We typically see this investing strategy applied to smaller investment properties, versus larger, commercial properties. But why? Keep reading to learn more about the BRRRR method.
The BRRRR method is a common value-add strategy implemented by both new and experienced investors. The acronym stands for buy, rehab, rent, refinance, repeat. We typically see this method applied to smaller investment properties such as single-family rental homes or one to four unit residential properties. Let’s dig deeper into the method and discuss why the strategy may be different for larger, commercial properties.
This one is simple. An investor buys a property that (1) they feel is undervalued and (2) is ripe for value creation.
Once an investor has acquired a property, they can then rehab the interior and/or exterior by upgrading the kitchens (appliances, countertops, cabinets, etc.), bathrooms (shower, sink, toilet, vanity), flooring, and paint throughout the property. Some properties only need minor cosmetic upgrades such as flooring or paint, while others need a complete overhaul that can involve stripping a property down to the studs, replacing major HVAC systems such as boilers, or even redoing water pipes or electrical wiring. The extent of the rehab is determined by the current condition of the property and the condition that the property needs to be in to lease to a tenant.
This one is also easy. Once the rehab is complete, the unit(s) should be ready to rent. By making upgrades to the unit(s), the investor should be able to obtain a premium rent compared to where the unit(s) may have recently been rented. Let’s say a unit is rented for $750/month before rehab. After injecting $5,000 to upgrade the kitchen countertops and cabinets and paint the walls, the investor might be able to achieve $900 or even $1,000 per month. There is no standard on what the rent increase should be compared to the amount of rehab, however, the larger the rent premium, the quicker an investor can recoup their rehab expense.
This one is also easy and depends on a few factors. First, the original purchase price, and second, the “total cost” after accounting for rehab and closing costs. If a property was acquired for $1,000,000, rehab was $250,000 and closing costs and fees were $100,000, the total cost would be $1,350,000 ($1,000,000 + $250,000 + $100,000). An investor should think of this as their cost basis and the total amount needed to get the property into its current condition. Some investors will fund the entire cost with cash, while others will use debt financing to supplement their cash. Some investors will even manage to fund the entire cost entirely with debt, however, finding a lender that will provide 100% of the total cost can be difficult. We typically see lenders who prefer to have their investor borrowers put some skin in the game by putting cash into the deal. Once a property is rented out and ready to refinance, lenders will appraise the property. Provided the NOI covers debt service by typically 1.25x, the lender will “cash-out” an investor up to a certain LTV, typically 70-75%. Some residential lenders will go higher up to 80%, however, we typically see lenders cap their cash-out at 75%.
This one is also easy. Once an investor completes the buy, rehab, rent and refinance, they can use the cash-out proceeds to move on to a second or even third property and repeat the process.
So, why might a commercial property be different from a smaller one to four unit residential property? Most residential lenders will cash an investor out immediately after stabilization. Meaning, once the property has been rehabbed and rented, the lender will order an appraisal and provide a cash-out refinance immediately after stabilization. This is great for investors because they don’t have to wait a certain amount of time before getting their equity out of the property. However, one main difference with a commercial property is most lenders want to see the property seasoned before providing cash-out.
Seasoning can mean a few things and each lender has their own definition. First, some lenders want to see an investor own a property for a certain period before they provide cash-out with a refinance. Some lenders want to see three months or even six months, while others want to see 12 months or a tax return after a full year of ownership. Some lenders take it one step further and prefer to see the property stabilized before providing cash-out and they might even use the same time periods which can delay an investor’s ability to quickly move on to the next property.