5 Steps to purchasing your next rental property
At some point in time in the near future, you’ll find yourself in one of two positions: You’re either looking to acquire your first rental property and don’t know where to begin, or, you’re looking for your next rental property to add to your portfolio of passive income. Either way, these next 5 simple steps will help you acquire that rental property and it’s a strategy used by many investors – The “Brrrr” method (and yes I do mean like “I’m cold”). It stands for Buy, Rehab, Rent, Refinance, and Repeat.
First step is simple. Buy. Obviously this is after you’ve done your research, chosen your financing strategy, and got an offer accepted to purchase the property. I’ll touch on financing really quickly.
The best deals, often than not, come in the form of distressed properties. Properties in these forms don’t usually qualify for conventional lending or FHA lending and therefore require other forms of cash in order to get the transaction moving. I won’t dig deep into the other modes of financing, but some options are using your own cash, establishing a partnership with someone, hard money lending, and raising private money. I’ll go in depth into these financing options in another article.
However you choose to purchase your property will depend on your own goals and financial health. Either way, you have a property in your possession that now needs to be REHABBED
Time to get the rehab project underway which is the second step. Whether its small cosmetic updates or a large demo project, you’ll now become the project manager in order to ensure the project gets done in a timely manner. This is your time to add value to the home, be sure to hold your renovation team and schedule accountable!
Now that you have your home renovated and ready to be occupied by tenants you’ll want to get the property rented out as soon as possible. The longer the property stays vacant, the more you’ll have to pay “holding costs” such as the taxes, utilities and insurance. The quality of your tenants will also determine the success of your investment so be sure to choose wisely or it can turn into the rental property from hell! Background checks, credit checks, recent pay stubs, prior rental history, and references are great ways to screen a candidate thoroughly.
Remember, the best deals usually aren’t approved by FHA or Conventional lending programs and therefore must have been financed through your own cash, a hard money lender, partnership, or private lender. With that said, you probably financed under a different set of terms than your typical 30-year fixed rate mortgage. You’ll likely have a year or two to pay back the investor’s money with interest which is a system most investor-friendly lending sources follow.
Let’s say you buy a property for 100k and put 40k into the rehab in order to have an ARV, after repair value, of 200k. The rehab is complete and now there are tenants inside the unit and the home is now cash flowing after a 5 month project. Remember, you have either a hard money, or private lender to pay off and they’re usually looking for their money within a year. So what’s next?
Time to refinance the already existing loan of 140k (purchase price + rehab) for the new ARV of 200k. THIS is the time in which you would bring your loan to a traditional bank and refinance for a traditional 30 year fixed rate mortgage. Traditional lenders need a 6-12 month “seasoning” period before they will look at your loan to refi. That means you’ll need to own the house for at least 6-12 months before you can be eligible for a refi so be sure to check with your lender to see when the seasoning period is. With the example that we’re using above, remember it took 5 months to complete the whole project so we only have to wait one more month before we can go to the bank to refinance our 140k loan.
The bank has done it’s research on the home and boom it offers you the opportunity to refinance the home. Most lenders will allow up to 70% of the ARV so in our case, the bank decides to give us a 30 year fixed rate traditional mortgage of 140k, so what happens next? We pay off the already existing 140k loan we owe to the hard money lender or private investor and we essentially have purchased our new rental home with no money out of our own pockets except for closing costs. Not only that, we have about 30% in equity still in the home so we may be eligible for a cash out refinance or a home equity loan. Either way, you have the opportunity to pull out the cash, 60k for this example, and using it how you would like. Since we’re discussing a 5 step process to purchase your next rental, the last step is…..
It worked once, why wouldn’t it work again ? These are how investors build their rental portfolio and this is how you could too. You pull out the 60k from the previous rental and now you look to use that money to purchase the next rental, and the next, and so on and so forth. I will say this, eventually at some point you’ll hit a ceiling and you’ll be too over leveraged to obtain another refinance. Is that the end? Absolutely not! There are plenty of other ways to get creative financing in the world of real estate, but that’s a topic for a separate article!
Buy, Rehab, Rent, Refinance, and Repeat. This is the BRRRR method explained and hopefully another strategy for you to add to your arsenal of creative financing to purchase your next rental property!