Just like some real estate flippers are exposed to price fluctuations while they are rehabbing a property, real estate investors using the BRRRR strategy are subject to interest rate fluctuations.
While interest rates do not normally rise significantly over a short period, the current market environment is such that we have seen an 100% increase in mortgage rates between January 2022 and November 2022, and this has stalled many BRRRR enthusiasts.
For example: I closed on my latest rental in March 2022 with a 3.5% 30-year fixed mortgage. By the time I was done with the rehab, rates had climbed to 5.5% and today they sit at 7%.
While I have added $50,000 in value to the property that I could remove and apply towards my next rental, doing so would increase my monthly payment to $2,475, which represents a $900 increase in my mortgage payment for this property.
If you too have been slowed down by rising interest rates, here are four potential steps you can take to alleviate the impact of the high interest rates environment we’re currently in and get back into the BRRRR game.
By Frugal Mogul
BRRRR’ing in a High Rate Environment
1.) Remember the end game
One should always start their BRRRR calculations by looking at the property’s after repair value (ARV) and run all of the numbers based on what your mortgage payment (plus accruals) will be in comparison to the projected rent from that property.
Even though cashflow is only one of four ways that investors benefit from real estate, I always want my properties to cashflow positive and would never enter into a deal if it was projected to lose money after the cash out refinance (the other three benefits are: appreciation, loan paydown, and tax deductions).
In a high interest rate environment, it will become harder to find properties that cashflow positive after a cash out refinance, so investors need to sharpen their pencils and be cautious about this when entering into a deal.
2.) Seek deeper discounts
In order to avoid having a property with negative cashflow after the cash out refinance, the BRRRR investor needs to seek deeper discounts when purchasing a property.
My “sweet spot” before rates rose was buying a property for $225K, renovating it for $50K, and then having it valued at $350K after all repairs were done. This allowed me to pull all of my funds out, and still cashflow pretty handsomely.
The above deal was perfect at 3.5% interest rates, but margins are too thin at 7% interest rates. I now need to buy that same property at a 20%+ discount in order to make the cash out numbers work in the current interest rate environment. This is no easy task!
3.) Venture outside the MLS
I have found all four of my current properties on the MLS, and I consider myself an “expert” within this very controlled listing environment. I now have to accept the reality that numbers may no longer work for properties listed on the MLS, as sellers have not yet adjusted asking prices to reflect a high interest rate environment.
Savvy investors look outside of the MLS for deals by reaching out to potential sellers directly to buy what the industry refers to as “off market” deals. Newer investors, such as myself, may need to venture into this secondary market to find ideal BRRRR properties. The good news for those of us who are uncomfortable with this strategy is that there are many Twitter accounts and subscriptions that share strategies on how to reach owners who may wish to sell their properties.
Editorial Note: we did a podcast last week on successfully finding off market deals with DealMachine’s CEO. For more content on buying off market deals listen to 10 traits of successful off-market buyers – with David Lecko CEO of DealMachine
4.) Maximize rental capacity
One uncomfortable reality to a high interest rate environment where prices are slow to drop, is that rents inevitably need to rise (no landlord is in the business to lose money).
Knowing this, a BRRRR investor can also plan to push the envelope of their individual rental markets by analyzing properties that are for rent at the higher end of their markets and mimicking the amenities in those properties.
For example, if the most expensive rental property in your market has central air, efficient heat, marble counters, and stainless appliances; imitate those improvements during your rehab to get maximum dollars for your property. This will improve your margins and somewhat offset the higher rates.
More from The Frugal Mogul
Frugal Mogul 🏡 (@RealFrugalMogul) / Twitter — twitter.com
Sharing my journey to financial independence through real estate. Follow for live tweets as I go from 0 to 15+ rental properties (currently at 4).