Real estate investing – and in particular, flipping – is getting a ton of attention these days. With the housing market making a recovery in the US and more reality TV shows coming out every month, everyone seems to get excited about the potential of a quick buck.
Nothing is as it seems on TV, though. Not long ago, a production company contacted me to discuss our business and see if they could make it into a TV show. She was the third company in less than six months to contact us about this – but you won’t be seeing us on HGTV any time soon. The conclusion of all the production companies that approached us has been that what we do, as buy-and-hold investors, is boring.
It’s true that there’s not a lot of drama or sex appeal in basic buy-and-hold investing. But there are a lot of ways to make money and build your wealth over time.
So, what is buy and hold real estate investing? It’s simply when you buy a piece of property, rent it out and hold it.
It’s the most common method of real estate investing, but most people think you’re holding on in hopes of the price going up (appreciation). Yes, that is one way that you make money, but there are actually three ways you make money as a buy and hold investor.
Appreciation is what captivates an audience. Who doesn’t love hearing stories about home prices doubling and people making big bucks on a quick flip? It’s a great story. And we do a lot of market research and carefully select the areas we buy in so we often see solid growth in the value of the properties we buy. But to a smart buy-and-hold real estate investor, the price going up is only icing on already tasty cake.
2) Cash flow
Rather than focusing on appreciation, we’re actually focused on a longer-term strategy that sees us making cash flow each month. This simply means we bring in more money through rent than we spend on mortgage, repairs, taxes, insurance and property management.
3) Paying down your mortgage
Finally, we are building our equity by other people (our renters) paying down our mortgages.
And that’s it. Appreciation is obviously pretty nice, but it’s not the foundation of buy-and-hold investing.
Doing the Math
Let’s look at a basic example. Pretend you found a nice property for $100,000 two years ago, and you bought it for 25% down ($25,000). Today, here’s how your investment looks:
1) Depreciation: Bad news, your property went down in value by 5% in those two years. It’s now worth $95,000. So this was a bad investment, right? Not necessarily.
2) Cash flow: Rent each month is $1,000. Your mortgage, insurance, taxes and miscellaneous expenses are $800 a month. Income minus expenses = $200 a month. 24 months x $200 = $4,800 in income so far.
3) Paying down your mortgage: Assuming you have a mortgage at a 5% fixed rate and 25-year amortization, at the end of the two years you will owe $71,805 on your $75,000 mortgage. You have now built an additional $3,195 equity into the property ($75,000 – $71,805 = $3,195) using the rent money you collected to pay down the mortgage.
So, your property may be worth less than you bought it for, but you’ve still made $7,995 from it in two years (adding together the positive monthly cash flow and the principal your renters have paid down).
The best part is you haven’t actually realized a gain or a loss because that only happens when you sell. You really haven’t lost the 5% that the property went down in value. Focus instead on the fact that you’ve made a 32% return ($7,995 divided by $25,000 invested) on your money after two years. And if you hold onto the property and ride the market cycle back up, when you do go to sell you’ll likely enjoy a nice lift in value to add to the other two ways you’ve made money.
Plus, the big, beautiful bonus of buy-and-hold investing is that you’ll have been enjoying some nice tax deductions along the way that can help offset income you’re making with this property and other sources of income too!