Investors looking to build value beyond simply purchasing turnkey properties (i.e., those already rehabbed, tenant occupied, and generating positive cash flow) can be rewarded with significantly higher cash-on-cash returns. And, as a renovated property becomes a seasoned rental, investors repeat the process with a cash-out refinance, building a high-return residential rental portfolio with low to no out-of-pocket expense.
Considering the recent and significant market shift away from historically low interest rates, the frenzied flow of home sales, and ever-increasing property values, a question is on the minds of many real estate investors: “Is there still opportunity for BRRRR investors in the cooling real estate market?”
In a word, yes.
Professional real estate investors continue to Buy, Rehab, Rent, Refinance, and Repeat. Although real estate investors always face challenges, the current environment can hold promise for experienced professionals looking to build a rental portfolio by renovating distressed or undervalued homes.
The leaders of LYNK Capital share some important market indices and trends that support the potential upside and ongoing need for renovations-to-rentals in the housing industry.
Pent-Up Demand for Housing
Even as the pace of real estate price growth slows and home sales are impacted by affordability concerns, a fundamental lack of housing inventory remains. Freddie Mac estimates a shortage of 3.8 million homes (including both rental and ownership) across the United States, and the Department of Housing and Urban Development’s August report indicates single-family housing starts in July were more than 10% below the June figure.
Although the Fed is expected to initiate additional rate increases and mortgage applications recently reached the lowest levels this millennium, the fundamentals of the real estate market are very different from the dislocation that occurred in 2008, because mortgage lending standards are now more robust. Given the pent-up demand and slowing supply, few expect real estate prices will fall by any significant amount.
Rising Cost of Home Ownership Creates Opportunity
“As the cost of home ownership continues to rise, many Americans are choosing to rent rather than buy a home,” noted LYNK head of Business Development Jarrod Ellis. “This demand creates opportunity for real estate investors looking to grow their rental portfolios. And, while relaxing modestly month over month, single-family rent prices remain at record annual highs.”
According to CoreLogic, the national Single-Family Rent Index (SFRI) is up more than 13% from a year ago (compared to the 2%-4% annual average maintained for the prior decade).
The Upside to Renovating Rental Properties
Aiming to acquire distressed homes to fix up, investors focused on renovating typically are not competing directly with traditional home buyers or potential renters looking for move-in ready housing. Given that two-thirds of existing homes across the country are at least 30 years old and 40% exceed half a century, those with an appetite to rehab properties in need of improvement have the numbers on their side.
As LYNK Capital CFO Matt Brothers explained, “Even with increased borrowing and supply costs, rent returns on updated homes can realize positive cash flow more quickly than in prior market cycles. The imbalance between supply and demand would indicate little chance of a dramatic dip in rental prices for the near future. This paired with the slow rate of housing starts, the current opportunity to capitalize on improving distressed housing cannot be understated.”
The Basics of BRRRR (Buy, Rehab, Rent, Refinance, Repeat)
• Buy
BRRRR investors are not seeking a property that has already been fully renovated; instead, their goal is locating the right value-add property that checks all the boxes: an attractive location for future tenants and requires enough improvements to bring out its value. Accurately calculating the After Repair Value (ARV) is a critical step in determining how successful the process will be.
When evaluating properties to renovate, investors have the option to buy properties that don’t qualify for traditional financing (i.e., major roof damage, inoperable kitchen, damaged drywall) or those that are less appealing than the local inventory (either too small, not enough bedrooms, or lacking expected amenities such as upgraded bathrooms). These can provide opportunity to update a home and outfit it with specific features to attract and retain an ideal tenant, providing the investor doesn’t bite off more than they can chew.
• Rehab
Beyond making a home habitable and considering wishes of future tenants, numerous considerations should be factored when developing a renovation plan—from cost and availability of materials, access to and affordability of skilled labor, and timeline to complete the property.
Experienced real estate investors, even those who have strong connections to suppliers and tradesmen, will readily acknowledge every plan should have some contingencies built in for cost and time overruns.
Projected rental value is important in deciding which improvements to make, but if you’re planning to rent the renovated property, it’s important to factor in the after-repair value (ARV) the home will reasonably sell for following rehab.
• Rent
A properly rehabbed home will attract strong tenants and typically require fewer expenditures for future maintenance.
Rental properties are long-term investments. Although some investors gain early equity through their improvements, and some realize positive cash flow from the get-go, most rental properties see the bulk of their profit over time.
Typically, projected cash flow is simply what’s projected at present and doesn’t account for future rent increases, appreciation, demand, and inflation. If financed with a fixed-rate loan, cash flow spread will continue to grow over the life of the rental property.
• Refinance
Once a rehab project is complete, investors looking to retain the property can often secure a rental property loan from the private lender who financed the renovation. Debt Service Coverage Ratio (DSCR) loans are qualified using the property’s income (rent) rather than Debt to Income (DTI) loans, which require proof of employment income and borrower’s tax returns.
Investors looking to repeat the process by reinvesting a portion of the property’s equity will refinance the property with a long-term fully amortized loan that can provide a cash-out option.
Although there is often a required seasoning period in which rentals need to have tenants before being eligible to refinance for a long-term rental loan, a short-term bridge loan with a cash-out option can be an optimal solution through the seasoning period.
• Repeat
Leveraging the learnings and equity earned through the process, investors can re, building a portfolio of properties and wealth. Experienced real estate investors often find that repetition offers advantages. Knowing which contractors to count on, how to navigate local processes such as permitting, and projecting potential pitfalls and windfalls.
Ben Lyons is the co-founder of LYNK Capital, a private equity fund providing capital to real estate investors and builders, and leads the LYNK Capital Mortgage Fund.
With nearly 40 years in the mortgage banking and real estate industries, Lyons’ experience includes the founding, building, and selling of several mortgage banking platforms.
Having been a founder or co-founder of a commercial bank, a title company, a consumer finance company, and several mortgage banks, Lyons has sponsored countless residential and commercial real estate projects.
An avid supporter of education, Lyons has served on multiple school boards and currently sits on the board of a private leadership and college preparatory school. He volunteers teaching personal finance and has authored “Be the Bank” and “From Worry to Wealth.”
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