Growing a rental portfolio first begins with identifying your capital. Once you have the funds to purchase your first property, you can start creating an operating system for your process. Remember that savvy landlords will execute on their system over and over again to perfect it and grow their portfolio in the process. Ultimately, to quickly scale a rental portfolio, you need to apply the “BRRR” technique. BRRR stands for Buy, Rehab, Rent, Refinance.
Below are steps outlining the correct model for applying BRRR to a rental portfolio.
Before you begin: Understand BRRR
The high-level idea to scaling your portfolio is to first buy a below-market house—for example, at $100k—and obtain a bridge loan for $50k to renovate the home. Once it’s renovated, rent it out and conduct a cash-out refinance at 75% LTV with a new appraised value of $200k. This will net $150k in cash, leaving $50k in equity in the home with a paying tenant to pay off the mortgage loan. The $150k in cash is then used to pay off any loans you took on, while the remaining money is used for the next portfolio deal. Rinse and repeat.
If you already own one or more cash-flowing rentals, you can jump straight to step 4. That step will show you how to use that property to quickly kick off scaling your rental portfolio.
BRRR is a proven system, but the devil is in the details, and it can be derailed if you don’t carefully manage the whole process.
Below we will detail each step and the potential risks you will face.
Step 1: BUY
Find the property that aligns with your goals
When buying a property for a portfolio, you must understand the knock-on effect a bad property might have on the rest of the holdings. We all have heard of somebody losing a 20+ unit portfolio in 2008. The quickest way to ruin your portfolio is either due to excessive leverage or poor property quality. This is an important point because you must expect a mild recession every 3-4 years and a bad recession every 9-12 years. So if you hold a property for 29.5 years (the tax depreciation allowance), you must expect at least two severe recessions during your holding period.
- To help you understand and quantify the risks, you must have at least rudimentary excel models. You can use free services such as Google Sheets or Microsoft Excel to create a model that can help you estimate risks.
- Important risks to model are vacancy, depreciation, rent appreciation, and tax growth. To get started, it’s OK to use a template that already incorporates all this information. You can “make-it-your-own” by making a copy and adding your own comments and adjustments as you gain experience.
- You can base your initial assumptions on data you can find online, such as vacancy rate as reported by US Census, average rent per month from Zillow.
- Make conservative estimates and only purchase properties that fall within the criteria. Vacancy and other disruption to your ability to pay down debt is a considerable risk. Make sure to have a rainy day fund or project conservative vacancy assumptions.
Additionally, you must find a property that needs to be rehabilitated and is selling well below the current average market rates for the area where it is located. To understand current market rates, you can download this Zillow report on housing prices. To find properties that need rehab, you can check out OfferMarket — an investment property marketplace.
Buy the property with correct financing
When buying the property, you have several options, each having its own ramifications.
- Cash. Using cash to buy an investment property is the safest option. But this might not be available to everyone, especially someone starting out. So if you can use cash, do it. Since you will be conducting cash-out refinance once you get the tenant in, you will be getting all your money back.
- Hard money loan. If the total cash amount is not available, hard money loans are appropriate to secure the property. Hard money loans are short-term, high-interest loans secured by property collateral. This lending product is specifically designed for the BRRR model and will be cheaper if paid off quickly. The shorter amount of time the loan is outstanding, the cheaper it will be in real terms. OfferMarket Capital has resources that can help identify competitive loans.
Once you have your property, it’s time to roll up your sleeves and start on the rehab. Remember that time is money, so quickly completing each step outlined in this guide will help you scale quickly and cost effectively.
Step 2: REHAB
Learning how to rehabilitate effectively is an art that will take more than one deal to understand and get good at.
- With every spending decision, keep in mind, the only reason to conduct a rehab is to get a tenant at or near market rent. Therefore, the rehab should be performed in a financially efficient way. Spend as little as possible to accomplish as much as possible to bring the property up to comparable standard to the rentals in the local market.
- A savvy landlord will keep spreadsheet records of each rehab to help them optimize and improve their system from each flip. You can use a template such as this one to capture, budget, and conduct post-mortem on each completed rehab.
- Once you have a rehab plan captured in your spreadsheet, you can estimate the project’s budget. You should expect to complete some steps yourself, such as painting the walls. However, it would be best to delegate more technical tasks to a professional. This will help you establish base costs for materials and labor in a given market and give you the necessary know-how to screen contractors.
- Cost-effective and quick rehabilitation will expand your margin on the property and help you scale the portfolio faster
To implement your rehab plan, you will need capital. Cash is an excellent option if you have it. Still, most professionals rely on bridge loans or rehab loans to finish the project and get it rent-ready. A bridge loan is a bridge between the acquisition and permanent mortgage. You can search online for “bridge loans” in your area to find regional lenders that extend these types of loans.
Step 3: RENT
Once the rehab is near completion, start aggressively advertising the property to get tenants in place as soon as possible. Make sure not to compromise tenant quality for speed as one bad tenant is more work than ten good tenants. Once the tenant is in, make sure you are systematic about how you interact with them to ensure your system is scalable to many properties.
- It’s imperative to screen and run background checks on all tenants that will occupy your properties. This is the highest risk-reducing step you can take because nonpayment or vacancy can jeopardize your ability to service debt on the property.
- Have a standard set of documents to share with your tenants so that your expectations are clear and explicit from day one. Written documents will also help you cover up your basis if things go wrong.
- Use a service such as Rentdrop.io to collect rent and avoid any collection headaches or fees systematically.
- Establish a network of reliable professionals that can service your tenants’ needs. Your rehab experience should either give you an idea of who you can use or the knowledge necessary to screen for quality professionals.
- If you have sufficient profit margins on the property, you should hire a property management company (which can cost between 6%-12% of the monthly rent). This will free up your time so you can focus on scaling the portfolio.
Step 4: REFINANCE
The final step in the process is to conduct a cash-out refinance into a 30-year mortgage. This will get the invested cash out, so you have the capital to purchase your next rental property.
For example, let’s say your initial property cost you $100k. You then got a $50k bridge loan to complete your rehab—the total liabilities are now up to $150k. Now its after-repair or appraised value is close to $200k, and you have a tenant paying rent every month. With these changes, you can approach a mortgage bank and apply for a cash-out refinance at 75% LTV, meaning that you will get a loan at the full $200k house value. This loan will help you pay off your obligations of $50k for the bridge loan and return your initial $100k. So now you are left with a cash flow positive rental with $50k in equity locked in it with all your initial cash being right back in your pocket.
This process returns all your initial capital to you and allows you to repeat it over and over again. There are risks inherent to this model, like vacancy rates or rehabs that run over budget. One way to reduce risk is to apply conservative metrics in your models and continuously refine this process with each iteration.