Today, I’m going to show you How To Use The BRRRR Strategy On Commercial Property
And as always, I will leave a comment below with a table of contents if you’d like to
skip around.
There are many different commercial real estate investing strategies.
And they run the gambit from simply lending money to other investors to running entire
redevelopments.
Whether you’re looking to grow your commercial portfolio by flying solo or with a group of
investors, the BRRRR method is a wonderful way to invest in real estate.
In fact, it’s the strategy that I’ve used on the majority of my commercial real estate
investments.
So, let’s dive into the BRRRR strategy using one of those buildings, 4015 Travis Drive,
as an example.
First, What Is The BRRRR Method? BRRRR stands for Buy, Rehab, Rent, Refinance,
and Repeat.
It’s been made popular thanks to the hosts at BiggerPockets, who have given many examples
of how this strategy can be used in residential investing.
The goal is to buy an undervalued property, rehab only the parts that will add or create
value, rent the property out to tenants, refinance the property based on the new value or income,
and move on to the next project.
Today, we’re going to be covering how to use the BRRRR strategy on commercial properties.
Buy The first step of the BRRRR method is to buy
an undervalued property. There are many reasons as to why a property could be undervalued.
Maybe the owner doesn’t know what it’s worth. Maybe the property needs to be rezoned
or re-positioned. Maybe the property just has a significant value-add component.
We bought 4015 Travis Drive in June of 2019. I had my eyes on that project since it came
across my desk in November. The seller and I traded offers back and forth for several
months before finally coming to an agreement.
I utilized the 5th step of my 5 Steps to Buying Your First Commercial Property: make an offer
a week. And don’t be afraid to make the offer that works for you.
The owner was asking $1.3 million for the 12,070 sq. ft. office building and it had
been sitting on the market for a bit. I offered $850,000 to open the door. Most investors
wouldn’t be willing to make an offer that low. But if you never make the offer, you’ll
never get the deal.
We ended up settling at $980,000 on the building - $320,000 under asking and only $81.19 per
sq. ft. With replacement costs sitting at around $130.00 per sq. ft. plus the cost of
the land, we certainly knew that we had bought right.
Rehab Before you close on the property, you need
to have your budget together for rehab.
Walk through the project with your contractor and get a game plan together for the aspects
of the building that you intend to improve upon.
Something important to keep in mind: do not over-rehab the property. I see investors do
that all the time. They get too attached to the project and want to renovate it to the
standard they would want to see out of an owner-occupied space.
Yes, you need to fix anything serious, like the roof and foundation, and you need to improve
the space, but only renovate aspects that you know will increase the value of the space
in a tenant’s eyes.
You are not renovating this property to the comps - you’re renovating it to produce
a higher net operating income.
On 4015 Travis Drive, we decided to increase the curb appeal first. We repainted the exterior,
sealed and striped the parking lot, updated the exterior doors, and added new landscaping.
These updates gave the building an immediate bump in status.
On the interior, we painted the walls, upgraded the doors, replaced the countertops in the
common area kitchen and bathrooms, and replaced the floor with a sturdy hardwood LVP.
Our renovation budget was around $230,000 for all 12,070 sq. ft. - right around $20.00
per sq. ft.
Again - every single one of these aspects was intended to help a tenant see the immense
value they were getting by renting with us so they would lease the space.
Rent It’s very important that you have a quality
leasing and management team.
When you’re undergoing these renovations to the property, they will be able to begin
marketing the space and touring tenants so they can start pre-leasing the space before
you have delivered it.
Of course, the faster you rent the space, the faster you can refinance and move on to
the next project.
The beauty of the BRRRR strategy is the rental rate you need to achieve to make the deal
successful. Since you’ve bought well below market, you should be able to achieve market
rents for what the building was prior to your acquisition.
Why would you do that?
Because the lease up for the property will be very aggressive.
Think about it - if tenants are looking at your beautifully renovated property and comparing
it to older, run down projects in the area that are at the same price point, they’re
likely going to choose your project.
That’s what we did at 4015 Travis Drive.
Market rents for office space in that area were in the low $20s per sq. ft. When we brought
the project to market for rent, we priced it in the low $20s per sq. ft., which pushed
tenants to the project. They couldn’t believe how nice the space was after touring other
similarly-priced office buildings.
Now - yes, the NOI does have a direct impact on your property’s value and therefore the
amount of cash you’ll be able to pull out on a refinance. But the BRRRR method isn’t
designed to bring you the absolute maximum value on the property.
You want to use this BRRRR strategy to quickly rent out a property, refinance it, and move
on to the next project so you can continue building your portfolio.
Refinance The refinance is where commercial property
truly stands apart from residential real estate when using the BRRRR method.
While residential properties are valued based on comps, commercial real estate is valued
based on the net operating income through cap rates.
The higher the NOI and the better quality the tenants, the lower a cap rate your bank
will place on the asset, which will in turn give you a higher value on the property.
We aim to refinance these commercial properties the second they are stabilized (typically
around 85-90% occupancy).
Since we’re not quite finalized on our Travis Drive project (I’ve only owned it for about
10 months at the time this article was written), I will give you our project refinance terms.
With an average rental rate of $23.50 per sq. ft. and operating expenses of $7.50 per
sq. ft., we expect to bring in an NOI of $173,808 per year at 90% occupancy. At a 7.5% cap rate,
which we feel is a bit conservative (I always recommend that all of your numbers lean heavily
to the conservative side - you never know what could happen) the property will be valued
at $2,317,440.
We will then refinance at that value with 20% equity remaining in the deal. After paying
off our loan, we will walk away from the refinance with north of $900,000 - 2x the equity necessary
to purchase the building AND we still own the project, which cash flows.
That’s right - we won’t just pull out 100% of our capital. We’re going to pull
out 200% of our capital and still own the property. And the timeline? Projected to be
36 months, with our realistic estimates in the 18-24 month range.
Repeat The final step of the commercial BRRRR strategy
- repeat.
Now that you’ve successfully completed this project, it’s time to go replicate it!
Using the BRRRR method, you can see how quickly you can grow your portfolio of commercial
real estate investments.
What To Keep In Mind When Using The BRRRR Strategy
Seasoning The Deal
Depending on your lender and their requirements, they may want you to season the deal. “Seasoning”
a deal means giving it time to settle in after stabilizing it so that there is enough data
to prove it is actually stabilized.
I’ve found that letting the lender know our strategy ahead of time can help cut down
on the time needed to season a deal, if any.
However, if your lender does require you to season the deal, you shouldn’t have any
issues in the short-term by having to wait on the refinance. You’ve bought the property
right, you rehabbed right, and if you rented to the right tenants, you should cash flow
just fine in the meantime.
Financing The Deal When we finance the project on the front end,
we combined the construction loan with the acquisition loan.
I also recommend discussing an interest-only period with you lender. And if you have a
good enough relationship, for for an IO period with interest carry in the loan.
An interest-only period is a time when you’re only responsible for paying the interest on
your loan, cutting your monthly carry costs significantly while you’re renovating and
repositioning your project.
If you’re able to get interest carry added in, then your lender is essentially lending
you the money to make those monthly interest payments, so you won’t have to come out
of pocket for those costs.
Having some sort of interest-only period, such as 12 or 18 months, isn’t uncommon
for commercial projects that are being renovated and repositioned, so your lender should be
familiar with the process.
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