specific appreciation threshold, or a sale when ROI drops below a certain level, have plans in place.
- Engage with Real Estate Networks: Networking provides a pulse on the market. Being connected can offer insights into when might be an optimal time to exit or if there are potential buyers in the wings.
BRRRR Method Risk #7. Overdependence on a Single Market
Diversification is a cornerstone principle of investment, and a real estate portfolio is no exception. Relying too heavily on a single market or area can expose an investor to localized risks.
1. Local Economic Downturns: If a significant employer in the area closes down or there’s a local economic slump, property values and rental demands could plummet.
- Diversify Geographically: Consider spreading your investments across different regions or even states. Each market will have its dynamics, offering a natural hedge against localized downturns.
- Stay Updated on Local Economics: Be aware of the major economic drivers in your investment areas. If a town relies heavily on a single industry, understand the health and prospects of that industry.
2. Changing Local Regulations: Some areas might introduce regulations that could impact rental property returns. For instance, rent control measures or stricter tenant protection laws can alter the profitability calculus overnight.
- Engage Locally: Join local landlord or property investment associations. They’re often the first to know about potential regulatory changes.
- Advocate: While individual influence might be limited, as part of a larger group, investors can lobby against potential detrimental regulations or at least prepare for them.
Action Steps:
- Periodic Market Analysis: Regularly review the performance of different markets. If one starts underperforming consistently, it might be time to reconsider your investment there.
- Network with Other Investors: Connect with investors who have diversified portfolios. Their experiences and insights can guide your diversification strategies.
Final Thoughts
The BRRRR strategy offers a structured pathway for real estate growth, but it’s not without challenges.
To succeed, investors must be diligent, adaptable, and proactive in mitigating risks. By staying informed and adjusting as needed, the BRRRR method can lead to substantial rewards in the real estate investing landscape.
Approach with care, knowledge, and the understanding that every investing strategy requires active involvement for success. Happy investing!
