In todays email:

We will focus on strategies with respect to buying residential real estate (not on buying, selling or creating mortgage notes, syndications, etc.)

• 😲 Strategies to avoid: BRRR (buy, renovate, rent, refinance)

• 😉 Strategies to embrace: Subject to, owner finance, lease options.

The 2024 Environment

There are many strategies, however, it is important to focus on those strategies that will have a better chance of success in the current macroeconomic environment.

The current environment is higher interest rates and lack of easy money. Getting a loans for an investment real estate was difficult in 2023 and I think it will not get any easier in 2024 for most investors. Why? The downpayment requirements have increased, prices remain elevated, and rates are higher. Even with all the talk of the interest-rate cuts, it will not significantly reduced the long-term interest rates in comparison to what they were in the past. My best guess, is that mortgage rates will hover between 6%-7.5% which is substantially higher than those rates in prior years of 3.0%-4.5%.

In addition, the loan covenants are getting more difficult. Loan covenants are terms and conditions outlined in a loan agreement that borrowers must adhere to. These covenants serve to protect the lender's interests by ensuring that the borrower maintains certain financial and operational standards.  For example, a covenant is a term of the loan you have to meet like a liquidity requirement or cash flow requirement. If you don’t meet the covenant then you are in default in the loan. In the context of residential real estate rentals, loan covenants may include:

1. Debt-Service Coverage Ratio (DSCR): This ratio measures the property's ability to generate enough income to cover its debt obligations. Lenders may require a minimum DSCR to ensure the borrower can meet loan payments.

2. Loan-to-Value Ratio (LTV): This ratio compares the loan amount to the property's appraised value. Lenders may set a maximum LTV to mitigate their risk and ensure borrowers have sufficient equity.

3. Property Insurance Requirements: Lenders often mandate that borrowers maintain adequate property insurance coverage to protect against damages. This is to ensure the property remains a viable asset securing the loan.

4. Maintenance and Repair Standards: Borrowers may be required to maintain the property in good condition. This includes addressing necessary repairs promptly to preserve the property's value.

5. Occupancy Requirements: Lenders may impose minimum occupancy standards to ensure that the property remains income-generating. This can involve maintaining a certain level of occupancy or preventing extended periods of vacancy.

6. Prohibited Transactions: Some loan agreements may restrict certain transactions, such as selling the property without the lender's consent or encumbering the property with additional liens.

7. Financial Reporting: Borrowers may be obligated to provide regular financial statements and updates to the lender, allowing them to monitor the property’s financial performance.

8. Cash Reserve Requirements: Lenders may require borrowers to maintain cash reserves as a financial cushion to cover unexpected expenses or loan payments during periods of economic downturn.

It's crucial for you to thoroughly understand and comply with these covenants to avoid defaulting on the loan. Failure to meet covenant requirements could lead to penalties, increased interest rates, or even foreclosure. Additionally, lenders may conduct periodic reviews to ensure ongoing compliance with these terms.

So why am I explaining all this? Because it is important that you critically look at each strategy and decide based on today’s environment which would be more suitable.

Today, I will focus on what I think is the worst strategy (in my opinion) for 2024.

Worst Strategy For 2024

BRRR (Buy, Renovate, Rent, and Refinance)

First, let me explain how the BRRR strategy works. The BRRR strategy in real estate refers to a systematic approach that investors use to acquire (buy), renovate, rent, refinance, and repeat. Each letter in BRRR represents a step in the process. Here's a breakdown of each step:

1. Buy: Investors identify and purchase a distressed or undervalued property. This could be a property in need of significant renovations, a foreclosure, or a property available at a below-market price.

2. Renovate: After acquiring the property, investors invest in renovations or improvements to increase its value. The goal is to make the property more attractive to potential tenants or buyers.

3. Rent: Once the renovations are complete, the investor rents out the property to generate rental income. This step helps cover the holding costs and provides a stream of cash flow.

4. Refinance: With the property now renovated and generating rental income, investors seek to refinance the property. By doing so, they can potentially pull out a significant portion of their initial investment or equity, using the increased property value and rental income to secure a new loan.

5. Repeat: With the refinanced funds, investors can use the capital to repeat the process with another property. This cycle allows investors to leverage their initial investment and continually grow their real estate portfolio.

The BRRR strategy is popular among real estate investors as it provides a way to recycle capital and maximize returns over time. However, it requires careful planning, market analysis, and execution to be successful. Investors need to accurately estimate renovation costs, rental potential, property values, and have the ability to refinance to ensure the strategy remains profitable.

Why do I say to avoid and why I feel so risky?

While the BRRR strategy can be a lucrative approach to real estate investing, there are potential challenges and risks associated with its implementation. Many of these risk were there in prior years but as the lending environment has gotten more difficult as explained above, and interest rates have increased and the home prices have gone crazy, so now is the worst time for BRRR. Here are some main issues that investors may face when pursuing the BRRR strategy:

1. Market Risk: Real estate markets can be unpredictable, and economic conditions can impact property values and rental demand. A downturn in the market could affect the success of the strategy, especially if property values decrease or rental income declines.

2. Low Inventory: Currently, the market has low inventory of houses for sale and finding houses in need of rehab are hard to find. So you have to do sufficient marketing to find these under priced properties and then put them under contract. That alone is a full-time job.

3. Renovation Costs: Cost have gone up significantly. In addition, estimating renovation costs accurately is crucial to the success of the BRRR strategy. Underestimating costs can lead to financial strain and may result in lower-than-expected returns. It's essential to conduct thorough due diligence and work with reliable contractors.

4. Financing Challenges: Securing financing for both the initial purchase and the subsequent refinancing can be challenging. Remember, you have to get funding for both the initial purchase and then for the refinance. Lenders may have strict requirements, and obtaining favorable terms can depend on factors like creditworthiness, property condition, and market conditions. Even hard money lenders look at your credit these days.

5. Market Timing: The success of the BRRR strategy is also influenced by the timing of property purchases and sales. Timing the market correctly is difficult, and investors may face challenges if they buy properties at the peak of the market.

6. Property Management: Managing rental properties can be time-consuming and may require skills in tenant relations, maintenance, and property upkeep. Inefficient property management can lead to increased expenses and reduced profitability.

7. Regulatory and Zoning Issues: Changes in local regulations or zoning laws can impact property use and affect the feasibility of the BRRR strategy. It's essential to stay informed about any legal or regulatory changes that could affect real estate investments.

8. Unexpected Issues: Renovation projects may encounter unexpected issues or delays, such as construction complications, permitting challenges, or unforeseen structural problems. These can increase costs and disrupt the planned timeline.

SUMMARY: With this strategy, everything has to go just right.

You have to buy the property right and at a low enough price, you have to renovate the property and there are sooo many things that can and do go wrong with the rehab process. Then, if you get the renovation done successfully, you now have to find a good tenant. Then you have to manage the tenant and deal with maintenance and repairs. Now after all that, you have to go to a lending institution and try to get a loan and there are many requirements (as explained above) making it difficult to get that loan.

Wow! So many moving parts.

Even just doing one of those is hard enough, but now you have to be an expert in finding discounted properties, rehabbing properties, rental and property management, maintenance, and raising capital and getting loans.

The BRRR strategy stacks the odds against your success and very improbable way of investing and scaling your real estate business in my opinion.

In the next newsletter, I will discuss what I think are the best creative real estate strategies for buying properties for 2024. These are things like buying houses subject to the existing mortgage or buying with owner financing or even buying with lease options.

Disagree? Feel free to email me your point of view. I like to hear other perspectives and experiences.

We would love to get your feedback and your thoughts! Let us know which topics are of interest or where you need more clarity. Just respond to this email directly 😌 or email [email protected].