Passive Investor Tips is a weekly series hosted by full-time passive investor and Best Ever Show host, Travis Watts. In each bite-sized episode, Travis breaks down passive investor topics, simplifying the philosophy and mindset while providing tactical, valuable information on how to be a passive investor.
The BRRRR method is most often discussed in association with single-family homes and fixer-uppers. In this episode, Travis discusses how the BRRRR method relates to value-add multifamily syndications and why it’s gaining popularity as interest rates flatten.
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TRANSCRIPT
Travis Watts: Welcome back, Best Ever listeners, to another episode of Passive Investor Tips. I'm your host, Travis Watts. I've got a really exciting episode for you here today. We're talking about real estate syndications and the BRRRR method, and how those two correlate. Disclaimers as always, never financial advice. I'm not a financial adviser, CPA and attorney, so please always seek licensed advice when it comes to your own investing.
With that top of mind, if you're not familiar, the BRRRR method stands for buy, rehab, rent, refinance, repeat. And this is usually a strategy that people talk about in terms of single-family homes, and not a lot of people talk about in terms of real estate private placements. That's why I made the episode here today. So here's an example of how the BRRRR method works with a single family home, since that's what most people are familiar with and talk about. It would be the example of buying a fixer-upper property for say $200,000, putting a 20% downpayment on the home, which would be $40,000. And then let's say you put $30,000 into improving the property.
So at this point, your total investment is $70,000. That's your down payment and your renovation budget. Now what you do is you rent out the property to a tenant, and you cash-out-refinance. So in order to make that work successfully, this home now needs to be valued around $290,000. So here's how those numbers break down. If the property is now valued at $290,000, based on comparable sales, and you wanted to keep 20% down on the property, then that's going to be $58,000. And when you do a refinance, you have to pay off the previous loan, which was $160,000. So when you minus out those numbers, from $290,000, you're left with $72,000 in equity, which comes back to you, so that you can take that money and go do another investment.
So all you're doing in essence is you're fixing up a property, you're getting a new appraisal, and then you're getting a new loan, and you're trying to extract your original investment so that you can keep doing more and more investments along the way.
So as you can imagine, this is a pretty difficult strategy to pull off, generally speaking, because number one, you need to find a property that's well below the market comps. Number two, you need to know what strategic improvements to do to the property, and you need to stay on budget. And number three, you need to get an appraisal that comes back and supports the market comps at a much higher valuation. And the reason this has been so hard to do over the last few years, which is what led to the BRRRR method falling out of popularity - because in 2021, we had all time high pricing, all time low inventory, and lots and lots of competition in the market.
Break: [00:04:08.16]
Travis Watts: In 2022 the Federal Reserve began aggressively increasing interest rates, which hurts valuations of properties. So as you might imagine, if you buy a home with a 3% mortgage, fix it up, and then you have to go get a 5% or a 6% mortgage, you may not have enough equity in the deal to pull off the strategy. So that brings us to 2023, and what we're seeing now are that prices came down in a lot of markets nationwide, and interest rates are nearing the top of the rate hike cycle. So this is why the BRRRR method is regaining popularity, because now you can finally buy real estate at a slightly reduced price, with the expectation that interest rates will either stay the same, or they may even go lower in the years to come. It's much easier to do this particular strategy when interest rates are flat, or in decline. And if we look at the forward curve on the Federal Funds Rate, you'll see that there's three likely possibilities from here. First of all, the FOMC, which is the Federal Open Market Committee - this is essentially just people on the chair and on the board of the Federal Reserve - anticipate a flattening of interest rates through the end of the year. If you look at the Fed futures on what expectations are of federal funds rates, they're in a slight decline through the end of the year.
And the third scenario is if something breaks in the economy - unemployment shoots up, more banking failures happen, a nasty recession comes into the economy... This is where it's likely that the Federal Reserve is going to aggressively decrease interest rates. So overall, it's a pretty good outlook in terms of the expectations of the Federal Funds Rate at this time, making the BRRRR strategy a little more enticing in 2023 and moving forward.
So with all this in mind, how does this all pertain to real estate private placements and syndications? As many of you know, I primarily invest in value-add real estate private placements or syndications. And it's a very similar method that I described using the single family home example, we're just doing it on a much larger scale with very large apartment communities. We buy a property at a discount, we force appreciation through strategic improvements, we rent it out to tenants in the meantime, and then we have the option to refinance or sell the property, ideally for more than what we paid for it.
I wanted to make this episode for you because I'm seeing in this sector more and more deals pop up where the operators or general partners are predicting or anticipating to do a refinance in one, two or three years, and that's something that we haven't seen in quite some time. So potentially some great opportunities coming up.
As I mentioned previously, the last two years have been really difficult for single-family and for commercial real estate, because of the all-time high pricing and high demand of 2021, and then the aggressive rate hike cycle through 2022, which hurts valuations. So if you're considering investing in value-add real estate private placements this year in 2023, please keep this in mind.
If you ever want to take a deeper dive, learn more about this strategy or how it can potentially benefit you, feel free to reach out I'm on Instagram, Facebook, Bigger Pockets, LinkedIn... I'd be happy to be a resource. This is what I do both personally and professionally, year in and year out, and I'm always happy to be a resource.
Thank you guys so much for tuning into the show today. You're listening to Passive Investor Tips, right here at Best Ever. Have a great week. We'll see you in the next episode.
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