I've been a buy and hold real estate investor for the last nine years.
While I've definitely considered other types of investing strategies (which we'll touch on in this post), I’ve determined that long-term buy and hold is the strategy that makes the most sense for my goal of long-term wealth creation.
I’ll preface this post by saying that it is a biased account on why long-term buy and hold investing is the way to go -- because I’m living proof of how great the results can be.
OK, now that we’ve got that out of the way, let’s dive into a few different real estate strategies; we’ll end with my favorite, and what I feel to be the most effective wealth generating tool in my real estate tool belt: long-term buy and hold.
Typical Real Estate Investing Strategies
Short term buy and hold (STBH)
As the name implies, short term buy and hold usually involves purchasing a property with plans to hold it for a short amount of time, typically fewer than five years.
This strategy is often implemented with a mismanaged or dilapidated property where the new owner will come in, make repairs, reposition the building and tenants to improve ongoing cash flow, and then sell it for a profit.
Depending on the condition of the property, it may or may not qualify for traditional financing. Traditional financing is usually the cheapest loan available to most investors, as compared to private loans or hard money lending.
STBH can be good for medium term wealth building, but these real estate investments are likely to have more erratic cash flow than long-term buy and hold (LTBH) properties. This is often because so much change needs to happen so quickly, i.e. change out tenants, make building/unit upgrades, change property management.
All of these things will affect the passive income you generate and all of these changes need to happen to help a building become stabilized. There is some risk involved due to the need to make a profit within a relatively short time horizon.
The shorter the time horizon in which repairs/changes have to be made, the more expensive it becomes because the owner is unable to pay for these changes from the rental profit. That means the expenses must come from an expensive construction loan, private money, or cash.
If the building repositioning does not ultimately command the projected sale price, the new owner can be in a lot of hot water. This is usually only a concern with a short time horizon.
Depending on how the property is sold, it may be subject to long-term capital gains tax, but you should consult with a tax professional prior to making any tax-related decisions.
Fix and Flip
Fix and Flips usually involve fixing a distressed property and then selling it for a profit. I won’t go into much more detail here, but know that Fix and Flips are usually done in a compressed time horizon and financing can be difficult and expensive to obtain.
Long-Term Buy and Hold (LTBH)
The long-term buy and hold strategy ... the crème de la crème. This strategy involves buying a rental property with the intention of a long holding period, typically 5-10+ years.
You can buy knowing that you’re going to own this property for the long haul and time is on your side. An investor doesn’t need to quickly make massive changes to the property in order to increase value overnight.
Since you’re investing over a long time horizon, your risk is often hedged. That means that even if you overpaid for the property initially, rents will typically increase over time and appreciation will increase the building’s value, allowing you to eventually earn a profit.
Don’t misread that to say that I’m endorsing overpaying for a property. The point here is to illustrate that time really can heal all wounds if you have a calculated plan in place. Buying a bad deal and simply waiting around for things to eventually turn around is a bad strategy.
When you decide to sell one of your properties after a long-term holding period, it is usually only subject to long-term capital gains tax.
Now please consult with your tax professional prior to making any tax decisions, because telling the IRS “Well, Michael said I only have to pay long-term capital gains tax” probably won’t hold up in court.
The Benefits of Buy and Hold
There are numerous benefits to buy and hold real estate:
- Goal planning
- The compound effect of appreciation
- Tax benefits
- Easier management over time
- Stable net worth
Let’s break each one of these down.
First off, you can set long-term goals since you plan to own the investment property for a while. Having a long-term time horizon gives owners the flexibility to slow down, breathe, and come up with a great plan on how to improve their building, if needed. There is no time pressure like there is with short term buy and hold.
Another amazing phenomenon is how appreciation compounds, which is the real wealth generator in real estate. Imagine you have a rental property that is worth $100,000 when you purchase it. If properties in the area appreciate at an average of 5%, that property will be worth $105,000 the following year. In 15 years, that property will be worth $207,892!
As mentioned earlier, owning a property for a long time does not create any large taxable events (other than taxes on the rental income) until you decide to sell the property. When you do decide to sell, you can utilize a 1031 exchange to defer paying capital gains tax by purchasing another “like-kind property” with the profit from the sale of the first property. Just know that 1031’s come with extremely strict requirements and guidelines to follow.
Another tax advantage of long-term ownership comes in the form of depreciation of the asset over a long period of time (depreciation on residential property is typically 27.5 years) to minimize the taxes you owe. Furthermore, from a logistical standpoint, the longer you own a property, the easier it becomes to manage. You will have a better understanding of the market and have a team in place to assist with repairs and maintenance.
Finally, one of the biggest benefits to owning real estate long-term is that it adds stable net worth to your balance sheet. Banks and lenders alike love to see that an owner has owned a piece of property for many years and will usually feel more comfortable lending on that piece of property. Additionally, as the property continues to appreciate, so will your net worth.
What Types of Properties Make Great Buy and Hold Investments?
The answer to this question: literally anything!
This is one of the many reasons why I love the buy and hold investing strategy. I personally have never sold any of my investment properties and don’t plan to anytime soon.
The first single-family rental (SFR) that I purchased is a long-term investment. The first duplex that I purchased is a long-term buy and hold. The first triplex that I purchased is a long-term buy and hold. The first 8-plex that I purchased is a long-term buy and hold. You get the idea….
Another one of my personal investing criteria is that I will never buy a property that doesn’t cash flow. However, if the property doesn’t cash flow on day one because it has been mismanaged and it has the potential to cash flow -- that’s what really gets me excited. This is where you’ll get into “value-add” territory.
If you can purchase a property and add value to it over time (i.e increase rents, rehab it to improve the condition, decrease operating expenses, etc.), this will usually pay dividends in the form of increased cash flow and increased market value at refinance or sale time.
Factors to Consider as a Buy and Hold Investor
There are a few main factors to consider:
- Building Age
- Local Market Conditions
- Team Lifespan
- Availability of deals
Let’s dive deeper into each of these.
You should always consider the age of the building. If the building is already extremely old, you need to look at the remaining usable life of the components of the building, such as mechanicals (HVAC, boilers, water heaters), roof, windows, etc.
It is important to assess the local market and the outlook for it. For example, do you think this market will still be relevant in 10+ years? Some local factors to consider are: population growth, job growth, wage/salary growth, and diversity of employers.
Consider the remaining lifespan of the team you utilize. For example, is your property manager planning to retire in the next two to three years? Is your accountant planning to leave the industry in the next five years?
I always like to have my team grow with me, especially with long-term buy and hold investing. If I have to start from scratch and build a new team every couple of years, the attraction of long-term buy and hold starts to lose its appeal.
A few years ago, I started investing in a new market and had to start from square one and develop my team. I found a broker that I clicked with. Then, I found a property management company that was able to meet my needs.
Next, I found a local lender who was willing to work with me. Lastly, I found a rock star insurance agent. Now, any time a new deal comes my way, I send one email that includes everyone on the team and we’re off to the races.
One of the things that investors love about Roofstock is that they’ve done all the legwork for a buyer in regard to assembling a team. When you purchase through Roofstock, you already have a vetted network of professionals at your disposal so you don’t have to go find your own agent, lender, or property manager.
The last critical factor to evaluate is the number of deals available in the areas you’re considering. I like to invest over long time horizons, so when looking at various real estate markets, I choose those in which there are numerous deals to purchase. I want my process to be repeatable when it comes to deal acquisition.
If you take one thing away from this article, it should be that there are numerous ways to create wealth and make money with real estate.
The investment strategy best suited for you depends on your personal financial situation, risk tolerance, willingness to take on a project, and time horizon.
However, I think most seasoned investors will agree that long-term buy and hold is the safest, most stable way to generate generational wealth.