A Statement Of Cash Flow Is Not Used To: Risks of the BRRRR Strategy

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Risks of the BRRRR Strategy

It’s all the rage, and for good reason. I remember doing my first BRRRR strategy in 2004. I bought a house with hard cash to fix and flip in Arvada, Colorado. You won’t believe it; The flip flop was on and I had a problem. I was going over budget and was forced to go back on my rehab. Like on the way back. I no longer believed the sale price and decided to just keep it for rent. It was a nice big house in a desirable area, and I had a tenant to live in in no time. Now to the problem. That darn hard money loan. Fortunately, this was back when you could state your income and since I had good credit, I was approved. I kept that house for over 10 years!

Little did I know at the time, but I just fell for the BRRRR strategy. I bought a property, I rehabbed it, I rented it out, I refinanced it, and then I repeated the process. I bought that house with no money down and got the alternative money and positive cash flow. The word BRRRR had yet to be formed, but I knew I was on to something.

The entire Pine Financial team is talking about this strategy for a few reasons. First, we can help with a loan to get it done, but that works extremely well. This is a great strategy when trying to buy a property with little or no down payment. Want more information about this policy? I wrote a free report here. (see below)

Although this is one of my favorite buying strategies, it is not risk free. Here are three risks when using the BRRRR strategy:

  • A different opinion of value: In addition to all the normal risks of renting, BRRRR risks all come down to your ability to refinance a private money or hard money loan. The easiest way to get stuck is if your refinance appraisal is low. In my world we get an appraisal up front with an appraiser’s opinion of what the property is worth after repairs. Also known as ARV or later repair value. The key word here is – opinion. Another appraiser may have a different opinion. This is more likely if you are only doing minor repairs. It is very difficult for an appraiser to understand the huge increase in value in a short span of time. A major overhaul helps with this. Even if you’re just rehabbing a rental, you’ll still want to show that you’ve made improvements to the property to justify the value.

The good news about appraisals when you refinance is that you need to allow the appraiser access to the home. This means you can meet him or her at the property. I highly recommend that you do that and bring an appraisal done for your hard money loan, lists of repairs done, any updated comps that support your value. With these documents, we have seen fantastic results, but you must understand that this is always a risk. If the appraisal is low, you may have to cover the difference out of pocket or, in the worst case scenario, sell.

  • The initial loan was done incorrectly: I haven’t seen this, but our preferred lenders have told me it’s common. If you deal with someone who doesn’t understand this strategy, they can screw up the initial loan making it difficult for you to refinance them. Some common mistakes are:

    • How about its title – the best loan for your refinance right now is a Fannie Mae loan. They have fantastic 30-year fixed rates and no title seasoning. Title seasoning refers to how long you must hold title or own the home before you can refinance. Most banks or lenders have title seasoning guidelines. Fannie Mae does not. However, what they do have is a guideline of not lending to an organization. This means they want you to personally own the home. It is possible for your organization to release the title home in your personal name, but buying in your personal name makes the loan process much easier. After your loan is due, it may be a good idea to leave your claim on the property at that time.

    • Draw – I’ve heard that some lenders don’t put construction money back. When a lender does this, you will receive the full amount of the loan. If the lender pays for the repairs but does not list them correctly at closing, it may appear that you received cash back and the refinance lender will not make the loan. These are rate and term refinance loans, meaning they will only refinance the loan used to purchase the property. If they pay off the loan you used to put cash in your pocket, that’s considered a cash out refinance and you won’t qualify.

    • Lien – It sounds simple, but a lien placed on the title by a lender is a big deal. The biggest issue is that they actually hold a lien. This must be shown in the title search and disclosed on the closing disclosure, explaining that your refinance loan is being used to pay off the purchase money loan. The lien also needs to match the payoff statement amount, and it’s best not to modify or increase the loan in any way after you buy the home. Any one of these rates and term refinances can create problems in distinguishing them from cash out refinances.

  • Tight DTI: In 2004 I had a DTI problem. Income to debt. I was making money, but most of it wasn’t showing up on my taxes. These could be non-refundable deposits that will be reported at a later date, the military paying for some of my expenses while in college, or amortization or depreciation of assets. Some of my roommates were also helping with my bills. If you look at my tax returns and mortgage payments, I wouldn’t qualify for a loan. The said income loan was allowed only because I qualified. Since we are no longer in debt, we need to be more careful here.

For Pine Financial, if our clients plan to refinance we must be pre-approved for refinancing before we will loan them the money. This is not a requirement for flippers, but we want to help our clients succeed, so we pay attention to this small detail. After you are approved, it would be a good idea to test it. What if the rent is $100 less per month than your project? How about $200?

I hope I didn’t scare you. That’s not the point, it’s about keeping you safe. If you haven’t experienced the BRRRR strategy, it’s hard to understand the power behind it. If I had to give advice, it would be to explore it, but also understand the risks involved. As a dedicated lender, we have been involved in hundreds of these specific transactions and are happy to help guide you if needed. A little hand holding.


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