Creating Value in a Rehab or a Flip
Whether you are interested in straight property flipping or rehabs, adding value for both approaches means thinking more short term than with other real estate investment strategies. A flip refers to a purchase and subsequent sale, only doing minor cosmetic updates, or even just presenting the property differently, e.g. with professional staging. Mostly, value appreciation is achieved through a strong upward trend in prices, leading the property to "naturally" increase in value. With a rehab, substantial investments into the home are made. Renovations increase value through an enhanced living space.
As of late, we hear a lot about the "BRRR strategy", which is less of a
strategy really. It's more of a process to follow when you are looking at
rehabbing a property. With any kind of rehab, including BRRR, the goal is to increase the value of the property via renovations. This implies that there is an existing potential for improvements with a specific asset. Rental properties often get "run down" over time. Based on the fact that a landlord is unable to adjust rents to market with the existing rent controls in place, the incentive for improvements is minimal or non-existent, especially with long term tenants occupying the premises. The result is a property with dated kitchens, bathrooms, flooring etc.
Through renovations, this property can be lifted up and made attractive again, commanding higher rents on the market. Eventually, leading to an increase in value of said income property.
What is the BRRR approach?
BRRR stands for "Buy", "Renovate", "Rent", "Refinance", offering a systematic approach for property investors. The details of each step are explained below. While the logic of buying and renovating a dated property and thereby increasing its value is widely understood, the interesting part becomes the renting and refinancing. By following those two steps, a successful real estate investor can achieve and extract substantial value. We can help at every step of the way and make contacts to our trusted providers whenever needed.
In some instances, you will also hear of the BRRRR method. The additional R stands for "Repeat". Under these circumstances, repeat means that the investor takes the equity gained through the process of refinancing the property (step 4) and puts those funds into a new target property. The BRRR process starts anew.
The first step in the BRRR approach requires a lot of research and due diligence. The success of your project pivots on whether you are able to find a suitable property. You be analysing different locations; which areas offer actual opportunities for BRRR?
You will also be analysing rents in all markets you're looking at. One of the deciding factors becomes the rents that you will be able to charge once the renovations are completed. Look for recently renovated units with the same number of bedrooms and a similar size, in a comparable location, with similar finishing standards and amenities. Your due diligence on those rents will determine the future value of the property, so going into detail is a necessity.
On each opportunity, you will also have to estimate the reno-dollars needed. Another critical number which can make or break a deal. Using a spreadsheet for all the financial information will go a long way. It will help you identify, how much equity you will need and what your potential profit will be.
Before you jump on the opportunity, there is another household item: Financing. Don't assume, you'll get a mortgage as easily as you got one for your home. Income properties are different, and many a first-time investor comes out surprised. You also need a certain degree of flexibility; you want to be able to get out of the agreement as soon as you are ready to refinance. Most likely, an open and/or variable rate mortgage will prove best for BRRR purposes. Have your ducks in a row, with a qualified mortgage broker, who has dealt with investment properties before. Know exactly how much you can spend and how much the lender will give you, not an easy task these days.
Are you interested in finding a BRRR opportunity in the Greater Toronto Area? Contact us, we are happy to help.
Here comes the fun part! Now that the property is yours, you can go ahead and get to work. There's a multitude of service providers who can help at this stage: Architects, interior designers, contractors and more. It's advisable to at least have your contractor lined up, making sure they have reserved the time to work on your project. Choose somebody who will reliably deliver on time and on budget.
Another common pitfall is to over-renovate. Yes, those carrara marble countertops look stunning, but will the future tenant be willing to pay more for them? Keep in mind that a certain location can only support so much rent. Again, having done your due diligence on the rents and tenant profiles prevalent in the area will help you determine which finishes are appropriate. Often, the most added value can be attributed to updating kitchens and bathrooms, the appliances, plus improving the curb appeal of the property.
Make sure to have funds available to pay for the renovations. Most lenders will not finance the reno costs, and if they do, they may only provide you with the funds once the renovations are completed. Investors often use a line of credit or other funding sources for these purposes.
If you don't already own other rental properties, this is where you become a landlord. Familiarize yourself with the responsibilities that come with it. The laws in Ontario are formulated mainly to protect tenants, knowing the ins and outs, the dos and donts is very important for a successful BRRR process. The Landlord and Tenant Board hosts a multitude of valuable information and forms on their website. You will also find the standard lease form that has to be used for lease agreements in Ontario.
Having gained the knowledge on the legal side, your next task will be to advertise the units for lease. There are many good places to advertise apartments for rent, depending on your location. Then you are on the qualifying and screening the tenants. Also here, there are vast resources available online to help guide you through the process.
Being a landlord is a major responsibility, however, can also be quite rewarding. There is also the possibility of working with a property management company. They can help you screen prospective tenants and take calls from your tenants 24/7 for any problem that may arise. Paralegals can help you with any disputes regarding the leases. We maintain a wide network of professionals for all aspects of managing your income property.
As soon as you have rented out the units, you can tackle refinancing the property. Based on the increase in rents the property value will have appreciated. The higher cash flow in rent will inevitably lead to to an increased NOI and proprty value. In this context you will often hear the term ARV (After Repair Value). This new and higher value will allow you to borrow more on the property. If things go really well, you are able to pull out all your equity that you initially put in and utilise the funds for investment in a further property. As an alternative, you can also list the property for sale and pull out all your equity.
Assuming you did your homework on the initial mortgage, the refinance will go smoothly, i.e. you are able to discharge the original mortgage and find a lender that is ideal for the current state of the property. Ideally, you will already have a good understanding what the refinance will look like, having discussed the process with your mortgage broker upon purchase. Keep in mind, you will be subject to the full scrutiny again, income, expenses, and most lenders require appraisals these days. Knowing your numbers and being able to present them well is key to succeeding at this step.
We have excellent contacts in the GTA for all mortgage financing matters. Reach out to us and we will put you in contact with a seasoned professional.
Here is an example of how a BRRR could play out:
Purchase price 600,000
Closing costs, running costs 25,000
Renovations 100,000
LTV 80%, Loan 480,000
Downpayment 120,000
ARV 900,000
Refinance LTV 80%, Loan 720,000
You have been able to recover purchase price and reno cost and almost all your other costs. Only 5,000 in equity remains in the property.
In terms of ROI, the equity base is 245,000 (120 + 100 + 25k)
Increase in equity 175,000 (900 - 600 - 125k)
ROI 71%