So far, we have talked about House-Hacking and Flipping Strategies for investing in Real Estate, but there is more. Today, we will talk about a strategy known as Buy and Hold. It is a popular strategy that can be easily defined by its name, purchase a property with the intention of holding onto the property long-term (e.g., 5-10 years). The idea is to generate passive income from rent payments and appreciation. Today, I will explore some of the ins and outs of the “Buy and Hold” strategy including benefits, risks, and best practices.
What are the Benefits of the Buy and Hold Strategy?
First and foremost, the biggest benefit is the ability to generate passive income. A well-managed property can produce a steady stream of cash flow that can then be re-invested into the property or used to purchase other investments. Additionally, passive income can be accumulated to provide a buffer against unexpected expenses and vacancies.
Appreciation is another benefit of this strategy. Long-term appreciation specifically can make the buy and hold strategy worth it to a prospective investor. Markets can experience fluctuations in the short term, but over the long term, real estate generally appreciates in value. This can result in significant gains for the investor that might hold onto a property for 10+ years.
Another benefit of the buy and hold strategy comes from leverage. Leverage can be a scary concept to people that might have become an adult during the Great Recession or those that experienced their first recession during the Great Recession. However, leverage makes this strategy quite intriguing because investors might only have to spend a small percentage of the home’s purchase price as cash down to purchase the property while using debt to purchase the property. This can significantly increase potential returns, especially cash-on-cash. But it is important to note that this requires rental income to cover the debt service (a.k.a. rental income covers principal, interest, taxes, and insurance more than likely).
What are the Risks of the Buy and Hold Strategy?
Unexpected expenses, such as repairs and vacancies are a significant risk of this strategy. These expenses can easily eat into the cash flow and might require the investor to use their own funds to cover the costs. Sometimes these both can overlap. For example, a tenant might destroy your property (which you might be able to take to court over, obviously consult with a lawyer or other legal professional before making that decision) while not paying you. You must remove the tenant, have the vacancy, and must repair the property all at the same time. This can be a significant expense. So, while you earn cash flow, put money aside for expenses that might come up. This reserve will come in handy someday. Additionally, an investor might purchase a property to only find out that there is some structural damage with the property that will require work. Or perhaps there is an issue with the subfloor that needs repairing. These at things that can come up, especially in older homes, that an investor can mitigate by having a solid cash reserve.
As evidenced by the Great Recession, significant changes in the real estate market can impact a properties value. Real estate values tend to appreciate in the long term, but short-term market situations can result in significant losses for investors, especially those that might panic and sell a portfolio during a downturn. Investors should plan on holding onto properties throughout market cycles to maximize their returns.
Real estate is relatively illiquid. This means that it can be difficult for you to access cash quickly. This can be particularly problematic when life throws us a curveball and we need to get some money to pay off a medical expense or use for job loss coverage. Always have a plan in this instance.
As mentioned in the benefit, leverage can be a wonderful thing, but on the flip side, a mortgage can provide some risk to the strategy. For example, if the investor has a variable rate loan on the property, the cost of the debt service can go up when interest rates rise. Additionally, the investor must be sure to stay on top of the mortgage payment. Missing payments can lead to foreclosure and the loss of the property.
What are some best practices for this strategy?
First, research the market before buying. Investors should know the local real estate market before making a purchase because an investor should be doing their due diligence to maximize the returns of their investment. This involves looking at rental rates, vacancy rates, and property values (e.g., recently sold homes comparable to the homes the investor might be interested in).
For the buy-and-hold strategy, it is beneficial to purchase a property that requires minimal repairs. Of course, there might be some repairs that are necessary to get the property rented, but it would be wise to keep these lower (or factored into your purchase price, such as in the form of a significant discount on the property). These costs can eat into the investor’s cash flow, and it would just be a great idea to keep these expenses as low as possible, especially for a budding investor.
Screen tenants carefully, screen tenants carefully, screen tenants carefully! This is so important I had to say it three times. There are many books out there that provide some details on some best practices to screen tenants that will not only keep you out of legal trouble, but also find you the best tenants. Everyone is the next guru on figuring this out, but realistically it is almost impossible to identify the best tenants all the time. But you can mitigate the risk of a poor tenant with good systems in place during the application process. Run credit checks, verify employment and income, and verify rental history.
As mentioned above, build a reserve fund. It will be necessary to use money in this to cover unexpected repairs or vacancies. This fund should be separate from the cash flow generated by the property. Finally, re-invest in the property because investors want to maximize the appreciation and cash flow on a property. This comes from regular updates or improvements that can increase the property’s value or decrease the maintenance expense.
Final Thoughts, For Now
As you might see, the buy and hold strategy is a tried and true strategy that can build wealth and passive income over the long term. The strategy requires discipline and patience coupled with a long-term mindset. If an investor can select the right properties, manage them effectively, and take advantage of market conditions when appropriate, the investor’s portfolio can provide generational wealth.
As with any investment, there are risks and challenges that come out of this investment strategy. Vacancies and unexpected expenses can really eat into an investor’s profit. Poor tenants can also destroy an investor’s mentality and their portfolio. Additionally, this strategy, along with any investment strategy, requires a lot of work. The work involves finding the properties, which is not easy at all, renting them and dealing with tenants. There is a lot of work involved with this investment strategy and that can easily turn people off. But the reward can be worth it to the savvy investor. The investor that develops the right systems to streamline tasks without over thinking, the investor that can take advantage of market conditions, the investor that can find the right tenants and manage them well will only be able to reap the benefits of their labor.
Ultimately, this is a strategy well-suited for a patient investor that has a long-term mindset and is willing to put in the effort. Reliable income and wealth will come to those that put in the work. This will not get you rich in a day or even on your first property. This will require acquiring many properties to build enough profit to quit your day job or build up your wealth. Stay positive, continuously fail forward, and above all, allow yourself to adjust your methods. This is a business, you must figure out what works best for you, in your area, for your product type, in your system.
Disclaimer: I am not a financial advisor. The content on knowxchange.com or “this site” are for educational purposes only and merely cite my own personal opinions and experiences. In order to make the best financial decision that suits your own needs, you must conduct your own research and seek the advice of a licensed financial advisor if necessary. Know and understand that all investments involve some form of risk. There is no guarantee that you will be successful in making, saving, or investing money. Additionally, there is no guarantee that you won’t experience any loss when investing. Please seek the advice of a financial professional and do your own research.