Why High Interest Rates Don’t Have To Be The Brakes on BRRRR

The BRRRR strategy in real estate investing stands for “Buy Rehab Rent Refinance Repeat”  I’ve utilized this strategy as one of the major pillars of my small real estate portfolio.  I purchase a run down property that no one else wants for cash,  I fix it up, rent it out, and then refinance the property based on the new appraisal. The refinance pays back the initial purchase price and the cost of the rehab due to the total value added exceeding the purchase price and rehab cost by 25%+.

This method allows the same money to get reused on the next property.  With a 6 month waiting period required between conforming loans for a cash out refinance, over a 5 year period the same money could be used to accumulate 10 houses.

BRRRR In Practice:

A rough example would be I pay $30,000 for a property, spend $20,000 fixing it up, then rent it out for $950 a month.  I then refinance the property and the appraisal comes back at $80,000 and the bank allows me to borrow $60,000 against the property at a 75% loan to value.  After $5,000 in closing costs I end up with all of my money back from the property and an additional $5,000.

14 months ago I closed on a property with a 3.75% interest rate. In this scenario the monthly payment on a 15 year mortgage would be $436. Estimating $100 for property taxes, $50 for insurance and $50 for maintenance.  This property would have positive cash flow of around $314 a month.

This is a sunny scenario.  There are risks to the BRRRR strategy.  The 3 biggest risks are repairs exceeding initial budget,  low appraisal risk, and interest rates increasing.  I’ve hit all 3 of these and the recent increase in interest rates has been the most difficult to manage.

How BRRRR Changes With Higher Interest Rates

This strategy has become much more difficult to maintain as interest rates have skyrocketed. Now a similar loan instead of being 3.75% is 7.5%.  Going with the same example this increases the mortgage to $556 and reduces total cash flow to $194.   In my example this a reduction in cash flow of almost 40%, with no other variables in place.

To make matters worse, I bridge finance these deals with my home equity line of credit on my primary residence.  My initial purchase is from my Heloc, and the balance sits on my Heloc for 6 months until I can refinance it.  My Heloc has increased from 3% to 8.25% since the fed started raising rates last year.  For a $50,000 house over 6 months my interest expense increased from $750 to $2,062.

How To Combat Increased Interest Rates’ Effect on BRRRR

Borrow Less: The first option is to borrow less money in the BRRRR deal.  The goal is to stay in the game and expand our total real estate assets.  We can’t do that if we pay cash for each property, but we can certainly leave SOME equity in the property.  What if instead of taking an additional $5,000 out we also leave an additional $5,000 in the property.  Rather than getting a $60,000 loan we would get a $50,000 loan.  This would reduce the loan payment from $556 to $463 and increase cash flow to $287.

In addition to saving money by having a smaller loan, it is also likely that we will qualify for a lower interest rate since we are borrowing at a lower LTV.  In this case the LTV of the loan would be 62.5%.  This reduction should be good enough for at least a quarter point.  If we leave an additional $2,000 in the property we would be at 60% LTV and I would expect to get a half point reduction.  In this scenario our loan would be for $48,000 and our payment at 7% interest would drop to $431 a month. This would increase cash flow to $319, slightly above where we were at with the lower rate, and we would still have most of our cash back.

Do More Work Yourself: This goes in hand with borrowing less. On the last house I did the work on everything but the HVAC.  I made repairs to electrical, plumbing, drywall, painting, windows, roofing and tree work. Had I hired everything out I would have surely paid $20,000 for that labor.  Instead Mrs. C. and I worked 60-80 hours a week for 2 weeks.  This kept me from needing to borrow that $20,000.  Instead I borrowed under $5,000 in material costs.

Increase Rents: Increase the rent to offset the increased interest cost.  I truly believe that I have my finger on the pulse of rents in my area.  I check 4 different sources for rents being charged and track them in a spreadsheet with details about each house or apartment.  I have been doing this for 5 years.  In general the lower your rent the more applications you will get and the higher your rent the fewer applications you will get.  It’s great to have options, but you only need one!  Honestly the part of the job I hate is telling fully qualified applicants that they didn’t get the house because we went with the highest qualified applicant.  These are people we would be happy to rent to.  Some landlords love to have a stack of dozens of applications, while others just want a couple.  By asking a higher rent price you constrict the number of applicants and maybe increase the time before getting a signed lease.

If I would normally list this house at $950 and get 20 applications with 4 I would be happy to rent to,  If I increased my ask price to $1,100 I might get 4 applications and only 1 I would be happy with, which is OK because I only have 1 house to rent out.  Likewise it works the other way.  If I drop the rent to $700 I will get hundreds of applications with dozens who are qualified and the tenant I get will never leave willingly because their rent is so much cheaper than other options.

If I were to increase rents I would also ensure I take a few extra steps to add value to the tenants, without adding a lot of expense to myself.  Likely I would spend $500 putting in a used washer and dryer for instance. I may also consider allowing a pet.  Very few landlords in our area allow pets, so this would help drive the rental price up.

Refinance In The Future:

Interest rates will likely not be this high over the long term.  The current federal funds rate is 5.0% to 5.25%.  The general consensus is that in 2024 the federal funds rate will be 3.75% and in 2025 will drop to 3.25%.  Some analysts believe the federal funds rate will drop to 2% by the end of 2024.   Refinancing properties costs money. In general I spend $3,000 to $5,000 per refinance.  The flip side of this is that we can refinance out equity during a refinance.  If I can withstand the lower cash flow for 2 years, Then in 2025 when rates are substantially lower, I can do a commercial loan bundle of several properties, paying a single refinance fee and not only get a lower interest rate, but also clear out several of my conforming loans AND get a lump sum of additional cash.

I don’t really need the cash flow for 2023, 2024, or even 2025.  These 3 years I will have substantial W2 income and plenty of income from my other rentals that have locked in lower interest rates. Delayed gratification.

Take Advantage When No One Is Buying:

“Be fearful when others are greedy and greedy when others are fearful” People are still buying houses and we still have very low inventory, however there are some signs of softness, at least in my market with some properties sitting on the market for multiple months now with price reductions.  While the market for move in ready single family homes is booming, fixer uppers and multifamily houses are seeing a lot less demand.  This is because most investors who would buy those properties can not stomach the 7% to 9% interest rates we are seeing now after paying 3% to 4% for a decade.

Invest every Friday: You understand dollar cost averaging for stocks right?  Well the same thing for real estate. We are dollar cost averaging both the purchase price and the interest rate, and the interest rate we have the opportunity to change in the future. Keep buying real estate regardless of what the overall market is doing.

Last April when we bought our 6 unit multifamily house the seller did a single showing and got multiple offers above asking.  We just looked at a 5 unit that has sat on the market for over a month with a price reduction.  There were 2 bids on the property and the other buyer is under contract, but still, this was a very different scenario than last year.  2 months ago I bought this house that also sat on the market with no offers for 12.5% under initial asking price.

My Most Profitable House Started With A 9.25% Interest Rate!

In 2006 Mrs. C. and I tried to purchase our first home.  We had saved up a 20% down payment, found a house we wanted and organized all our documents for a lender.  Keep in mind 2006 was the wild west in home loans.  They were doing “liar loans” left and right.  Our problem was we didn’t lie enough.  Mrs. C. had some small debts in collections and I had no credit. We were denied a mortgage in 2006!  We had worked through a mortgage broker who normally passes the mortgages on to a big bank and that big bank denied us.  The mortgage broker offered to finance us on an interest only 9.25% loan for 12 months while we fixed our credit and then we would have to do a refinance after 12 months.

We refinanced a year later into a 15 year at 7.37% interest.  Today that 5 bedroom 2.5 bath house that we paid $48,000 for is worth closer to $150,000 and rents for $1,400 a month.  We have a mortgage for under $60K on it at 4.25% now.

Have you been scared by high interest rates?  Has it stopped you from investing?