- Rental property owners are looking for reliable ways to grow quickly and ensure stable cash flow.
- One way: buy a house, repair it to rent it out, then refinance it to get cash and buy the next one.
- Two investors explain the reasons why they are now turning away from this model, nicknamed BRRRR.
Jessica Davis Holland, a real estate investor from Austin, Texas, and her husband recently splashed out $225,000 on a three-bedroom, two-bathroom home in the booming suburb of Cedar Creek.
It was the fourth property in the past three years that the couple had purchased and renovated. Their initial goal, as with their previous projects, was to turn the house into a profitable rental property and then use the money they would get after refinancing to buy their next repairman.
After all, the Austin market was booming. Home prices were rising at what seemed like an exponential rate, which meant cash refinances were lucrative. Rents were also rising, which meant that money coming in from tenants often exceeded the cost – including principal, interest, taxes and insurance – of keeping the house.
Except this time the numbers didn’t work out the way Holland originally expected. On top of the purchase price, they spent about $65,000 on renovations, $5,000 on property taxes, and another $22,500 carrying the property — including closing costs and monthly mortgage payments — for a few months while the renovations were wrapping up.
With the $2,000 a month rent they could probably get, their monthly costs would exceed their income, so the couple decided the best way forward was to sell the house after completing the renovations. The $354,000 they made from the sale was more than they invested in the house in total, so they came out on top.
“We looked at long-term rent and we would have been in the hole a few hundred dollars a month based on interest rates and property taxes,” Holland told Insider. “We decided to reverse it because we weren’t in a position to say, ‘I’m fine if I spend $400 a month hauling this property. “”
Home rehabs like Holland are quickly discovering that the once reliable method known as “BRRRR” – short for buy, rehab, lease, refinance and repeat – has become much riskier as house prices homes in hot pandemic markets are crashing and 30-year mortgage rates hit the 7% threshold.
While family owners have practiced the BRRRR strategy for decades, it became even more popular in the years leading up to the pandemic, as investor influencers on social media and podcasts with major online forums, including BiggerPockets, extolled its virtues. And then, when interest rates fell and rents soared between 2020 and 2022, rehabbers across the country embraced the strategy with even greater enthusiasm, believing it was a surefire way to save money. add new properties to their portfolios and earn more money.
But a perfect storm of falling home prices, rising taxes, rising mortgage rates and high building material costs made the BRRRR model less appealing to investors. And Austin is particularly vulnerable, because real estate prices have fallen sharply since last summer, when they peaked.
The BRRRR method has become more difficult
John Crenshaw, a 27-year-old Austin investor who owns several rentals acquired via the BRRRR method, said it has become more difficult for him and his fellow investors to use since mortgage rates rose.
Not only are homes selling and appraising for less than they did six months ago, reducing the size of cash refinances, but lenders have become more risk averse.
“Instead of doing an 80% withdrawal, a lot of people are only doing 75% or 70% withdrawal, so you’ll only get 70% of your loan value back and the other 30% has to stay in the property,” Crenshaw told Insider.
While a difference of 5% or 10% may not seem like much on paper, it’s more than enough to change the equation for most investors, Crenshaw said. After a 70% withdrawal on a home that the lender says is worth $300,000, the borrower would receive $210,000, about $30,000 less than with an 80% withdrawal. And borrowers who refinanced a home two years ago would have gotten a 30-year mortgage at around 3%, according to data from Freddie Mac. Today, they would get a rate of around 6.65%, which could increase monthly mortgage payments on a $300,000 home by nearly $500 per month.
What owners can do instead of BRRRR
And because it’s impossible to simply raise rents to cover their costs, landlords are looking to expand their options — and ideally, their wallets — when they need to pivot.
When the BRRRR numbers don’t work, Holland said, there are a few strategies investors could consider instead.
“What are your exit strategies? ” she asked. “Can you keep it? And if you can keep it, are you going to rent it long-term or short-term, or are you going to flip it?”
While Holland and her husband ended up selling the Cedar Creek property, she said they explored all of their options, including using the property as a short-term rental on Airbnb. But even this strategy has its own competitive advantages and disadvantages, she said, such as seasonality and uncertain revenues.
In their case, when the cost of renovation and high mortgage rates matched, the best option was to simply sell the property to someone who wanted a well-renovated home – and move on to the next one.