Summary: In this article, learn the basics of how buy and hold real estate investing. Topics include what is buy and hold investing, benefits of buy and hold, short term vs long term buy and hold and more.
Real estate is one of the most tax-favored investment classes in the U.S. In fact, in 2020, a WMRE survey revealed that 61.5% of high net worth investors planned to allocate more money to investment properties.
The majority of these investors will be able to deduct depreciation and any real estate investment losses. In other words, they get to reduce their tax bill.
According to our Co-Founder and expert real estate investor, Kathy Fettke, if you use a real estate investing strategy such as buy and hold, “you can get to a point where you pay almost no taxes when you own enough real estate and can show that you’re working on it”.
In this article, we’ll show you how buy and hold real estate works and why it is one of the most profitable ways to invest in real estate.
What is Buy and Hold Real Estate Investing
There are different strategies for investing in real estate. You should choose a strategy based on your goals and how much responsibility you wish to assume.
As with flipping or wholesaling, buy and hold investing involves finding properties that are below market value and sprucing them up to make them more valuable (in some cases you can find income property that has already been renovated to like-new condition, but is still below market value). However, the difference is that instead of selling your property for profit i.e. a flip, you hold on to the property for a while. During your hold time, you rent out the property to generate monthly income.
Eventually, you might choose to sell the property or do a 1031 exchange. But you can hold for as long as you like, depending on market conditions. In a short-term buy-and-hold, you sell your property within five years. If you hold for more than 5 years, you’re employing a long term buy and hold strategy.
Benefits of Buy and Hold Real Estate Investing
1. Consistent Income
Rents from tenants pay your mortgage and still leave you with cash in hand as a buy and hold investor. Buy and hold real estate investing offers predictable cash flow since real estate markets aren’t as volatile as the stock market. And you can expect payouts from rents to continue throughout the duration of holding.
However, buy and hold real estate investing isn’t always passive. As a landlord, you’ll be responsible for handling property marketing, tenant vetting, rent collection and property maintenance on your own, unless you hire a property management company.
If you have stellar credit and can afford a 20% down payment, you can easily own any piece of for-sale real estate in the US. The best part is that you not only get to own that asset but also the rental payments from that asset.
If you fix up the property and find paying tenants, their rent payments go toward paying off your loan. Buy and hold real estate investing offers that unfair advantage.
Moreover, this piece of real estate can be used to get financing for other projects. This is because long term buy and hold investments add stable net worth that lenders want to see.
3. Tax Benefits
You can minimize the taxes you owe through depreciation. With depreciation, you can deduct the cost of improving the property over its useful life. On residential properties, that’s usually 27.5 years. Other expense deductions include:
- Property taxes
- Mortgage interest payments
- Property insurance
- Management fees
- Office space, legal and business equipment
- Travel costs
- Cleaning and maintenance costs
- HOA dues
All of these can add up to tens of thousands in tax savings. A qualified tax accountant can help you determine how to use depreciation and what expenses can be deducted for your rental property.
4. Home Value Appreciation
Real estate, for the most part, increases in value over time. This is why investors have always used appreciation as a long term exit strategy.
Let’s say you bought a property in Jersey City, NJ, for $170,000 in 2013. If you held it till 2022, at an average annual appreciation rate of 6.24%, the property would be worth $311,407 today. This means that when you sell, you’d net $141,407 (almost double the starting price) in profits. You could also defer capital gains taxes if you put the proceeds from your sale into a like-kind property via a 1031 exchange.
Even if you aren’t planning to sell, the gain in home equity can be leveraged to get financing for other investment opportunities or renovation projects.
5. Generational Wealth
High-net-worth investors typically invest in real estate since it enables them to preserve and accumulate wealth. Cash loses some of its value over time through inflation. But inflation actually has the opposite effect on real estate since the value of homes rises with inflation.
Moreover, the ultra wealthy invest in real estate so their heirs can benefit from what is called the stepped up basis. Stepped up basis is the fair market value of a passed down property on the day the benefactor dies. So, for a property worth $50,000 in 2010, if the benefactor dies, the stepped up basis becomes the current fair market value of the property. Usually, upon the sale of the property, without using a 1031 exchange, you’re expected to pay a capital gains tax. With the stepped up basis, you can eliminate this tax altogether for inherited properties.
Short term buy and hold vs Long term buy and hold
The difference between short term and long term buy and hold is obvious – the holding period. With short term buy and hold, you generally do everything you want to do with the property within 5 years. That is, you buy and fix, bring in new tenants, improve cash flow and then sell – all within 5 years. You can pull this off easily with a poorly managed property that already has tenants in place.
However, since you’ll be spending a lot of money and making significant changes within a short period, short term buy and hold might not deliver as much cash flow as LTBH.
The majority of real estate investors skew towards long term buy and hold. This is because committing for the long term allows them to weather fluctuations in cash flow and periods of widespread volatility. With the long term buy and hold strategy, an investor holds on to a property for a period of 5-10 years before selling. Over time, since real estate runs in cycles, investors benefit from rent increases and higher appreciation rates.
How To Buy and Hold Real Estate (Formula for Success)
Assess the Local Market
Unlike flipping, with buy and hold, you’ll need to fill up your property with high quality tenants. Therefore, you want to identify areas with high population growth and high home appreciation rates. This signals a growing job market which is a green light.
Ideally, you want to look for expanding markets since you can snag good deals in these markets. Make a list of potential markets to analyze since choosing the wrong market means dealing with high vacancy rates which would hurt your cash flow. It could also mean that you have to face negative property appreciation rates at the time of selling.
Well, we’ve done some of the work for you. As per Realwealth’s research, here are the 21 hottest markets to buy rental property in 2022.
Generally, you’ll want to pay attention to these things when choosing a market to invest in:
- New Jobs and number of Fortune 500 companies
- Population growth
- Vacancy rates and homeownership rate
- Home affordability rate
- Property tax rate
- School district
- Number of restaurants and malls
You will be managing your rental property in this place for years, so ensure you do careful due diligence.
Check the Building's Condition
Once you’ve done your homework on the area, you should assess the building itself. Some houses are not suitable as rental properties. They might seem like a great deal but you have to put yourself in your tenant’s shoes. How would you love living here?
You can have a Realtor help you with a comparative market analysis (CMA). If you’d like to have a stab at it, here’s how to do a CMA. If the property had been used as a rental before, check the cash flow, rents, vacancy rate and expenses.
Instead of seeking bargains as a new investor, you should pay attention to potential cash flow. With limited resale inventory today, investors are searching for deals in turnkey and new construction. Investing in a turnkey property that generates good cash flow is usually less stressful than buying a rehab. If you have to make a lot of upgrades and fixes on the property after purchase, then it’s probably not a suitable candidate for a buy and hold strategy.
As a new investor, you should be willing to pay a slightly higher price to find income-producing properties unless you have some experience handling large scale home repair projects.
Add Value to the Property
Yes you want to find properties in decent condition. But ideally, you shouldn’t be paying market value for your buy and hold. Buy and hold investors typically look for off-market deals and then add value to them by updating floors, kitchen and bathroom hardware, painting and improving the landscaping.
Purchasing a property and adding value to it over time (i.e. increasing rents, renovating the property to improve its condition, decreasing operating expenses, etc.) pays dividends in terms of increased cash flow. You can raise rents by up to 30%. The market value of the property also rises which helps whenever you want to sell or refinance.
With turnkey and new construction, you need to do a thorough home inspection. Ensure that any type of turnkey buy and hold you invest in meets the REAL Income Property™ Standards. You want to squeeze out as much value as you can from the property.
Know How To Find Good Tenants
The success of a buy and hold investment depends on having reliable tenants. So it’s imperative to learn how to market your property, vet tenants, and keep vacancy rates low.
Some of your tenants will leave at any point due to relocation, downsizing, upsizing or homeownership. One or two may need to be evicted. You’ll need measures in place to attract and vet new tenants as fast as possible.
Here are some strategies for marketing your rental property:
- Place a “For rent” sign in the yard
- Advertise on Zillow, Craigslist, Trulia and Realtor.com
- To attract high quality tenants, take professional photos of your listing.
- Conduct a move-out inspection with the outgoing tenant.
- If necessary, hire professional cleaners and contractors.
This guide to marketing commercial properties offers some insights on marketing your rental through social media ads.
You can also hire a flat fee realtor to help list and market your home. These realtors will help with specific aspects of marketing your property. Depending on your negotiations, they could also assist with tenant screening. You should have a written contract detailing everything your agent will do and the fees you will be charged
You should do a good job of screening out problem tenants and anyone who might have problems making payments. Be sure to state your tenant requirements in your rental ad without violating fair housing laws. Basically, you’d want to do a background check. You want to know their credit score, employment history and eviction history. All of these can be stressful, which is why you should simply hire a property management company to take care of marketing and screening tenants.
Work with a Reliable Team
Without the right people on your side, managing rental properties may spell trouble. With one or two properties, you could handle property management on your own. You can save money if you’re handy with repairs.
As your rental portfolio grows, managing your rental properties on your own will lead to overwhelm. While hiring a property management company will cut into your profits, you’ll also be able to sleep well at night not having to worry about clogged toilets.
Aside from handling tenant complaints, you’ll need to find tenants, screen them, collect rents, handle evictions, do periodic property maintenance, among other things. This is why investors recommend building a team especially if you’re in it for the long term. Your team should include a real estate agent, a handyman (or property management company) and a lawyer.
Prepare for Unexpected Expenses
There will be bumps along the way while managing your rental property. A couple of major expenses may suddenly pop up. You might have to deal with vacancies. Without sufficient reserves, you will run out of steam. Tap into personal funds, money earmarked for other projects or high interest credit cards if necessary.
Moreover, you should consider getting landlord insurance since homeowner’s insurance doesn’t cover losses incurred when your property is rented out. Landlord’s insurance covers property damage, lost rental income and protects against liabilities.
Using a Buy and Hold Real Estate Calculator
A ROI of 5%-10% is also acceptable.
You’ll need to estimate your costs and forecast potential income from your rental. Some of these costs include maintenance, mortgage, HOA fees, taxes, pest control, landscaping, among others.
When analyzing your property, you can use the 50% rule to estimate operating expenses. That is, 50% of your gross rental income (yearly income from rents) goes towards operating expenses. While the 50% rule is used for quick deal analysis, you might need to do more analysis. Input all operating expenses in this buy and hold real estate calculator to assess your potential ROI.
The safest, most stable way to create generational wealth in real estate is the long term buy and hold strategy. But as with any investment, don’t expect the big bucks right away. You need to do your due diligence and work with an experienced team. Since 2003, RealWealth has been helping its members find and locate profitable buy and hold investment properties. We provide education, networking and research to help you build a real estate portfolio for real wealth, so you can live life on your own terms. Become a member today for free to start investing.