In our first post on Property Strategies we looked at the nuances of buy to let and this week we are going to delve into a technique that we can use with this strategy – BRR or Buy, Refurbish, Refinance. But in case you missed my last post, let’s just recap on vanilla buy to let investing.
At its most basic level, buy to let is where you buy a property, find a tenant and collect the rent. This is a fantastic strategy for those that just want to own a few properties perhaps to boost their income or as a pension plan for the future. However, if you’re looking at becoming a serious investor and want to grow a portfolio of 50 or 100 properties (or more), then there are other ways of doing buy to let that are far more effective and far more exciting.
For example, my using my favourite technique within the buy to let strategy, BRR. Essentially, you purchase properties, undertake a refurbishment before refinancing them and recycle your money back out.
A fantastic technique that can also be used with other strategies as well (i.e. commercial property and HMOs), BRR works by “adding value”.
But how can you add value? Even just a minor refurbishment can add value to a property; putting in a new kitchen, bathroom, carpets or windows, or even by just giving a property a lick of paint. Even fairly simple minor “upgrades or repairs” can add value – and, by refinancing the property following your refurb, it should be possible to recycle all or some of the money invested back out.
If you want to take this technique one step further and make your margin even greater, you could also try to buy the properties slightly cheaper.
To illustrate this, consider a property that’s in need of some refurbishment and is on the market for £80,000. In good condition, this same property may be marketed at £100,000 but might have been reduced to reflect the work that needs doing to it.
If, for example, you can buy this property for £65,000 and spend perhaps £7,500 bringing it up to scratch, then it should be worth in the region of £100,000. Then, if you get a 75% or 80% LTV mortgage, you should be able to pull most (if not all) of your money back out again.
This is a great example of just how effective BRR can really be.
However, it won’t work in all areas. As a general rule, BRR might be difficult in locations where properties are of greater value as there IS an upper value. (At the time of writing, it is probably around £150,000). This is due to stress testing by the banks.
Stress testing is a calculation that the banks use to determine how much they will lend to a borrower. In simple terms, they come up with a theoretical interest rate and multiply this by 125%, 130% or 145% over and above that figure. In order to lend to you, the rent needs to work out greater than the notional interest rate. (By the way, this is not the interest that you pay – it’s just an interest rate which they use to calculate whether the property stacks up or not).
So, stress testing does limit the top value of a property that you can actually buy, which is around £150,000. As such, you need to look for properties in the region of £100,000 or less.
If this isn’t going to work for you, in other words, if you’re buying in an area where property values are higher or where you’re going to struggle to do BRR, then there are other things you can do.
Title splitting for example – where by you purchase a house and split it into 2 or 4 flats. To make this work, you do need to make sure that the figures add up, but this might be a better option for your investment area. If the figures don’t work, it might be that you have to opt for a cheaper area where the figures do work.
Another option could be doing some kind of development. Popular with investors particularly in big cities like London, you could consider altering the layout of a house and creating an additional bedroom. Maybe move the kitchen into the living room for example. Doing this wouldn’t alter the floor area of the property, but it would increase the value of the property as the UK tends to calculate value based on the number of bedrooms.
When you’re carrying out just a basic level of refurbishment to then refinance, it is possible to buy the property using a buy to let mortgage. Having said this, the lender would only grant you a mortgage if the property is considered habitable – in other words, it must have a working kitchen and bathroom. Lending criteria does differ from bank to bank so if these “rooms” are not up to scratch, you might come up against stumbling blocks.
What can you do if you find yourself in this situation? Well, one way of getting around this is to buy the property using 100% cash.
If you borrow 100% of the funds, do the refurb and then refinance, then the banks are likely to be satisfied. Ironically though, if you only borrow i.e. the 25% deposit (which means you are getting 75% LTV), unless you are borrowing from a close relative, the banks probably won’t be happy.
(It’s strange isn’t it, that if you borrow 100% of the money and then refinance later down the line the banks would be happy, but if you instead just borrow 25% of the money and then take out a mortgage with them that they wouldn’t be).
Whilst this all sounds slightly complex, when you do get your head around the BRR technique and really understand how it works, you will see that it can be highly powerful for growing your property business. It has certainly worked very well for me.
Peter Jones B.Sc FRICS
By the way, I’ve rewritten and updated my best selling eBook, The Successful Property Investor’s Strategy Workshop, which is an account of how I put together my multi-property portfolio, starting from scratch and with no money of my own, and how you can do the same. For more details please go to ThePropertyTeacher.co.uk