The “buy and hold” strategy for Real Estate investing is a very powerful approach that you can certainly use to generate wealth. It is also a fantastic passive strategy, once the ball is rolling. Meaning, you don’t have to constantly work for this investment vehicle to make money for you. Becoming a Real Estate investor, was the first solid step I took in my path towards Financial Freedom. I remember exactly how great I felt when I received that first $1530 rent check from my tenants in early 2016. I was like, “Oh wow, this works, I am actually getting money”.
The steps are quite simple:
- You buy an investment property.
- You rent it out to a tenant.
- Your mortgage gets paid off monthly from the rent. So your equity is constantly increasing. (Equity is a fancy word for ownership stake).
- Over time your property increases in value, so you can sell it at a higher price.
One of the beauties of “Buying and holding” rental properties is that you can scale. This means that you can execute this approach with 1, 10, or 100 properties depending on your capital, and goals.
But, there are certain considerations when scaling up with the buy and hold strategy!
For example, it is beneficial to have a high credit score. Another important factor is your “Debt-To-Income” ratio or “DTI”. Your DTI ratio is a measure that divides the amount of debt you have over your income. Calculating your DTI is easy! Simply add up your total monthly debt obligations (existing mortgages, student loans, car payments). Then, divide your debt obligations by your gross monthly income.
Lenders will stop lending you money when they believe you already have too much debt in comparison to the monthly income you are generating. (In other words, your ratio is too high.)
A DTI ratio of 36% or lower is generally considered “good” when applying for a loan. (The lower the better). For example, if your monthly debt obligations add up to $4,000 and your monthly income adds up $8,000 (DTI ratio of 50%), it will be very hard to get additional loans.
Now, remember that your tenant’s payments contribute to your monthly income.
The beauty of the “buy and hold strategy” for rental properties is that your asset will generate wealth in FOUR main ways:
1.) Appreciation
The price of the property increases over time. This means that the price you can sell the house down the road is greater (sometimes considerably greater) than the price you paid originally. This concept resembles stock investments. If you bought a house for $150k and sell it 15 years later for $230k, you gained $80k in appreciation.
A healthy Real Estate market generally experiences between 3% to 7% yearly appreciation of the total value of the house. The beauty of this is that you use the bank’s money as leverage, which is extremely powerful. Meaning, your return could be 3% to 7% of the TOTAL value of the house, NOT the amount of money you invested. The money you actually invested is the down payment you provided to buy the property. In other words, this 3% to 7% yearly appreciation is over the total value of the house. The combined value of both your initial down payment + the money the bank lends you.
2.) Cash Flow
Your Real Estate asset capability of producing monthly Cash Flow.
In simple terms, Cash Flow = What you collect on rent – What it costs you to own a house (referred to as PITI – Principal, Interest, Taxes, and Insurances). This is the monthly income that the asset generates by itself.
This “cash” is extremely passive (it doesn’t need a lot of work). For example, think of the constant daily work required to run your own business. How much work is required to operate a coffee shop, a hair salon, or a McDonald’s franchise. Additionally, the money can be used for whatever you want, but it is typically used to pay down the mortgage (until the mortgage is fully paid off). Any excess can be considered “cash flow income” that you didn’t have to work to obtain. At least not in the traditional way of working “40 hours a week” in your 9-to-5 job or operating a business.
3.) Amortization
When you use your cash flow to pay off your mortgage, you’re decreasing your debt. By decreasing your debt you’re creating equity. As time passes, you own a bigger percentage of the property. Essentially, you are increasing your net worth by paying off the loan. Your ownership stake in the asset is increasing while your liability is decreasing.
Let’s illustrate the power of this concept with an example. Suppose you purchased a property for $200k. You paid a $40k down payment, and financed $160k (your mortgage debt). Since you use the rent to pay off the mortgage, you are increasing your ownership stake in the property. When the mortgage term is completed (whatever you signed up for with the bank – 15, 20, 30 years), you will own 100% of the house. Gaining $160k of equity on this particular example. Even if there is absolutely no appreciation (explained in point 1) you still “create wealth”.
4.) Tax Advantages related to investment properties
There are two main tax “categories” you can take advantage of when you invest in Real Estate. The first category revolves around tax incentives you can use while you own the property. The second category revolves around incentives you can use when you sell. These incentives are so good, I sometimes think the government wants to encourage Real Estate ownership.
Tax advantages while you own your investment property:
- You can deduct from your yearly rental income the yearly costs you had to incur that year stemming from the property. Meaning any costs stemming from using the asset as an investment vehicle can be “offset”. Deductions include the interest you paid on your mortgage to the bank. Or the property taxes you paid the municipality. The home insurance, property managements fees, and the Home Owners Association fees (if applicable). If you perform rehab projects you can deduct the materials costs related to renovations/repairs, associated labor, etc.
- And last, but certainly not least, the asset’s yearly depreciation = (value of the property)/27.5. From a tax perspective, all these “costs” can be subtracted from the income the property “generated”. Meaning if you collected $20,000 in yearly rent, but the property set you back $18,000 over that timeframe, your “net” income was only $2,000.
Tax advantages when you sell your investment property:
- The capital gains “tax rates” related to the property’s increase in valuation are low. Long Term Capital gains have been historically taxed at a lower “tax rate” than general income. This means the money generated from your asset’s appreciation is taxed lower, compared to the money you earn from your salary. For example, let’s suppose you bought a property for $250k and sold it for $350k. This means you made $100k from the asset’s appreciation. You have to pay less taxes on those $100k compared to the taxes you are responsible for if you made $100k off your salary.
- To use long term capital gains to your advantage, you have to hold the investment property longer than one year. The differences between capital gains tax rates and income tax rates are considerable (please see table below). Tax rules and rates tend to change over time. The following table contains info for 2019:
- Executing a 1031 Exchange. This is another tax benefit that can be utilized when you sell. It allows you the possibility of deferring the tax payment associated with the capital gains of the property. The requirements for this tax advantage is that the capital gains are used to purchase a “like-kind property” within 180 days of the sale.
- Think of the 1031 as the government giving you permission to keep investing the money you gained from your investments, and pay them later. This benefit resembles the tax shelter provided on a 401k for stock investments. The government only asks for taxes after you cash out the 401K. In the meantime, you can sell stocks, and buy other stocks without having pay the capital gain taxes right away. Meaning you can keep investing that money while it is “sheltered” within the 401k. You can pay the government for the appreciation of your investments later. This gives you more capital, or “leverage” to compound in your favor. Let me be clear, you still have to pay taxes, but you can “defer” them.
How to find good Real Estate investments to use the buy and hold strategy:
After learning the powerful benefits related to Real Estate investing, you might be eager to dive right in and start building your empire. Well, let me give you a word of caution first! Every investment has a degree of risk and not all real estate investments will be as fruitful. To get or maximize the benefits of investing in real estate, you need a sound investment strategy. My strategy revolves around two strategic investment concepts.
These concepts are aimed to minimize risk, and maximize return. They will help you evaluate if the property you’re looking at is a favorable investment. These concepts have served me well in the past, but there aren’t any guarantees for the future. A great thing about these concepts is that they are “general”. This means they can be applied to ANY real estate market (national or international). Before investing always do your “homework” and analyze these 2 concepts.
Concept 1 focuses on Cash Flow:
Try to find a property that will rent for 1% of your purchase price. What I mean by this is that the money you will receive in monthly rent equals 1% of the total price you paid for the house. I am going to illustrate this with a personal example. When I purchased my first rental property, I paid approximately $160,000 and rented it for $1600 a month. Successfully achieving this concept should give you an adequate amount of monthly cash flow. This will enable you to pay for the property monthly costs, without taking money out of your own pocket.
Furthermore, I always strive to keep the costs of the house less than 0.5% of the purchase price. Or half of your monthly rent payment. Meaning that the normal costs of the property such as taxes, HOAs, property management fees, insurance, etc. should be less than 50% of the monthly rent. I exclude the “mortgage” from the list of costs (the mortgage will certainly push it higher than 50%).
Concept 2 focuses on Appreciation:
As I said earlier, try to find a property that will appreciate between 3% to 7% every year. Ideally, the more appreciation the better. Yet, 3% to 7% is a realistic target you should aim for in a healthy real estate market. Successfully achieving this concept should give you an attractive Capital Gain when you decide to sell the property. Additionally, rents tend to appreciate similarly to property values. Thus, as your property increases in value over the years, the rent you can collect from that property will also increase. That general relationship maintains the 1% rule from “Concept 1” congruent.
You can invest in different types of Real Estate. But, not all of them are created equal. There are two main categories: Residential real estate or Commercial real estate. You can dive deeper into residential and break it down into subcategories like single-family or multi-family. You can also break down commercial into subcategories, like retail space, office space, warehouses.
When you’re evaluating the “buy and hold” strategy for different property types, always remember these two concepts.
Generally, multi-family property is really good for cash flow (concept 1). But, its appreciation tends to lag behind single-family (concept 2). Conversely, appreciation of a luxurious mansion in Southern California tends to be higher than 7% a year when the market is booming (concept 1). But, the rent the mansion generates is considerably lower than 1% of the purchase price (concept 2).
I am sure there are exceptions but typically, the higher the cost of single-family homes the further away from the 1% monthly rent goal it will be. To illustrate this, analyze the monthly rent that a 10-million-dollar mansion generates. Believe me, it is far from $100,000 per month. In reality, it is generally closer to $50,000 per month (or half of the 1% target).
I strive to find a balance between appreciation and cash flow. That way my investments are more versatile and robust. My buy and hold strategy properties use all the wealth-generating tools from real estate, not one of the two. Whatever you invest in, always keep the two concepts in the back of your mind.
Buy and hold Strategy Conclusion:
If you like Real Estate investing, and want to take this “Buy & Hold Strategy” to the next level, check out my article on the BRRRR Strategy! It is essentially very similar, but incorporates additional features to maximize profits! If for whatever reason these strategies are not for you (low on funds, bad credits, etc.) but you STILL want to invest in Real Estate, I have a great solution! Check out my article about Investing in REITs! You can learn how to invest in Real Estate digitally, without the typical entry barriers.
I also have a solution in case you don’t want to invest, but you still want to partake in this profitable Real Estate industry. Check out my article on 4 Real Great Real Estate Careers for 2021!
Another iteration to this approach is to rent your properties “short-term.” This is generally done by listing your property on platforms such as Airbnb. To learn more about that strategy read my article about Investing in Short-Term Rentals!
When deciding to make a down payment, I recommend individuals to put down at least 20% of the value of the house. If not, you will be forced to pay PMI (Private Mortgage Insurance). PMI is insurance the bank makes you pay so they are protected in case you default on your loan. I consider that particular insurance throwing money away.
Additionally, being able to provide at least a 20% serves as a “gauge” to determine if you’re “overstretching” to make that investment. Being able to pay 20% or more helps you delimit your budget, and deciding what you can afford or not. Consider this, almost anyone can buy a million-dollar house if they only put down 1%. However, obtaining such a big loan to buy a property isn’t a smart thing to do for most people.
My ACTIONABLE “Buy and Hold” Strategy Tips:
If your business revolves around Real Estate, do yourself a favor and check out the tools below. It doesn’t matter if you’re a Real Estate Agent, Broker, or Investor. These products and services are designed to make your Real Estate life easier. For example, they can help you find investment properties or manage them. There is something for everyone, regardless of where you currently stand in your Real Estate journey.
How to evaluate potential investments:
Dealcheck is considered the leading investment property analysis platform. Which is a great tool for both Real Estate investors and agents. The platform makes it easy to analyze all types of potential ventures like rental properties, flips, multi-family buildings. It also estimates cash flow and helps you find and compare/contrast potential deals.
Click HERE to visit Dealcheck! Additionally, I have obtained a great discount for MoneyTipsCoach.com readers. If you use promo code: VIP25OFF you will get 25% off!
Real Estate Property Search Engine (how to find cheap homes):
Foreclosure.com is the largest provider of distressed properties currently available in the United States. This information is extremely beneficial when you’re trying to find a good discount on investment properties. Distressed properties are “on-sale”. Foreclosure.com info is always accurate and up to date. (I used to look for these types of properties in places like Zillow, Trulia. Unfortunately, their information for distressed properties is highly inaccurate our outdated.)
Foreclosure.com platform is extremely easy to use and provides the most comprehensive residential foreclosure listings. They are regarded as the national expert on reporting the status of defaulted Real Estate.
Click HERE to visit Foreclosure.com
Property Management Software:
Buildium is a software designed to help property managers and real estate investors become more efficient. It is a great tool for individuals looking to scale their business or portfolio. Their property management software is extremely powerful. With Buildium you can easily track budgets, manage rental listings, pay vendors, and run comprehensive tenant screenings. It can also help you communicate with tenants, vendors, and owners more efficiently.
Click HERE to visit Buildium!
Real Estate Education & Community:
Property MOB offers a bunch of tools and services. Just to name a few, they have training courses, online coaching, virtual assistants. In this platform you can also get advice from their resourceful community of Real Estate investors.
They also offer very detailed step-by-step tutorials like their “How To Wholesale Real Estate Step By Step“.
Last but not least, they provide the #1 Bestselling CRM Platform (Customer Relationship Management). A great tool for both Real Estate investors and agents!