Risks of the BRRRR strategy

It is fashionable, and for good reason. I remember doing my first BRRRR strategy in 2004. I bought a house in Arvada, Colorado, with a lot of money to fix and renovate. You wouldn’t believe it; the flip was a flop and i ended up with a problem. I was over budget and was forced to cut back on my rehab. Like way back. I no longer had confidence in the sale price and decided that I would keep that as a rental. It was a nice big house in a desirable area, and I had a rent-to-own tenant in no time. Now to the problem. That damn hard money loan. Fortunately, this was when I was still able to report my income, and since I had good credit, I was approved. I kept that house for over 10 years!

Little did I know at the time, but I just fell for the BRRRR strategy. I bought a property, rehabbed it, rented it, refinanced it, and then repeated the process. I bought that house with no down payment and received option money and positive cash flow. The term BRRRR had yet to be coined, but he knew he was onto something.

The entire Pine Financial team talks about this strategy for a few reasons. First, we can help with the loan to make it, but it also works very well. This is one of the best strategies when trying to buy a property with little or no down payment. Do you want more information about this strategy? I wrote a FREE report here. (See below)

Although this is one of my favorite buying strategies, it is not risk free. Here are three risks when using the BRRRR strategy:

  • Different view on value: Outside of all the typical risks of owning a rental, BRRRR’s risks come down to your ability to refinance private money or hard money loan. The easiest way to stumble upon that is if your refinance appraisal is low. In my world, we get an appraisal up front with the appraiser’s opinion of what the property is worth after repairs. Also known as ARV or after repaired value. The key word here is opinion. It is quite possible that another appraiser has a different opinion. This is even more likely if you only do minor repairs. It can be very difficult for an appraiser to understand a large increase in value in a short period of time. Major repairs help with this. Even though you are only rehabbing for rent, you still want to show that you did improve the property to justify the value.

The good news about appraisal when you refinance is that you should let the appraiser in the home. This means that you can meet him or her at the property. I highly recommend that you do so and that you bring your hard money loan appraisal, lists of repairs performed, and any up-to-date compensation to support its value. With these documents, we have seen fantastic results, but you must understand that this is always a risk. If the appraisal is low, you may have to cover the difference out of pocket or, in the worst case, sell.

  • The initial loan was made incorrectly – I haven’t seen this, but all of our preferred lenders have told me this is common. If you’re dealing with someone who doesn’t understand this strategy, it could ruin your initial loan and make it difficult for you to refinance. Some common mistakes are:

    • What’s It Titled: The best loan right now to refinance is a Fannie Mae loan. They have fantastic 30 year fixed rates and no season titles. Title seasoning just means how long you must be on the title or own the home before you can refinance it. Many banks or lenders have title seasoning guidelines. Fannie Mae doesn’t. What they do have, however, is a guideline for not lending to an entity. This means that they want you to be the owner of the house personally. It may be possible to stop claiming your entity’s home deed in your personal name, but the loan process is much easier if you purchase in your personal name. Once your loan is in place, it might be a good idea to stop claiming the property in your entity at that time.

    • Sweepstakes – I have heard that some lenders do not hold construction money. When a lender does this, they will get the full loan amount at closing. If the lender loaned money for repairs but did not include it correctly at closing, it will appear that you received a cash refund and the refinancing lender will not make the loan. These are rate and term refinance loans, which means that they will only refinance the debt that was used to purchase the property. If they pay off a loan that was used to put cash in your pocket, it is considered a cash refinance and you will not qualify.

    • Link: It sounds simple, but the link that the lender places in the title is very important. The biggest problem is that they actually place a lien. This should appear in the title search and be disclosed in the closing disclosure, making it clear that your refinance loan is being used to pay off the purchase money debt. The lien should also match the amount on the settlement statement, and it is best not to modify that loan or increase it in any way after purchasing the home. Either of these could create a problem separating a rate and term refinance from a cash-out refinance.

  • Tight DTI: In 2004 I had a problem with DTI. Debt to income. I was making money, but a lot of that money was not showing up on my taxes. These could be non-refundable deposits that would be reported at a later date, money from the Army to pay for some of my expenses while I was in college, or amortizing or depreciating assets. I also had some roommates who helped me with my bills. If you look at my tax returns and mortgage payments, I would not qualify for the loan. I only qualified because declared income loans were allowed. Since we no longer have established loans, we must be very careful here.

For Pine Financial, we require our client to be pre-approved for refinancing before loaning them money IF they plan to refinance. That’s not a requirement for flippers, but we want to help our clients succeed, that’s why we pay attention to this little detail. Once approved, it would be a good idea to do a stress test. What if the rent is $ 100 less per month than you project? What about $ 200?

I hope I did not scare you. The point is not that, it is to stay safe. If you haven’t experienced the BRRRR strategy, it’s hard to understand the power behind it. If I had to give advice, it would be to explore this, but also to understand the risks involved. As a strong money lender, we’ve been involved in several hundred of these specific transactions and we’re happy to help guide you if you need a little help.