Dropmodel Release: An Inside Look at our Buy-Renovate-Rent-Refinance (BRRR) Model
The Buy-Renovate-Rent-Refinance (BRRR) strategy is one of the most powerful real estate investing strategies out there, and it’s winning over investors every day. That’s why we’re excited to announce the latest analysis tool at Dropmodel: the Buy-Renovate-Rent-Refinance (BRRR) Cash Flow Model.
The BRRR Investment Strategy Explained
The BRRR strategy involves buying a property, renovating it, renting it out, and refinancing soon thereafter. Most investors know that adding value via renovations is an investing no-brainer. It has a high impact on value and market rental rates and is fairly easy to implement in a short period, which helps increase investment returns.
The real magic of the BRRR strategy is what happens to returns after not just renovating and renting, but also refinancing. The sooner an investor can refinance, the better—because that is when the investor can reduce their net investment, lock in new long-term fixed rate debt, and reap the benefits of passive “buy-and-hold” real estate investing.
Refinancing allows investors to pull out some or all invested cash required to complete the purchase and renovations, and maintain a significant equity position (property value less outstanding loan balance). Another benefit of refinancing, which is just icing on the cake, is that the refinance proceeds can be mostly or all tax-free. That means one can increase the value of the property, get enough refinance proceeds to return all or some of the purchase and renovation costs, and put additional cash in one’s pocket without being taxed.
In short, BRRR allows investors to end up with a very low (or zero) investment basis (cash in the deal) after refinancing. When net income is positive, and investment basis is low, investment returns look good or great (e.g., infinite returns because an investor’s basis is zero and they have positive cash flow after debt).
Let’s say an investor decides to buy-renovate-rent and continue to hold the property without refinancing. What’s different?
Answer: all of the cash used to purchase the property and renovate it remains “tied up” in the deal. In other words, the appreciation and higher cash flow due to higher rents are there, but there is also a lot of trapped equity in the deal that could be put to use in other investment vehicles. The result is lower returns on net invested capital, aka return on equity, than there would otherwise be.
But Isn’t It Risky/Unwise to Refinance and Increase the Loan Balance?
Maybe, maybe not. Investors can often achieve investment returns that are higher than the cost of debt—especially the after-tax cost of debt, which factors in the benefits of deducting interest. In these cases, it makes sense to lock in long-term fixed rate debt and deploy the refinance proceeds into other investments that produce higher returns than the cost of the borrowed funds.
Of course, higher leverage is accompanied by a higher risk of negative cash flow and/or negative leverage if market values/rents decline, so investors should take market factors and their risk tolerance into account to determine acceptable levels of leverage for each property.
Whether additional leverage (higher loan balance) is risky and/or unwise is fairly complicated and impossible to know in advance. We built the BRRR model with these considerations in mind, with the goal of helping others gain clarity and mitigate risk through a better understanding of each project.
Introducing: The Dropmodel Buy-Renovate-Rent-Refinance (BRRR) Cashflow Model
We’re not going to sugarcoat it: the Dropmodel BRRR model is a powerful beast and it needs to be in order to do justice to this strategy. While it takes about five to ten minutes to complete, the comprehensive and often eye-opening results make it all worth it.
The input phase consists of 10 sections, each covering distinct project components, including one that covers the future sale of the property. This section generates investment returns that rely on a sale (e.g., Internal Rate of Return). For those than plan on having a hold-period of forever, they can choose to ignore any investment returns that take a sale into account.
The first thing you’ll see in the results is an Executive Summary, helping you and other stakeholders get oriented with an overview of the major project cots, activity, and investment returns.
The most eye-opening and valuable information in the results view will likely be the annual cash flow table. This is where you’ll see all of the detailed projections of income and expenses, loan activity, assets and liabilities over time, and time-based investment metrics by year (e.g. return on equity, cash on cash, etc.). Most of the investment performance metrics in the report will be based on what occurs in the cash flow.
The Key Performance Metrics section provides two sets of metrics, one for the first year after refinancing and the other for the total for the entire hold period. Both are important for getting a sense of the project’s potential compared to alternative projects.
The Project Breakdown section will provide detailed views of all important project components, including purchase loan, renovation, refinance loan, operating expenses, and future sale.
The Project Overview section outlines the sources and uses of funds that flowed in and out of the project, as well as a timeline showing critical dates so you can plan your project, including the start and finish dates of the renovation, refinance, and future sale.
The BRRR strategy should be included in every investor’s repertoire, and we built this model so that you could spend less time in spreadsheets and more time making money.