Using The BRRRR Method in Canada

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The BRRRR method is a popular real estate investing strategy that can be used to finance the purchase of investment properties. The acronym stands for "buy, rehab, rent, refinance, and repeat." This strategy can be used to purchase both residential and commercial properties, and it can be an effective way to build wealth through real estate investing.

This page will take a look at how the BRRRR method works in Canada, walk through a few examples of the BRRRR method in action, as well as examine some of the pros and cons of using this strategy.

The idea behind the BRRRR method is that you purchase a property, rehabilitate/renovate it, rent it out, refinance the loan on the property, and then repeat the process with another property. The key to success with this strategy is to purchase properties that will appreciate in value, so that you can later refinance the rental property mortgage and pull out cash to use as a down payment on your next property.

If done correctly, the BRRRR method allows you to purchase rental properties without requiring much of your own money. Instead, you’ll use debt to kickstart your real estate investment portfolio and reap in the rewards through passive rental income.

The BRRRR method involves five steps that follows its acronym:

1) Buy - Find a property that meets your investment criteria. Usually, it will be homes that need some repair, causing them to be listed under market value. Be sure to do your due diligence to make sure the property is a sound investment when accounting for the cost of repairs.

2) Rehab - Once you’ve purchased the property, you will need to repair and renovate it. This step is important in order to increase the value of the property and to attract tenants.

3) Rent - After you’ve completed the repairs and renovations, the next step is to find tenants and begin collecting rent. Ideally, the rent you collect should be more than the mortgage payments, allowing you to be cash flow positive from the very beginning.

4) Refinance - Use the rental income and appreciation in the property’s value, through your home renovations, to refinance the loan. Pull out your home equity as cash equal to the value of the property minus the mortgage amount.

5) Repeat - Once you’ve completed the BRRRR method on one property, you can then repeat the process on other properties to grow your portfolio with the money that you cashed-out from the refinance.

The BRRRR method is a great way to generate cash flow and grow your real estate portfolio quickly. By finding properties below market value, renovating them, and then renting them out, you can bring in income each month that can be used to buy more properties. Here’s a detailed look at each step of the BRRRR method.

Buy

Find a fixer-upper property below market value. This is an important part of the process as it determines your potential return on investment. Finding a property that works with the BRRRR method requires detailed knowledge of the local real estate market and experience to sort and weed through listings. You’ll need to find a property that is selling for significantly less than its market value. This can be done by looking for foreclosures, power of sales/short sales, or houses that need significant repairs.

When determining whether a property is a sound investment, you’ll need to consider the after repair value (ARV), which is the property's market value after you repair and renovate it. Compare this to the cost of repairs and renovations, as well as the current property value or purchase price, to see if the deal is worth pursuing.

The ARV is important because it tells you how much profit you can potentially make on the property. To find the ARV, you'll need to research recent comparable sales in the area to get an estimate of what the property could be worth once it's finished being repaired and renovated. This is known as doing comparative market analysis (CMA).

Once you have a general idea of the property's value, you can start to estimate how much it would cost to renovate it. Consult with local contractors and get estimates for the work that needs to be done. It's always a good idea to get multiple bids from contractors before starting any work on a property.

Once you have a general idea of the ARV and renovation costs, you can start to calculate your offer price. A good rule of thumb is to offer 70% of the ARV minus the estimated repair and renovation costs. Keep in mind that you'll need to leave room for negotiating. It's also a good idea to get pre-approved for a mortgage before making an offer on a property so you know exactly how much you can afford to spend.

Rehab/Renovate

Once you’ve found a property, it’s time to start the renovation process. This is why armchair investors often shy away from fixer-uppers and the BRRRR method – they don’t want to get their hands dirty!

This step of the BRRRR method can be as simple as painting and repairing minor damage or as complex as gutting the property and starting from scratch. You can use tools, such as a painting calculator or concrete calculator, to estimate costs. Follow what you had planned when buying the property so that you don’t get over budget or make any unnecessary improvements that won’t significantly increase the property’s value.

The key to success with a fixer-upper is to carefully manage the renovation process. This means setting a budget and sticking to it, hiring and managing reliable contractors, and getting all the necessary permits.

Forced Appreciation

The end result that you are looking for is “forced appreciation.” In real estate, forced appreciation is when you actively increase the property value. This might be by adding living space to the home, developing the land around it, or improving the structure itself.

For example, building a deck, finishing a basement, or adding an enclosed porch are all ways that you can add value to your home. If done correctly, these additions can significantly increase the home’s resale value.

Another way is by developing the land around it. This might involve landscaping, installing a driveway, or putting in a fence. These types of improvements can make your property more attractive to potential buyers and force the value of your property to go up.

Finally, you can also improve the structure of the home itself. This might involve making repairs or upgrades to the home, such as fixing a leaky roof or upgrading the plumbing. These types of improvements can also increase the value of the property.

Rent

Once repairs and renovations are complete, it’s time to find tenants and start collecting rent each month. The rent you collect should cover the mortgage payments, leaving you with extra cash flow each month. Each mortgage payment that you make also increases your home equity. In a way, your tenants are paying for your mortgage, which builds up your equity!

If all goes well, the repairs and renovations on the property would allow you to charge a higher rent. If you're able to increase the rent collected on your property, you can also increase its value. This is known as “rent appreciation”.

Rent appreciation is another way that your property value can increase, and it's based on the property's capitalization rate (cap rate). The cap rate measures the net operating income (NOI) of the property, based on rent, against the property value or the price of the property. By increasing the rent collected, you'll increase the property's cap rate. This in turn increases how much a real estate investor or buyer would be willing to pay for the property.

Renting out the home to tenants means that you’ll need to be a landlord, which comes with various duties and responsibilities. This might include maintaining the property, paying for landlord insurance, dealing with tenants, collecting rent, and handling evictions. For a more hands-off approach, you can hire a property manager to take care of the renting side for you. While this will reduce your income as it adds an additional ongoing cost, it does help keep your income passive.

Refinance

Once your property is rented out and is earning a steady stream of rental income, you can then refinance the property in order to pull out your equity. This can be done with a traditional lender, such as a bank, or with a private mortgage lender. Pulling out your equity with a refinance is known as a cash-out refinance. With this, you’ll be borrowing more money than you did with your original mortgage.

In order for the cash-out refinance to go smoothly, you’ll need to have enough equity built up. Most lenders will only allow you to refinance up to 75% to 80% of your home’s value. Since this value is based on the repaired and renovated home’s value, you will have equity just from fixing up the home.

Lenders will need to verify your income in order to allow you to refinance your mortgage. Some major banks might not accept the entire amount of your rental income as part of your application. For example, it’s common for banks to only consider 50% of your rental income. B lenders and private lenders can be more lenient and might consider a higher percentage.

For homes with 1-4 rental units, the CMHC has specific rules when calculating rental income. This varies from the 50% gross rental income approach for certain 2-unit owner-occupied and 2-4 unit non-owner occupied properties, to the net rental income approach for other rental property types.

Let’s say that you’re new to the BRRRR method and you’ve found a home that you think would be a good fixer-upper. It needs significant repairs that you think will cost $50,000, but you believe the after repair value (ARV) of the home is $700,000. Following the 70% rule, you offer to buy the home for $500,000. If you were to purchase this home, here are the steps that you would follow:

1) Purchase:
You make a 20% down payment of $100,000 to purchase the home. When accounting for closing costs of buying a home, this adds another $5,000.

2) Repairs:
The cost of repairs is $50,000. You can either pay for these out of pocket or take out a home renovation loan. This might include lines of credit, personal loans, store financing, and even credit cards. The interest on these loans will become an additional expense.

3) Rent:
You find a tenant who is willing to pay $2,000 per month in rent. After accounting for the cost of a property manager and possible vacancy losses, as well as expenses such as property tax, insurance, and maintenance, your monthly net rental income is $1,500.

4) Refinance
You have trouble being approved for a cash-out refinance from a bank, so as an alternative mortgage option, you choose to go with a subprime mortgage lender instead. The current market value of the property is $700,000, and the lender is allowing you to cash-out refinance up to a maximum LTV of 80%, or $560,000.

How do the numbers work out in this BRRRR example? You refinanced the rental property mortgage to $560,000, allowing you to cash-out $70,000 compared to your original mortgage balance of $400,000. This $160,000 can then be used as the down payment for a second rental property.

The upfront costs that you paid out of pocket includes $50,000 in repairs, $5,000 in closing costs, and a $100,000 down payment. Your net rental income is $1,500 per month, or $18,000 per year. Before considering your monthly mortgage payment and taxes, your return on investment (ROI) for the first year is:

The ROI for the first year is 11.6%.

How will your return look like if you account for your mortgage payment? A $400,000 mortgage with a mortgage rate of 3.5% for a 25-year amortization would have a monthly payment of just under $2,000. This eats up almost the entire rental income that you’ll be receiving, and you may even end up cash-flow negative when accounting for operating expenses. In this example, the majority of the gains will be from price appreciation of the property.

However, approximately $850 of the $2,000 mortgage payment is going towards the principal in the first year. This pays down the mortgage balance and turns into home equity. This means that only the mortgage interest cost, which in this example is roughly $1,150 per month, will reduce your ROI.

Depending on the ARV spread, your return on future properties will be higher. This is because in an ideal scenario, your future out-of-pocket expenses will instead be paid for using money that you have cashed-out from a previous BRRRR cycle.

For example, the $160,000 cashed-out from this example can be used to purchase another $500,000 property with a $100,000 (20%) down payment, with $60,000 left over for repairs and closing costs. You might be able to get by without paying a penny out of pocket in your subsequent BRRRR properties!

The 1% Rule and the BRRRR Method

The 1% rule in real estate is a guideline that suggests that your monthly rent should be at least 1% of the purchase price of the property. This rule of thumb can be helpful in determining whether an investment property is likely to be profitable or not.

For example, a $250,000 property should have a monthly rent of at least $2,500 per month, and you’ll want your mortgage payment to be less than $2,500 per month.

There are several reasons why real estate investors might choose to use the BRRRR method:

1) It can help you grow your portfolio quickly. By renovating and then renting out properties, you can bring in income each month that can be used to buy more properties.

2) It can generate positive cash flow. The rent you collect should cover the mortgage payments, leaving you with extra cash each month.

3) It can help you build equity quickly. By renovating a property, you can increase its value, which means you’ll have more equity to borrow against when it comes time to sell or refinance.

4) It forces appreciation on the property. Because you’re buying properties below market value and then adding value through renovations, your downside is limited if the market declines.

5) It’s a flexible strategy. The BRRRR method can be used on a variety of home types, such as single-family homes, condos, and multifamily properties. And, it can be done with either traditional financing or using private lenders.

BRRRR properties are not ATMs that allow investors to refinance and pull cash out of their investment property indefinitely, and it comes with risks. There are a number of reasons why the BRRRR method is not ideal for everyone. Here are five risks of the BRRRR method:

1) It can lead to over-leveraging. Since you are refinancing in order to purchase another property, oftentimes right up to the loan-to-value (LTV) limit allowed by your lender, you have little room in case something goes wrong. A drop in home prices might leave your mortgage underwater, and decreasing rents or non-payment of rent can cause problems that have a domino effect on your finances. The BRRRR method involves a high-level of risk through the amount of debt that you will be taking on.

2) It can tie up your cash. When starting, the down payment for the purchase of the rental property and the cost of repairs can be significant. Repair costs might also balloon out of budget, forcing you to cough up even more cash. You’ll need to pay these costs upfront, and you won’t be earning any rental income during this time. This ties up your cash until you’re able to refinance or sell the property. In addition, you might be forced to sell during a real estate market downturn with lower prices. Being approved for refinancing isn’t guaranteed either.

3) It can be difficult to find the right property. You’ll need to find a property for below market value that has potential, and it can be hard to sift through listings for the right one. Besides the value you might pocket from flipping the property, you will want to make sure that it’s desirable enough to be rented out to tenants.

4) It can be time-consuming. From searching for undervalued properties, managing repairs and renovations, finding and dealing with tenants, and then dealing with refinancing, there are a lot of moving parts to the BRRRR method. This can become hard to manage when you have multiple properties going through the BRRRR steps at the same time.

5) You need to have a good understanding of the market. The BRRRR method is a strategy that can be employed in any market, but it’s important to understand the conditions of your particular market. Is the market in a bubble? Are prices increasing or decreasing? What is the average vacancy rate? All of these factors will affect your bottom line when you go to sell.

BRRRR Method Differences in Canada

There are a few differences when using the BRRRR method in Canada. For one, it can be more difficult to cash-out refinance with BRRRR when compared to the United States. That’s because home appraisers might be more cautious when valuing refinances compared to purchases. This can limit the amount that you are able to cash-out.

A rule that the U.S. has that isn’t as common in Canada are refinance seasoning requirements. In the United States, you will typically need to wait at least six months before you can refinance again with the same lender. In Canada, there is usually no such minimum waiting period, which means you can cycle through the BRRRR method faster.

One major difference is the make-up of the real estate markets in each country. Major housing markets with high home prices, such as Toronto or Vancouver, might not be suitable for the BRRRR method if you’re evaluating properties solely on the 1% rule. For example, the benchmark price of a detached home in Vancouver in July 2022 was just over $2 million. This means that your rent will need to be at least $20,000 per month!

The BRRRR method is a great way to build wealth through real estate, but it’s not without its risks. Make sure you understand the market and the property before you dive in, and have a solid exit strategy in place. With careful planning and execution, the BRRRR method can be a great tool for building your real estate portfolio.