This Real Estate Strategy Lets You Make ‘Infinite Investments’ After Putting Down Just a Little Cash
Novice real estate investors often ask “How can I buy properties without spending much of my own money?”
Check Out: 401(k) Growth Potential: Ways to Double Your Savings in 10 Years
Read Next: 7 Unusual Ways To Make Extra Money (That Actually Work)
There’s no shortage of gurus happy to teach you “$0” real estate investing strategies for creative financing, installment contracts or the BRRRR method (Buy, Rehab, Rent, Refinance, Repeat). And they work — for experienced investors.
As you wrap your head around the BRRRR strategy, keep the following pros and cons firmly in mind.
The BRRRR Strategy in Real Estate
You can think of BRRRR as flipping houses to yourself: you buy a fixer-upper, “force equity” by rehabbing it, and then refinance it with a long-term mortgage to keep as a rental.
When you refinance, you can potentially pull all of your initial down payment back out of the property. If you also pull out both sets of closing costs, you could — in theory — have $0 of your own money tied up in the property after refinancing.
It works because mortgage lenders use the after-repair value (ARV) when calculating your maximum loan amount. Imagine you buy a property for $100,000 and put $50,000 of repairs into it, driving the property value to $200,000. If the lender lets you refinance 80% of the $200,000 value, you can borrow $160,000, leaving you $10,000 to spare for reimbursing your closing costs.
You now own a rental property with none of your own money tied up in it.
“Infinite Returns” Using the BRRRR Method
The BRRRR strategy lets you recycle the same down payment over and over again, continually adding new properties to your portfolio. Properties that hopefully generate cash flow each month, and appreciate over time.
Again, in theory there’s no limit to your returns on your recyclable down payment. You keep using it to add assets with a $0 investment, and each one generates real returns.
What’s the annual return on a $0 investment if you end the year with $3,000 in cash flow? Now multiply that by 5, 10, 20 properties and you start seeing an infinite horizon of returns.
Downsides & Risks
The math equation above might technically result in a “divide by 0” error, but it ignores another resource you invested: your time and labor. It’s no small feat to fully renovate a single house, much less repeating the process three or four times a year.
Beyond the time and labor, this strategy also requires enormous skill. Or, more accurately, a series of skills. You need to know how to score great deals on properties, how to accurately forecast the ARV and renovation costs. You need to know how to manage contractors to keep them in-budget and on-schedule, which is not easy. And then comes knowing your way around both hard money lenders and conventional or portfolio lenders, navigating permits and inspectors, managing properties or managing property managers (which can be almost as much work).
Those skills take time to learn, and often involve expensive mistakes along the way.
Then there’s the dangerous use of leverage. Leveraging other people’s money to buy your own assets sounds great, but it also cuts both ways. Leverage can boost your cash-on-cash returns but it can also put you upside-down on both equity and cash flow.
Imagine going through all that work buying, renovating, and refinancing a property just to discover that you lose $3,000 a year on it rather than earning cash flow. That’s a very real risk.
Final Thoughts
I started my career in real estate investing doing BRRRR deals. And I had to learn the hard way just how dangerous leverage can be.
As a foolish young investor, I assumed that a property’s cash flow was simply “the rent minus the mortgage.” I didn’t realize that rental properties come with many irregular but inevitable expenses, such as vacancy rate, repairs, maintenance, and accounting costs. And that says nothing of property management fees, insurance, and property taxes.
In the industry, some investors refer to the “50% Rule.” It states that half of the rent will go to non-mortgage expenses like those outlined above. While a rough rule of thumb rather than a literal truth, it should open your eyes to expenses that many novice investors ignore.
Learn More: If You Bought $1K of Elon Musk’s Favorite Crypto 5 Years Ago, Here’s How Much You Would Have Now
Finding properties that cash flow well is hard work, and it takes a great deal of skill. If you just assume you can pull off the BRRRR strategy with a random house you find for sale on the MLS, you might find yourself owning a liability rather than an asset.
More From GOBankingRates
This article originally appeared on GOBankingRates.com: This Real Estate Strategy Lets You Make ‘Infinite Investments’ After Putting Down Just a Little Cash
