28 Unbelievable Home BRRRR Mistakes (Buy, Rehab, Rent, Refinance, Repeat)
28 Home BRRRR Mistakes (Buy, Rehab, Rent, Refinance, Repeat)
If you're investing in property for buy and hold purposes, chances are you've heard of BRRRR. The strategy is buying a distressed property, rehabbing it, renting it out, and then refinancing it to get all of the cash you put into it. The end result is buying a $125,000 home for only $90,000, for example. It won't make you rich fast, but the debt paydown of its mortgage can be a much more lucrative strategy than home flipping.
The problem comes when people don't prepare and treat this home investing strategy differently than others. If you're considering it, or have already started here are 28 pitfalls to avoid.
ARV and Rent Estimates Only from Online Tools
We've all started here. At some point when learning you think that Zillow, Redfin or Realtor's After Repair Values, or ARV, are accurate. In some cases they certainly are, since they pull comparable properties, or comps, based on other homes in a similar bed and bath configuration, location and square footage. However, you should never trust these tools as a way to price your potential purchase amount or potential selling price. Instead, look at comps that were listed on the MLS. Check their finishings, square footage and bed & bath configuration. If you're in a market like mine in Richmond, VA you will easily find neighborhoods built all by the same builder, which means you simply need to find those home selling prices to find a value on your property. A great free way to do this is to use Zillow's Draw Circle tool.
Draw a small circle on the map around your property with the neighborhood of your prospective property.
Choose 3, 6 or 12 months for previously sold properties.
Set a square footage range around your property.
Look at the photos, finishings and condition.
Determine what your home could potentially be worth after the rehab phase.
The crazy part is the ARV is crucial in accurately guessing since you will need the money for your refinance stage. What is even wilder is that the cashflow on some BRRRR properties can be around $300 per month and still be considered a great deal. Missing your target on rent estimates can ruin the deal, after spending money on a property rehab... Always leave yourself some wiggle room on the deal, or master your ARV and rent estimates effectively so you won't pass on any potential gems.
Pro Tip: Ever notice that all of the properties through FSBO are either completely overpriced and don't sell, or sell for 13% less than agent represented properties? Get an agent set up to sell your home properly ahead of time, and check with them what they think they could get out of it.
No Proper Education or Studying
The fact is you are about to spend quite the chunk of change and what some people will jump into without preparation is mind-boggling. Imagine taking some of the largest risks in your life without understanding rehab costs, property estimating skills, or project management! There are tons of resources (like this handy article!) where you can learn about how to become a better BRRRR investor. Definitely start with Bigger Pockets as a great area to start basic learning, enhance advanced skills and meet other investors and hear about their experiences.
Basing Your Deal on 1%, 50%, and 70% Rules
I've heard many people tell me that they are passing on something that is objectively a great deal on paper, but it doesn't meet one of the 1, 50 or 70 percent rules.
1% Rule: A property that is worth $100,000 should rent for at least $1,000 per month.
This is absolutely not always the case. As a property becomes more expensive for total value, the rent will never continue at a 1% rate. It will actually go down the more expensive a property is. You wouldn't expect a $1,000,000 single family home to rent for $10,000 per month. Also, a property only worth $50,000 should rent for more than the 1% rule or there is a serious problem. There is a sliding scale that you should find. For me, my best property does not meet this rule since it rents for $1,950 and worth $325,000 which puts this at just 0.6%. Its the perfect mix of no headaches, and solid returns. The cheaper class C and D properties may meet those 1% rules but an extensive maintenance call can wipe out your bottom line entirely.
50% Rule: A property should generally have expenses around 50% of monthly rental revenue before paying for a mortgage.
This rule does not always apply and you should not estimate your costs as half of your rent. Calculate each cost itself and estimate conservatively without trying to cut any corners.
70% Rule: A property purchase and rehab cost should 70% or less of total ARV.
The 70% rule has always bothered me, because this shouldn't be the end all for home flipping or BRRRRing property. I heard one friend passing on a deal because it was at 85% but it would still have made them a significant return. A good rule is that if the property will take a substantial amount of time I would expect the home to be below the 70% rule, and if it is a quick cosmetic turn it is still a good deal above the 70% rule. Your project fits somewhere in between, make sure to calculate rehab costs and find a reasonable cost basis to your ARV rather than basing it solely on this 70% rule.
Skipping Inspections, Sewer Scopes and Septic Inspections
The one thing that is fantastic about real estate investing is that everything is calculated. It's not like another business where you have to take on an additional operating expense like a new employee or equipment, with no precise expected return on expenses. With real estate, some investors will cut corners on inspections to save on cost, but a $30,000 foundation job or $15,000 septic replacement can kill your deal. Not only is there an unexpected cost implication but it will also slow down the project. In BRRRR, your speed is rewarded since you can get your cash out of your project as soon as its over. Do yourself the favor, get inspections done.
Using Eraser Math
The second you start erasing is when you have made a mistake. We've all been in a situation where we want a deal so badly and it feels so right that we flip the pen around to start erasing costs, so that way the deal can still work! This of course is not how it works, and if you find yourself erasing property management costs so it will work, what will you do when you can no longer self manage 10+ properties?
No Professional Team in Place
If you don't have a professional team it can affect each step of a BRRRR strategy. Some of this can be found on the fly, as I had, but it is best to build this during the learning stages of BRRRR. Of course first learning about real estate investing you will want to action, so take action on something like building your network. Create a solid foundation so that you can build off of it when things get hectic - and stressful!
Real Estate Agent
Know the difference... Mortgage Broker: Acts as a middleman between you and mortgage lending institutions.
Direct Lender: The mortgage company themselves. They can provide a better price, but you will have to shop around for a mortgage yourself filling several different forms and credit checks.
Skipping home or flood insurance can have devastating consequences and should be set up ahead of time for your closing. If you own a home without insurance, consider the risk you take instead of mitigating hundreds of thousands of dollars for only hundreds per year. If insurance hurts the profitability of the deal you shouldn't consider it anyways.
Forgetting Closing Costs
When you run your numbers you can't underestimate or forget about the closing costs. They can add around 1.5% to 3% of the purchase price. In your closing you will need to account for prorated taxes, title search fees, title insurance, mortgage costs and even closing attorney fees.
Thinking You Know it All
A few Bigger Pockets episodes doesn't mean you're a pro, and even the most experienced home renovators can find a transition to buying and holding methods much more difficult. Its important to remember you are one of many with this strategy, and chances are you aren't the best. Stay grounded and remember anything can happen, but the real estate business most things are calculated.
Live in It Before Rehabbing
One of my first properties I bought and lived in for a year before renovating it and selling it. After that time I knew which things bothered me, needed updating and would provide the most value for a new tenant. One of the reasons I did this, was actually due to it being a requirement with a HUD home. Consider moving with your renovations to reduce your personal expenses and grow your investing in an exponential manner. A small sacrifice now will mean big things for your future.
Underestimating Your Rehab Costs
Estimating your rehab costs effectively will come with time and repetition. Not properly preparing for them can get your in over your head and potentially kill any profitability in the deal. A few ways to improve on this are by reading "The Book on Estimating Rehab Costs" and following deal analysis videos or posts.
Assuming Certain Materials Are Best
If you're thinking you have to upgrade to fancy granite counters and hardwood floors to satisfy a Class-B renter, remember these materials will need to not only look good, but be cost-effective for your budget and long lasting. The best material aren't what may be used for a home flip.
Not Considering Long Term Needs
During the rehab phase it is important to consider the long term needs of the property. Some of the issues may need to be fixed eventually so some are best to be tackled while you already have a crew on the job. Anything that needs repair, and can only get worse by ignoring it are things that should be included in your rehab budget.
Don't just focus on appearances. Rehab to preserve the longevity of a property.
Expecting Things to Go According to Plan
Something just about always comes up, especially on your first property BRRRR! Make sure you have a plan set up ahead of time. Take your plan and ideas to other investors and ask for their opinion!
Underestimating Monthly Costs
For apartments, condos and townhomes the HOA costs may seem high, but a lot of those costs are for capital expenditures, building maintenance and lawncare. That should be a wake up call if you think you can get away with paying next to nothing for these! Capital Expenditures: The costs for major repairs your property will need over long periods of time like roofing, HVAC replacements, plumbing and siding. Generally expect a budget of 5% of rental income for capital expenditures. Maintenance: These can be more expensive than you may think, since if you're just starting out you don't have a dedicated maintenance team. Have you seen how much tradespeople make nowadays?! Generally expect a budget of 5% of rental income for maintenance.
Lawncare: Since you will need a grass cutting every other week for most of the year that $45 grass cutting can get expensive, fast! Don't forget... Trash, stormwater, homeowners, HOA fees and yearly LLC costs.
Overleveraging by Refinancing
I'm sure you're hoping to recycle your capital through your BRRRR method endlessly, but for proper risk mitigation this may not exactly be the best strategy for you. I have read these stories of people growing their real estate business from 1 to 40 units and then losing all but a few because they grew their business by being in debt for millions of dollars while not paying down their equity since they continue to borrow.
Moving Every Property into One LLC
Putting your property into an LLC is a good idea so your portfolio isn't exposed to liability of another property. The problem is some investors will put all of their property into one LLC and miss the point entirely.
Some HOAs Don't Allow Renting
Before you get under contract, make sure to check in with the HOA agreement to see if there is a cap on rentals for the units or if the HOA allows it. Nothing would be worse than finding this out after spending thousands on a property rehab.
Did you know? Refinancing through Freddie Mac or Fannie Mae loans are not possible when purchasing a home within the past 6 months.
No Exit Strategy
Any business plan should consist of a need, solution, strategy, and feasibility. Within that, there are finer details, which some are neglected. Consider your exit strategy. If you're older and self-managing will you expect to be paying off a mortgage when you're 75 years old? Remember that this is an investment to provide income so that may mean to let it go in 15 years, or leaving it all in a trust for when you pass as wealth transfer. With any business, consider your exit strategy more carefully.
Lack of Reserves
A lot of BRRRR strategies involve holding a property for 15-30 years. During those times, plenty of things can break. If you haven't seen the salaries for tradespeople in the US, you may want to check that. Couple that with rising material prices in 2021 and you could be in some trouble trying to replace that HVAC unit that was stolen.
Hiring a Bad Property Manager
Finding a good property manager is sort've like finding a good realtor, just a lot of bad ones to sift through. You can do all of the rehabbing in the world, but if your property management company doesn't provide good service, communication and timely maintenance requests you could be be providing low quality leasing for your normal price. This will result in turnover and high home turn costs.
Not Checking Renters Properly
Request an Application.
Run a Credit Check
Run a Background Check
Contact Previous Landlords. This can be hit or miss since a landlord with a bad tenant may say the tenant is great as a way to get rid of them.
Contact the Tenant's Employer. If they are working from home due to covid rules, make sure they will be able to work remotely if they are from out of state, a different city, etc.
Make sure their income is at least 3 times rent.
Your requirements for credit, background and income should be standard across the board and you are ethically and legally required to accept the first one that meets your written requirements. Note that written requirements can change by each property, as each one is a different price, and property class.
Underestimating Self Managing
Some investors think there is no way to build a successful real estate rental business without a great property manager. I have done the opposite since I work on this full-time. Expect to add a few extra hours each month per property and remember at some point real estate investing shouldn't be a way to create an extra job and stress. So... don't create extra work and eventually get a property manager. You can expect to...
Schedule lawn care and trash
Marketing your property and find a good tenant
Learn about landlord-tenant laws
Not Keeping Up to Date with Real Estate Data
Two major things are happening in 2021 with a surge in commodity prices and trades labor. Everyone wants to fix up their home and this increased demand means an increase in labor and limited material costs. Check out the Redfin Data Center for current sales data in your market and follow material and labor prices as they change over time.
There's nothing like hearing the stories of 2 college students syndicating deals from 0 to 300 units in one year. If you expect to be driving a Ferrari in Italy (like I certainly hope to!) tone it down and remember BRRRRing is not a way to get rich quickly. Its best for building wealth over the course of your lifetime. The main benefit of course being the debt-paydown effect over 30 years. Many "good" BRRRRs end up only paying $200-$400 per month in cash flow, so don't expect a huge life change after your first deal.
Estimating Maintenance, Cap Ex, Vacancy the Same for All Different Types of Properties
On top of this, you can expect Class D properties to have more headaches and cost more of total rent as a percentage than higher-priced properties. For example, a $150 maintenance call will crush the bottom line on a cheap property, while it won't affect many class A property owners quite as much. If you budget 5% maintenance costs of a $600/month rental it ends up being a budget of $360 per year. A class D property like this will definitely cost
Not Starting due to Fear
Some fear can be natural as you're taking a risk, but if you haven't prepared and studied your strategy that fear can be warranted. If you're too afraid after having studied, you may want to consider partnering with an established investor for your first deal or hiring a home renovation consultant.
Forgetting to Keep Your Future Tenant in Mind
First you should keep in mind the best tenant for your property before you acquire it. When assessing it consider your school zone and total rooms. Ask yourself "Will it be better to rent to young professionals or a family" when looking at the property. Also ask yourself if a family oriented property may better serve your goals, since good schools can incentivize renters not to leave your property in a recession. Alternatively, you might want to keep young professionals in mind before your rehab. They may not consider your property as a good rental if not every roommate has good living accommodations.
When renovating your property make sure not to over improve. At a certain point, finishing touches and nice materials have a diminishing return. Just make sure its durable first, with design in mind second. From there choose timeless materials so your home isn't out of style in 8 years.