Buy and hold real estate is a staple of our own personal financial freedom plan.
We buy houses through Turnkey Real Estate, push the positive cashflow into the purchase of the next one, and then so on. Wash rinse repeat.
And we aren’t alone. According to the IRS, roughly 16.7 million people reported income from rental properties of one form or another, a major portion of which was from buy and hold real estate.
However, it’s certainly not without it’s potential drawbacks. So let’s cover some of the pros and cons of incorporating a buy and hold read estate strategy yourself.
- 1 What Is Buy And Hold Real Estate?
- 2 Advantages of Buy-And-Hold Real Estate
- 3 Drawbacks to Buy-And-Hold Real Estate
- 4 How To Buy And Hold Real Estate Investing In 5 Steps
What Is Buy And Hold Real Estate?
An investor following the buy and hold strategy for real estate would purchase a property and then hold on to it for an extended period of time. The owner usually plans to sell the property in the future but will rent it out in the meantime to help with financing for buying and holding real estate.
The buy and hold real estate strategy is one of the most common investment options among investors who are looking for long-term gains and short-term cash flow. The rent from the property creates income that can be used to pay the mortgage and extra cash for the investor. The value of the property will increase over time, giving investors the opportunity to make money when they sell it in the future.
Advantages of Buy-And-Hold Real Estate
Like blue-chip stocks, buy-and-hold real estate tends to be a more stable investment, appreciating in value over time and providing income through dividends. However, real estate also has the potential to provide greater returns than stocks, making it a more attractive investment for some. Typically, real estate is not as exposed to the stock market’s fluctuations and offers tax benefits that other investments do not.
Here are 6 top benefits of buy-and-hold real estate investing to help you decide if this long-term strategy is the right move.
1. Monthly Recurring Rental Income
Real estate that is bought and held offers the potential for a dependable monthly income from rent. Single-family rent prices increased by 11.5% in the year up to November 2021, according to a report from CoreLogic. Some markets such as Miami, Phoenix, and Las Vegas posted annual rent increases between 16.7% and 33%.
While Cash on cash returns for newly acquired, single family rental properties certainly has gone down in year 1, overall there is still very available inventory out there if you are willing to go to 0% in your first year.
Remember that rents generally increase over time. They likely won’t increase like they have in the last 1-2 years (10% +), but a reasonable increase of 3% is what we plan for.
2. Property Appreciation Long Term
Held over a long term, real estate can help build wealth. The Federal Reserve reports that the median sales price of houses has increased by more than 238% over the past 20 years. This means that if you bought a house for $150,000 20 years ago and took care of it, it would now be worth $357,000.
What we like to use for a planning factor when we buy rental property is a 3% appreciation per year. Likely it will be less or more in any given year, such as in 2021 when appreciation in some areas of the country was quite large.
3. Potential Hedge Against Inflation
Real estate has the ability to maintain its value, or even increase in value, when inflation rates rise. Your rent is likely to increase every year along with the inflation rate, while housing prices will go up even faster than that. Between 2001 and 2020, the U.S. inflation rate averaged 2.13% per year, while median home sales prices rose by an average of 11.9% per year.
4. Buy and Hold Offers a High ROI
Return on investment (ROI) measures how much profit is made on an investment compared to the cost of the investment. The current 20-Year Treasury Rate is 2.18%. If an investor buys a 20-year treasury security for $150,000 and holds it until it matures, they will receive $3,270 in interest income, for an ROI of 2.18%.
Buy-and-hold real estate historically offers a much higher ROI. To give an example, say an investor bought a rental property for $150,000 in cash in 2001. During the time that the property was owned, it made an annual net operating income of $9,000, totaling $180,000. If the property sold today for $357,000, the ROI over the 20-year holding period would be 358%:
- ROI = Gain on investment – Cost of investment / Cost of investment
- ($357,000 gain on sale + $180,000 total NOI) / $150,000 initial purchase price = 3.58 or 358%
It is important to remember that the example above was simplified for this article. The ROI calculations do not take into account potential changes in rental income, capital expenses, or home values that could either increase or decrease potential returns.
5. Significant Tax Benefits
Buy-and-hold real estate also offers several unique tax advantages compared to other investment assets:
- Deductible operating expenses, such as property management fees, repairs and maintenance, property taxes, and insurance.
- Mortgage interest deduction.
- Depreciation deduction of a residential rental property over a period of 27.5 years to reduce taxable income.
- Deferred capital gains tax through a Section 1031 exchange.
- Owner expense deductions, such as continuing education, travel, and home office.
- Potential exemption from FICA taxes of Social Security and Medicare for income from a rental property .
- Potential pass-through deduction of up to 20% of net business income, provided an investor owns a pass-through business and has qualified business income (QBI), according to the IRS.
6. Tenant Paydown of Mortgage
If you look to buy real estate where your tenant pays a certain % more than your mortgage payment, then you are essentially outsourcing payment of your mortgage to the tenant.
Over time with this principal paydown, this can add up to substantial equity that has accumulated. One of the more well known real estate gurus Robert Allen in particular is a fan of this strategy. Every 10 years doing a refi-cash out of the equity in the house and using that as a potential source of income.
Drawbacks to Buy-And-Hold Real Estate
The benefits of buying and holding real estate are numerous. There are some drawbacks to this investing strategy to consider.
Although real estate can be a great investment, it is not as liquid as other assets such as stocks and treasury bills. Real estate can take 30 days or more to sell, even when an owner is willing to sell for less than the property is worth.
2. Property Management
Dealing with tenants and repairs can challenging. You may occasionally need to chase down a tenant for rent, or there may be an emergency repair in the middle of the night. This is why landlords often times hire a property management company that is local.
A management company that is experienced in working with tenants, knows how to keep a rental property well-maintained, and has an established network of cost-effective contractors and vendors is a good management company.
3. Market Cycles
Over time, real estate markets move through different phases that can be generally characterized as recovery, expansion, hyper-supply, and recession.
If an investor who usually buys and holds assets decides to sell, they may find that the market is going down, which could reduce or get rid of any potential profits. To help prevent selling during a down market, investors can plan and monitor market cycles. This will help them keep or grow their earnings.
4. Changing Neighborhoods
The value of a property can change over time depending on the surrounding area or neighborhood. One of the risks of buy-and-hold real estate is that the property value could be negatively affected if something happens that decreases the desirability of the area, like if a major employer leaves or property taxes are raised.
Of course, the opposite is true as well. Some investors would only consider investing in large, urban gateway markets. Investors who live outside of an area are interested in small secondary and tertiary markets like St Louis or Memphis.
How To Buy And Hold Real Estate Investing In 5 Steps
1. Find The Right Property
If you want to buy a property for rental or rehab purposes, you should get the best possible deal. An increased emphasis on making offers that can maximize your bottom line is placed on properties that are in need of rehabilitation. This should also be the case for a buy and hold investment property. Your monthly cash flow is directly dependent on your housing expenses, which can be expensive depending on the purchase price. When negotiating for a rehab property, you should use the same tactics as you would when negotiating for a rental property. Price is not the most important thing to consider when buying a property. It is more important to choose the right one. Not every house will make a good rental property. If there is no demand, you will have difficulty finding tenants, but you can get a great deal on price. Developing areas that are growing in popularity among homebuyers are good places to invest, even if the prices are slightly higher. Consider how a potential tenant would view the property. Before you make an offer on a rental property, do some research on what other rental properties in the area have to offer. This is where you have to be careful. To find the right buy and hold property, you have to be careful.
2. Finance The Property
A common misunderstanding about buy and hold financing is that you can’t use hard or private money to fund your purchases. The financing options for a buy and hold investment property are the same as any other property investment, just structured slightly differently after a few months. You can still use any of the following buy and hold real estate financing options:
- Traditional Lender Financing
- FHA Purchase Loans
- Hard Money
- Private Money
- Seller Financing
One of the most well-known ways to finance a real estate property is to go through a traditional financial institution. If you’re looking for this investment opportunity, you’ll need to go through a credit check and application process to be approved. A down payment of up to 20 percent or more may be required. Although traditional financing may be an option, it could have higher interest rates and require a larger down payment than other financing methods.
If you’re just starting out, you might be able to get an FHA loan with a 3.5% down payment to buy a property. If you’re looking for a government-backed loan, such as an FHA loan, you may have more difficulty acquiring one if it’s not for your primary residence. However, buyers can purchase up to four-unit properties as long as at least one of the units is their primary residence. If you are looking for an opportunity to buy a property, this is it. You can live in one unit and rent out the other until you are ready to move on.
Hard money loans can be used to finance the purchase of a buy and hold investment property. There is a minimum waiting period required before you are able to refinance a loan on a property you have purchased. This varies depending on your lender, but can be anywhere from 90 days to a full year. If you take out a hard money loan to buy a property, you’ll be able to refinance and pay off the loan after six months.
Private money and business partners can also help you get started with buy and hold real estate investing. To secure additional funding, you need to have a strong deal analysis with numerical support to back up your pitch. If you have worked with other properties in the past, it is a good idea to have case studies from your portfolio ready. Try to meet potential private lenders and partners by attending real estate events in your area.
Here is a more thorough update on 7 ways to finance a rental property using other people’s money.
3. Upgrade The Property
Both rehabs and buy and hold properties require you to add value. Our own typical strategy is to buy full rehabbed properties, but the this is more of a choice around increasing our return on attention, not return on invesment.
If you’d like to do the rehab yourself, you’ll need to look for deals on properties. To get a good deal when buying and holding property, you need to be willing and able to put in some work. You don’t need to make a lot of changes to the property, but you need to make it more attractive and liveable. The least you need to do to improve your home is to update the flooring, paint the walls, and improve the kitchens and bathrooms. You need to take these expenses into account when you are making your budget. If you make some small improvements to your rental property, you could increase the rent by 25-30%.
4. Manage The Property
Investors who avoid purchasing buy and hold properties cite horror stories about problem tenants as one of their main reasons. For every ten tenants, however, nine are typically great. The last one could ruin a good property. The best way to avoid getting a bad tenant is to work with a property manager. Before buying a property, you should have a system in place for managing the property, whether you plan to do it yourself or hire someone to do it for you. You can’t just find any old tenant and expect them to pay rent on time every month. It takes a fair amount of time, effort, and patience to run a rental property. The rewards for sticking with something long-term are usually pretty good, but it requires good management skills and dedication to get there.
Typically we prefer to manage rental property remotely and outsource the property management to a local team.
5. Prepare For The Unexpected
A rental property can change at any time. Sometimes things happen that are out of our control. One day you may be praising your tenants for their timely payments, and the next day the furnace may break down. It is common to experience several months without any issues, then suddenly be faced with two or three major expenses. You should keep a healthy buffer of money set aside to be prepared for unexpected events. If you don’t have any reserve funds, you will have to hurriedly look for money to pay for these items. This can come from high-interest credit cards, personal funds, or money meant for other projects. This can lead to bad tenants and costing more money in the long run.
Two types of emergencies we plan for are rental vacancies and maintenance expenses.
For our own portfolio of properties, we keep between 3-6 months of mortgage payments in “reserve” as well as between $3k-$5k per property for maintenance expenses.
This gives us an adequate buffer against unexpected expenses.
What about you the reader? Do you prefer buy and hold real estate or not? Let us know in the comments.