4 Real Estate Investing Strategies: Buy and Hold Real Estate

Welcome to the second part of my 4 part real estate investing strategies blog. In this blog post, I will go over buy and hold real estate. Just like previous post, I will go over what they are, what it takes to invest in buy and hold real estate, the level of risk associated with buy and hold real estate, and how this strategy can benefit you financially. I hope you enjoy and learn a thing or two!

2. Buy and Hold Rental Properties

• What is Buy and Hold Real Estate?

  • Buy and hold real estate is a form of real estate investing where an investor purchases a piece of property (home, office space, retail, lot, etc.) and holds it as a long term investment. The most common way for financing a buy and hold real estate investment is generating rental income from a tenant that occupies the property. This will help float (cover the mortgage and other associated expenses that come with owning the property such as interest, insurance, taxes, maintenance, etc.) the property along as the landlord intends to sell it down the road. If a landlord is able to keep their property occupied for the duration of their investment plan, and the property expenses are less than the rental income, this can give the property owner short term month-to-month cash flow. When the landlord is ready to sell the subject real estate, long term gains can be realized if the property has appreciated over the course of the landlord’s ownership.

• What does it take to invest in Buy and Hold Real Estate?

  • For purposes moving forward, we will be referring to buy and hold real estate as a piece of single family residential (1-4 units). Other sectors of real estate such as commercial, industrial, or land acquisition take specialized knowledge from those who work in that sector. For most people, purchasing a home that needs little to no rehab and can be rent ready shortly after acquisition is a great strategy for investing in real estate. To buy this rental property, first you need to establish if this is your primary residence and you will be renting out, or living in at least one of the units. If so, discussing this with your lender will make you eligible for different types of loans such as the typical conventional loan, or a government backed loan such as FHA, VA loan, or USDA loan. It is vital you get prequalified by a lender before making a purchase so you know how much you can spend. Make sure to consult a trusted lender in your area. Establishing if this your new rental investment is your primary residence will help you qualify for other loans. If this is not your primary residence, then most of the loans that will be available for investors are conventional loans and jumbo loans. These have different requirements than a primary residence loan and it is important you are aware of these before you consider purchasing a rental unit. If you already own a home, you can use a home equity loan where you tap into your homes equity through a home equity loan or a home equity line of credit. With historically low rates, it is no wonder why the market has been so hot recently. Money is cheap and people are taking advantage of it. Once again, getting prequalified should be the first step you take when buying your first rental property.

  • The beautiful thing about rental properties is they can be bought in any market condition. Looking for high growth and expanding economic areas in your city will be a great place to buy a rental. Cities that experience population growth will see a rise in consumer demand, and in turn appreciation to the property you own. Whether it be job growth, or reinvestment into the city, many factors can affect the price of your home. I will help you identify which factors can have a higher probability of increasing the value of your home over time. There is no guarantee but there is always a way to make a confident decision based on knowledge and research. San Antonio has experienced explosive population growth in the last 10 years, with an increase of 19.16% since 2010 (San Antonio Population.) Population can be researched for changes in the market and indicate which markets are growing and/or have the potential to grow. Population growth is a correlated outcome to industry expansion. The San Antonio Business Journal publishes a crane watch which highlights commercial real estate projects in the San Antonio area. (Click here to view the Crane Watch.) This is a good resource for finding dominant companies that help expand the local economy by the creation of new jobs. Ensuring a rental property stays occupied during your ownership is vital for growth in value over time. Lastly, affordability is another key factor in determining which area can be subject to growth in the future. Affordable markets tend to grow faster than others since they target a larger number of the population. Markets that are over priced can grow much slower because the volume associated with growth will decrease as prices of real estate go up. The law of demand states that if the price is higher, the quantity demanded will fall. If the price is lower, quantity demanded will be higher. This is something to keep in mind when researching an area for potential rental properties. Affordability directly affects your initial investment into that market and can affect the quality of your investment down the road. Location is a big driving factor for real estate. You will hear the phrase “location, location, location” and there is merit to that saying. From an investment standpoint, it is better to buy the cheapest house in a prime area than the best house in the worst area. It is very important due diligence is performed before deciding to buy a rental property in that area.

• What is the level of risk associated with buying a Rental Property?

  • Rental properties will vary in quality, from complete renovations to little or no cosmetic updates. It is also possible you can buy a house that needs no initial rehab and can be cash flowing right away. Since this blog is about Buy and Hold Rental Properties, I will discuss the risks associated with purchasing properties that require little, if any, rehab in order to be rented out to a tenant. It goes without saying, a house that is in better condition will be worth more than a similar house that is in worse condition. This requires more capital to invest with because the price of your initial investment may be a lot higher. However, it can be easier to obtain a loan for a higher quality house since the bank/lender will be far more likely to underwrite a loan on a property that is in livable condition compared to one that needs work. This is because the bank uses the property as collateral for the loan. It is important to remember that in the Financer’s eyes, you are an investment and they want to secure their investment as best as they can by mitigating their risk. In case of borrower default, the financer has the right to seize the property in order to protect their investment. A lender will need an appraisal in order to determine how much they are willing to loan. In simple terms, an appraisal is what the lender believes (in their authorized opinion) the property is worth in terms of market value. Appraisals can make or break your ability to obtain financing for the property. Most banks will require a loan to value ratio of 80%. That is 20% of the homes value you have to put up front (a down payment), and the bank will loan the other 80%. For example, a house is listed at $200,000. The bank will need to appraise the house at or above $200,000. If the bank’s loan-to-value ratio (LTV) is 80%, you will need to put down $40,000 in order to secure a loan for $160,000. If the bank appraises the property lower than $200,000 than you will need to either have more cash up front, negotiate the asking price, or find another appraiser who might value to house more. This will help fit the requirements for a banks loan and secure your financing for the property. To continue our example, let’s say the home only appraised for $180,000. There are a couple of options you could take. The first is putting more money down. If the appraisal is $180,000, and the LTV is 80%, the bank will only make a loan for $144,000 ($180,000 x .8 = $144,000). Instead of only having to put 20% down, at a value of $40,000, you will now have to put down an additional $16,000 in order to secure the loan ($200,000 - $144,000 = $56,000). Your down payment went from 20% to 28% ($56,000 / $200,000 = .28 or 28%) That $16,000 increase made your initial investment of $40,000 increase by 40%. If you do not have this extra capital on hand, this is a very difficult situation to be in and it can be difficult to obtain financing. Another option you have is to negotiate the asking price. If this is done during the option period, and the seller is not willing to negotiate, the buyer can back out for any reason without loss of earnest money deposit. Read this article here about why the option period is vital for the buyer in order to learn more about the home and making sure you are making a quality investment. Negotiation during the option period can work a few ways. One route is asking the seller to make some repairs in order to improve the condition of the property. This can be helpful to the seller if the appraiser states the necessary repairs can add value to the home and give the seller a better chance at getting a full price offer. If the seller does not want to make necessary repairs, then as the buyer you will have to make them. This is where your agent will negotiate asking price in order to save you money for the future repairs. As a buyer, it is important you conduct inspections on the property as well. You can find some things that both the seller and listing agent were unaware of and this will give you more insight to the quality of the house. This can help you avoid major repair issues you may not have noticed, help estimate repair costs, and verify what the seller has disclosed and if is is accurate. It isn’t uncommon to have sellers require an as-is purchase, nor is it uncommon for buyer’s to use as-is for negotiation. It is important to know that you will increase the risk you have going into the investment property, or even a primary residence. Obtaining another appraisal from a different appraiser is another option, but it isn’t something to rely on. It can be timely during the option period and there is not guarantee that it will improve the perceived value of the house. In fact, it may even lower it!

• How can owning a Buy and Hold Rental Property benefit me financially?

  • The price of rent you will charge is also critical making a profitable investment. If you are charging rent, and it is much higher than the other properties in the area, you run the risk of having a higher vacancy rate. If there are no tenants to make payments, then you will have no cash flow! Calculating your monthly and annual expenses is also important and I can show you how to make quick estimates when deciding to buy a rental property. There are general rules you can follow to evaluate your potential real estate rental investment. These are known as the 1% and 2% rules, Gross Rent Multiplier, Cap rate, net income after financing, and the 50% rule. These rules are used to analyze the income potential of an asset. Something to keep in mind is these rules do not apply to every single property. Each property is unique and determining the rent you will charge and the amount of cash you are willing to put into a property should be determined after due diligence and market research. These rules should be a quick test to gauge whether the rental property will benefit you. The 1% rule will tell you if the monthly rental income you going to charge is 1% or greater than the purchase price of your rental property. If rent is $1,800 a month, the property’s purchases price should be around $180,000 ($1,800 x 100 = $180,000 or if your purchase price is $180,000 then $180,000 x .01 = $1,800). The purchase price should include any necessary repair costs that may arise. However, this rule excludes the fact that a purchase price of a house does not determine what it will rent for. The rental market is what will determine the rental price. This rule also does not take into account for additional costs a property may incur when being financed. Your premium, interest, taxes, insurance, and maintenance will be your biggest expenses affecting the amount of cash flow you receive from a property. There are other costs such as vacancy rate, HOA fees, a potential management fee, and unexpected costs that may arise when owning a rental property. These are the determinants you want to consider when deciding the amount of rent you want to charge. The gross rent multiplier is used to measure the total purchase price of an an asset compared to the monthly gross rent you will charge. This will give you an estimate of how long the property will take (usually in years) to earn the amount of gross rental income that is equivalent to the total purchase price. Your calculation for GRM will be as follows: The total purchase price of an asset is $200,000 plus $50,000 in needed repairs bringing your total to $250,000. Your monthly rent is $2,000. Annually, your gross rent will be $24,000. $250,000 / $24,000 = 10.416. Most healthy real estate markets will have a GRM of 5-20. This means in about 10.5 years, your property will have grossed an amount equivalent to the total purchase price. The lower the number, the better the deal. If, an asset’s total cost is still $250,000 and you can only charge $1,500 a month, your GRM will increase to almost 14 ($250,000 / ($1,500 x 12) = 13.88). The GRM does not account for operating expenses so it is critical we use the 50% rule for this. The 50% rule states that 50% of an assets gross income (whether annually or monthly) is going to be dedicated to operating expenses. I talked a lot about financing a property earlier in this post, and as a note, the 50% rule does not include financing expenses. Allow me to explain. The 50% rule is used for calculating an asset’s capitalization rate or cap rate for short. Your cap rate takes your annual net operating income and dividing it by the total purchase price including repairs. The 50% rule is used to calculate the net operating income. For example, if an asset produces a gross net income of $36,000 annually ($3,000/month), 50% of that gross income will be used for operating expenses. $18,000 annually or $1,500 per month. Your net operating income, or NOI, is $18,000. Remember, the cap rate is assuming you pay in cash for the total purchase price. Your net operating income will not be the same if financing is involved. Going back to cap rate calculation, your NOI is $18,000 and your total purchase price is $300,000. This will give you a cap rate of .06 or 6% (%18,000 / $300,000 = .06 or 6%). Healthy real estate markets can produce Cap rates between 4%-10% a year. If you are an investor who is using financing to purchase a property, you should use a calculation called cash-on-cash return. First you will need to find your net income after financing. To do so, take your NOI (gross income - 50% of gross income for operating expenses) and subtract your financing costs. To calculate your financing costs, using an amortization calculator online is very useful in doing so. The monthly payment is estimated and only a lender can provide an accurate monthly payment estimation because of the fees associated with originating a loan. For a $300,000 property and 20% down payment, with a 3% interest rate, and 30 year term, your monthly payment will be around $1,012 a month. Multiply this by 12 to see your annual financing expenses and you get $12,144. Going back to our example, your NOI is $18,000 and your financing costs are $12,144. This means your net income after financing (NIAF) and operating expenses is $5,856 ($18,000 - $12,144 = $5,856.) To calculate your cash on cash return take your NIAF, and divide it by the cash you have put into the property. The cash into the property will include down payment, estimated cash repairs, and closing costs. For our $300,000 property, and 20% down payment, plus an estimation of $10,000 in repairs and anywhere from 2% to 5% in closing costs (2% of $300,000 is $6,000 and 5% of $300,000 is $15,000), the total amount of cash you will be putting into this property will range from $76,000 to $85,000 ($300,000 x 20% = $60,000. $10,000 in repairs. $6,000-$15,000 in closing costs. $60,000 + $10,000 + $6,000-$15,000 = $76,000-$85,000.) $5,856 / $76,000 = .077 or 7.7% cash on cash return. $5,856 / $85,000 = .069 or 6.9%. Aiming for 8%-12% for cash on cash return is a great benchmark to start. As you can see in our example, this hypothetical deal doesn’t meet the criteria. There are ways to influence cash on cash return and should be considered, although not idolized, in making your investment decision. A cash on cash return will let you know how much money you are getting back from the cash you have investing into the asset each year.

  • The above paragraph was intended to help investors understand the rental income a property has the potential to produce. This paragraph will suggest ways to build equity in your rental properties. Equity is a long term wealth builder and is a great financial benefit of real estate rental property investing! Equity is the term used to describe an investors percentage of ownership in the underlying asset. It is important to understand how equity can be calculated when determine the value of an asset and how your equity, or share of ownership, is valued. The value of an asset, that is bought through leverage (assuming debt, or financing the purchase of an asset), is composed of two parts. The liability, which is your debt obligation, and the equity, the percentage you own. The simple balance sheet equation is as follows; Assets = liabilities + equity. If you purchased a $100,000 home with 20% down, you own 20% of the $100,000 which is valued at $20,000. The other 80% is liability or debt. This value is $80,000. Together, liability + equity is equivalent to the total value of the asset. The trick to gaining equity in the asset you own is to increase the value of your position. This can be done in multiple ways. The first and a very common strategy for real estate investors to improve their equity position in an asset is to buy at a discount. This is referring to taking a buying position that is low and anticipating your selling point in the future is much higher. There are many methods to buying a property at a discounted price. Foreclosures, inheritance and estate sales, or landlords who want to sell their property quickly are all great ways to find a property that will offer this below market value discount. The key is finding a property that is currently undervalued compared to the market. Another common practice for adding equity to your position in an asset is to add value to the property. This is not the most common practice for people only looking to buy and hold and do not want to bother with repairs. However, it is important to note that forcing appreciation to an asset you own by increasing its after repair value can add a lot of equity into your pockets. You will realize the gain in equity when you sell. The third way to increase your equity in a property is paying down the mortgage you use to finance the purchase of the property. Even breaking even on the underlying asset is not bad when you are able to build equity in the property for free. When rental income covers the necessary expenses for ownership, long term equity gains are realized and wealth is created. The last way equity can be built in a property is through passive price appreciation. This is where the value of the property will increase over time because you bought in the right location and an area that has high and increasing consumer demand. This isn’t something that can be calculated accurately at the beginning of the purchase and there are baselines for estimating property price appreciation. Most healthy real estate markets will increase between 3% to 5% a year. While this is a conservative estimate and real estate is always fluctuating based on market conditions and perceived consumer demand, these price appreciating percentages have just as much potential to double, if not triple, if you do your market research and identify high demand and high growth areas in your local market. It is also important when holding a property to continually study comparable property sales to stay informed on market trends and understand the potential value of your asset.

  Thank you so much for sticking around to the end of the blog. There is still a lot more to unpack when it comes to formulas that help us determine which investments are worth your time. Be on the lookout for more content coming up. This was the second part of my four part real estate investing series. The next part will be about the Buy, rehab, rent, refinance, repeat method. I will also be posting some videos about internal rate of return and a more in-depth explanation of capitalization rate, how to calculate them and what they can do for you as an investor. I will also give my best strategies for identify target markets that are affordable and have high consumer demand and high growth characteristics that can help you achieve the most gains in your equity position when purchasing the property. Once again, as a quick disclaimer, this post is not intended for investment advice and the content above is intended for educational and entertainment purposes only. Leave a comment down below about what you think of the blog post or if you have an questions, feel free to reach out! Let’s talk soon.