Buy and hold is a long-term real estate investment strategy where a real estate investor buys an investment property with the intent to hold the asset for the considerable future. Along the way, this investor can earn passive income through the rental income on the property and use this cash flow to pay the mortgage. Down the line, investors can even sell the asset for more money, considering that real estate generally increases in value over the years. For this reason, buy and hold is a tried-and-true real estate investing strategy and a solid choice for preserving wealth.
In this article we'll explore the different types of buy-and-hold properties, their benefits, when to sell, and ultimately how to finance the purchase.
What does "buy and hold" mean in real estate?
Investing in real estate long term is a common strategy around the industry. For this reason, when one ultimately buys the real estate asset is not that important, as long as the investor has the intention of holding the asset for the considerable future. With that said, home prices will fluctuate depending on the conditions of the market, so savvy investors will know how to find the opportunity to buy low in order to make more money.
Still, a buy-and-hold strategy infers that the investor believes the asset will be worth more years from now. In other words, now is a good time to buy and hold real estate, as long as the investor will actually hold the asset for the foreseeable future.
Additionally, keep in mind that if you are looking to finance the purchase, what rate you get will definitely depend on when you purchase. So, real estate investors looking to purchase properties without an all-cash deal should monitor the interest rates and shop around for the best one.
Investors considering a buy-and-hold real estate strategy should calculate the rental income potential of any property they're considering. Investors who have to finance their purchase in order to invest in real estate should generally be prepared to put down up to 20% of the purchase price.
A buy-and-hold real estate strategy is beneficial because investing in real estate offers much less volatility than the stock market and more predictable cash flow.
Real estate investors can also take advantage of opportunity zone programs. Opportunity zones are designated areas created by the Tax Cuts and Jobs Act of 2017 that allow certain investments in lower-income areas to have tax advantages.
Buy-and-hold real estate investing and dividend stocks are similar in the sense that investors can expect a payout through the duration of holding. While stock dividends depend on the dividend prices set by the company's board of directors, the potential of real estate income depends greatly on the marketability of each individual asset.
Types of buy-and-hold properties
If you want a solid buy-and-hold investment property, you should be willing to invest some money into upgrading the property. Look into replacing flooring, painting, and performing any other upgrades that may be needed to make the property more appealing for potential tenants. Remember, many real estate investors in a buy-and-hold strategy rent out these properties to tenants in order to earn passive income.
Single-family homes are a great property type for implementing a buy-and-hold strategy, but different investors may prefer different property types, such as a duplex or triplex, manufactured homes, multifamily buildings, etc., so read up on these different property types and the advantages and drawbacks of each and determine which sector you would like to invest in. Ultimately, investors should be after an appreciating asset with cash flow.
In order to buy multiple properties, the most pressing challenge will be the money needed. The majority of real estate investors purchasing multiple properties will need to get familiar with the financing options at their disposal. To do this, reach out to an experienced mortgage broker, who will research the best lenders for you. Still, real estate investors interested in multiple properties will have to put down a sizable down payment. We'll discuss financing further a bit later.
Another way to gain exposure in multiple properties could be investing in real estate investment trusts (REITs), or real estate crowdfunding. Though you will be sharing the properties in your portfolio with other investors, you'll still gain the benefits of investing in the real estate sector. If you do decide to take this route, you won't need as much capital as you would if you directly invested in properties, and the company will take care of researching opportunities for you.
So, if you prefer a more hands-off investment property than directly owning the property, consider investing in a REIT.
When should you sell a buy-and-hold investment?
You should plan to hold your buy-and-hold investment property for at least 10 years, and preferably more, but if you are thinking of selling, make sure you consider the following:
- Tax breaks: There are certain tax code advantages to be aware of. For example, investors can use a tax-deferred exchange, meaning investors can sell one property and buy another investment property but avoid paying capital gains taxes.
- Your loan term: If your loan term is ending, it may be the correct time to sell.
- The market: Familiarize yourself with the prices of comparable homes on the market. If prices are up and it's a seller's market, consider putting your property up for sale so you don't have to wait until the next cycle.
- Rising property taxes: If property taxes are rising in your area, it may make sense to sell your property in order to avoid those higher rates.
- Stagnating rental income: Investors should consider selling the property if their rental market makes it impractical to raise their rates at a healthy pace.
- A better opportunity: It may make sense to sell your property, too, if you're confident you can reinvest those dollars into a better investment.
Keep in mind that when you sell real estate you've held as an investment, the rate at which you're taxed on the profit from it may vary.
Benefits of a buy-and-hold real estate investment strategy
A real estate portfolio is a collection of different investment assets. It is a very effective strategy for making money investing in real estate, as these properties generate a steady cash flow in the form of passive income. As mentioned, many investors choose to invest in single-family homes. This steady cash flow can then be used to pay off the mortgage debt on these properties. A rental real estate portfolio also helps diversify risk with your investment, and it comes with many tax benefits you will want to take advantage of.
For example, most rental property costs are tax deductible, so make sure you save those receipts. Expenses that fall into the tax deductible bucket include, but are not limited to:
Investors should definitely be aware of what costs they can include in their tax deductions. An accountant experienced with rental property investing can help.
In order to structure your real estate portfolio between growth and income, you will want to make sure the cash flow generated by your properties is positive. Remember, one of the reasons to consider expanding your real estate portfolio is to diversify your risk, so before you pick up another property, do some market research for properties perhaps in another sector or another area. This will help balance your overall portfolio.
You should consider a buy-and-hold real estate strategy because it is a great strategy to preserve and accumulate net worth. First, a buy-and-hold real estate strategy allows the real estate investor to take advantage of appreciation. Generally speaking, real estate should be worth more in the long run than the day you purchased the asset. So, if you're able to hold the asset through various real estate cycles, you can expect that real estate's value to go up. If this happens to not be the case in your situation, you can still claim depreciation of the asset to minimize the taxes you'll owe.
Second, along those lines, a buy-and-hold real estate strategy also allows investors to take advantage of other tax benefits. Keep in mind that if you decide to sell the asset, you will have to pay capital gain taxes. As mentioned earlier, investors should know they can use a 1031 exchange to defer paying capital gains taxes and directly use the profits from the sale to purchase another similar property. There are a number of criteria you must check off in order to take advantage of this, so familiarize yourself with these requirements to avoid paying these taxes. Again, an accountant familiar with real estate investing can be very helpful here.
But in order to fully gain from all the benefits of real estate investing, investors will want to make sure to thoroughly perform their due diligence.
Drawbacks of buy-and-hold real estate
There are plenty of potential disadvantages in a buy-and-hold real estate strategy. First, real estate is illiquid, meaning investors will not have immediate access to cash for their properties.
Second, real estate values are susceptible to fall. In this case, investors can lose their whole investment. Rental income can also drop to zero, depending on market demand for your asset. If your tenant defaults, you'll have to go through the eviction process. To avoid this, investors should target assets in areas of high demand, perform in-depth tenant screening, and buy rent default insurance.
Third, owners will be liable to fix any property damages in the asset. These ongoing maintenance and repair costs can add up, including:
How to finance buy-and-hold real estate
Unless purchasing an investment property with all cash, investors will have to review their financing options in order to invest in real estate. To buy and hold real estate, the most common financing options are traditional lender financing options, FHA purchase loans, or seller financing.
FHA loans generally require a 3% down payment, with the only caveat that these loans can only be used on owner-occupied properties. In other words, you must live on the property in order to take out an FHA loan. So, non-owner-occupied properties will need a different source of financing.
Seller financing is a loan provided by the seller of a property to the purchaser. Motivated sellers are more than willing to craft creative terms that can help the buyer finance the purchase, so explore this option if possible. Be aware, there are pros and cons for both buyer and seller when using seller financing.
A positive for seller financing is that since the seller is working with the buyer, deals close much quicker. On the other hand, the buyer using seller financing does not have to work with the bank to acquire financing, which typically comes with its own process and fees.
A disadvantage to seller financing is there is a higher risk for foreclosure if the buyer cannot continue making payments. In addition, buyers will likely be paying higher interest than if they took a loan from the bank.
The bottom line
There are many ways to get started in buy-and-hold real estate investing for those looking for a hands-on, income-producing property. For investors interested in the real estate sector but wanting more of a hands-off type of investment, or, perhaps for investors with less capital at their disposal, investing in a REIT is a solid strategy to diversify your investments and still get a foot in the real estate sector.
It's a common misconception that investors need to be strapped with cash in order to buy and hold real estate, but there are many mechanisms out there for all investors to get started in the real estate sector. A buy-and-hold real estate investment strategy holds many benefits for investors, ranging from less volatility to more predictable returns when compared to other similar investments.