BRRRR With a Rent-by-the-Room House: Buy, Rehab, Rent, Refinance, Repeat

The five steps, and where renting by the room changes them

Buy: find a house you can buy for well under what it will be worth after the work. Rehab: fix it so it rents well and appraises higher. Rent: put residents in it. Refinance: replace the purchase money (cash, a hard-money loan, a line of credit) with a long-term mortgage based on the new value. Repeat: put the money that comes back into the next house.

Renting by the room touches every step. You buy differently, because the floor plan matters more than the finishes: enough bedrooms, or space to add one legally, and room for a second or third bathroom. You rehab differently, because each bedroom is a separate home for a separate person. You rent differently, with one lease per room. And the refinance can come out very differently, because the lender may value the house as one whole rental no matter how you rent it.

That last point is where most rent-by-the-room BRRRR plans go wrong, so we will come back to it with numbers.

• Buy: the floor plan matters more than the kitchen
• Rehab: every bedroom legal and rentable on its own
• Rent: one lease per room
• Refinance: ask how the lender counts room rent
• Repeat: only with money that really came back out

Rehab for rooms: escape windows, bathrooms and locks

Start with safety, because it decides which rooms you can rent as bedrooms at all. Model codes used by many cities require at least one emergency escape and rescue opening in every sleeping room. One city's building department summarises the usual requirement for new construction as a window with at least 5.7 square feet of clear opening (5.0 square feet on the ground floor), at least 24 inches high and 20 inches wide, with the sill no more than 44 inches above the floor. Your city may use a different edition or local changes, and replacement windows can follow different rules, so ask your building department before you count a basement or an attic room as a bedroom.

Then smoke alarms in every bedroom and outside each sleeping area, carbon monoxide alarms where your code requires them, and a fire extinguisher in the kitchen. Each bedroom door needs a lock, and many co-living owners use keypad locks so a code can be changed between residents instead of rekeying.

Bathrooms decide rent. A house with five bedrooms and one bathroom will rent to five people only at a discount, if at all. Adding a bathroom, or a half bathroom, is often the best money in a room-rental rehab. After that: durable floors, a kitchen big enough for several people to cook, a second refrigerator, laundry, good internet, and parking. Leave expensive finishes for the house you plan to sell.

• An escape window in every bedroom that meets your local code
• Smoke alarms in and outside every bedroom
• Carbon monoxide alarms where required
• A lock on every bedroom door
• Enough bathrooms for the number of residents
• A kitchen, fridge space and laundry sized for the house

Rent it room by room

Price each room on its own: size, private or shared bathroom, light and noise. The rooms together should bring in clearly more than the whole house would, after you pay the utilities, internet and supplies a whole-house tenant would have paid themselves, and after you allow for more vacancy and more turnover.

Lease each room separately, with its own deposit and dates, and put the house rules in every lease. Lenders who do count room income will want to see proof: signed leases and rent actually arriving in your bank account. Collect rent electronically and keep the records clean from the first month, because those deposits may become your loan application.

• Price each room on its own
• Count utilities, internet and supplies you now pay
• Allow more vacancy than a whole-house rental
• One lease per room, with its own deposit
• Clean rent records from the first month

• How to price a rent-by-the-room house
• Free rent-by-the-room calculator

Refinance: how lenders count room rent

A conventional investment-property loan usually documents rent from the appraiser's comparable rent schedule or from leases. Fannie Mae's guide, for example, names the appraiser's single-family comparable rent schedule as a source for the rent. Appraisers estimate market rent by comparing similar homes, and in most neighborhoods those comparisons are whole houses, so the rent the lender uses may be the whole-house rent, not your rooms.

Debt service coverage ratio loans, often called DSCR loans, are made by private lenders and qualify the property rather than your personal income. The ratio is the property's monthly rent divided by its monthly payment (principal, interest, taxes and insurance). Each lender sets its own minimum, and, more importantly, decides which rent it will use. Some accept signed room leases with bank deposits; some use the appraiser's whole-house market rent; some take the lower of the two.

Timing matters too. Many lenders require you to have owned the house for a period before a cash-out refinance; Fannie Mae's guide, for example, requires a borrower to have been on title for at least six months. Budget for interest and holding costs through the rehab, the leasing and that waiting period. Before you buy, ask two or three lenders the same three questions and keep their answers: which rent will you use, what minimum ratio do you need, and how long must I own it first?

• Which rent do you use: room leases, whole-house market rent, or the lower?
• What minimum coverage ratio do you require?
• How long must I own it before a cash-out refinance?
• What proof of room rent do you need: leases, bank deposits, months of history?
• How much of the new value will you lend?

A worked example, in round numbers

This is an example to show the arithmetic, not a forecast. Every figure is invented and rounded, and rates, values and lender rules will be different where you are. A three-bedroom, one-bathroom house is bought for $180,000 with $8,000 of closing costs. The rehab costs $70,000: two basement bedrooms with code-compliant escape windows, a second full bathroom, locks, alarms and paint. All in, $258,000 has gone into the house.

Rented by the room, the five bedrooms bring in $700, $700, $675, $650 and $625, which is $3,350 a month. The appraisal comes back at $330,000, and the lender lends 75% of that on a cash-out refinance: $247,500. After about $6,000 of refinance costs, roughly $16,500 of your own money is still in the house. On a 30-year loan at an example rate of 7.5%, the principal and interest is about $1,731 a month. Add $250 for property taxes and $175 for insurance and the payment the lender looks at is about $2,156.

Now the coverage ratio. On room rents, $3,350 divided by $2,156 is about 1.55, comfortably above most minimums. But suppose the lender uses the appraiser's whole-house market rent of $2,100: $2,100 divided by $2,156 is about 0.97, below 1.0, and the loan may be smaller or declined. Same house, same residents, a different answer depending on one sentence in the lender's rules.

Finally, the monthly cash flow on room rents. From $3,350, take the $2,156 payment, about $475 for the utilities and internet you now pay, $335 (10% of rent) set aside for vacancy and repairs, and $150 for cleaning and supplies. That leaves about $234 a month. That is positive, but thin: one long vacancy or one bad repair in a year wipes it out. Run your own deal with your own numbers, and with the whole-house rent, before you make an offer.

• Purchase $180,000, closing $8,000, rehab $70,000: $258,000 in
• Appraised $330,000, 75% cash-out loan: $247,500
• About $16,500 still in the deal after refinance costs
• Room rents $3,350 against a $2,156 payment: about 1.55
• Whole-house rent $2,100 against the same payment: about 0.97
• About $234 a month left after utilities, reserves and cleaning

• Free cash-on-cash return calculator

Repeat, without spending the reserves

Repeat only with money that really came back out. If the refinance left $16,500 in the deal, that money is not available for the next house, and neither is the reserve you need for a furnace or three empty rooms in one summer. Keep each house's reserve in the house's account before you count anything as free.

Track each property's books separately from the start: the purchase, every rehab expense (improvements are usually added to the property's cost and depreciated, while repairs are deducted, and the Internal Revenue Service explains the difference in Publication 527), each room's rent and each month's bills. A clean record is what your accountant, your next lender and your future self will ask for.

RentCaddie keeps the rented part of the plan in order: each room on its own lease, rent collected online with a receipt for every payment, the house's utility bills split to the residents by the days they lived there, expenses and loans tracked by property, and a rent roll and profit and loss you can hand to a lender or an accountant.

• Count only money that came back out
• Keep a reserve for each house
• Separate books for every property from day one
• Improvements and repairs recorded the way your accountant needs

• How RentCaddie runs a rent-by-the-room house