Most of the long-term wealth in Real Estate comes from the buy and hold investment strategy.  Common sense tells you that if you buy a piece of property, hold and maintain it long enough, and then sell it, you will make money. With this plan, you can do absolutely nothing and still become “wealthy” over time.

Many families have apartment buildings, raw land, and industrial property that has been passed down through generations. However, most ‘buy and hold’ investors are looking closer to home. If you begin now, you can accumulate significant base wealth and monthly cash flow, either for your retirement or for your children’s inheritance. You don’t have to wait 100 years, but you can follow this same strategy.  Over the last eight decades since the great depression, Real Estate has outperformed every other investment. While it has its market swings, it has always bounced back. Real estate is one of the only assets that you can buy that provides cash flow, capital appreciation, and tax savings, all at the same time. And you can have someone else giving you those benefits because, in the case of a rental property, your tenant makes all the payments and buys the asset for you.

While many creative real estate strategies provide income today, the buy and hold strategy can, and does, provide long-term wealth for you, and your families.

With that said, let’s talk about the basics of the buy and hold strategy.  Build Equity and Income Simultaneously You are building two things with a buy and hold strategy, equity and income. If you buy your investment right, your purchase payments will be less than the rental income in the current market, and the property will more than pay for itself. In addition, you are building equity in the properties so that 20 or 30 years down the road you not only have a consistently growing cash income as rents increase, but you also have significant asset value and equity.

The real key to buy and hold is time. When you buy a property, don’t worry about what it is worth this year, next year, or even in five years. You are looking at potential value in 20 years. Watch your market cycles and try to buy at or near the low point, and then just hold on to it. With the historical performance of real estate, you can afford to take the long view and wait out any shorter downturns in the market.

If you do your research and analyze past and current growth patterns properly, you can get a pretty good idea of what property will be worth in 20 years. There are many factors that influence a property’s future value. We’ve talked about some, but it is worth repeating with a more detailed list:

Buy and Hold Usually Means Renting

Your first decision is to evaluate if you are really cut out to be a landlord. If little things bother you and you don’t deal well with someone else’s problems, stay away, or hire a good property management company. On the other hand, if you get along well with a wide variety of people and can easily forget or leave behind problems, you could be a good landlord. Just remember, your tenants are buying your property for you. Treat them well and they will generally treat you well. The few that don’t treat you well can be left behind.



If you answered, “yes” to these questions, then you should do well at being a landlord. Don’t get me wrong I have great tenants in most of my rentals.  However from time to time it can get a little nasty.  People come up with all kinds of stories on why they can’t pay you your rent. Suddenly, their problems become your problems.

I would be a liar if I told you that I followed my own advice to the letter. I just want you to be aware of some of the potential liabilities of being a landlord.  Being a landlord doesn’t have to be hands on all the time. I have some tenants that pay their rent to a long-term escrow company. The escrow company makes the underlying mortgage payment for me.  The tenants are never late with the rent and I don’t do a thing. It is on total autopilot. I haven’t even been in the property for years. This situation isn’t the norm, but it is nice to have a few of them in your portfolio.

If you said No to the questions above and started having heart palpitations then you may want to look at the other strategies, or focus on property arrangements where you don’t have to deal directly with the tenants. A good way to approach that is get a partner where his or her job is to deal with this aspect of the business. Have a hired gun so to speak. It is a great way to manage property.  Purchasing and managing a good rental property takes practice and planning. We can’t help much with the practice, you just have to do that.  However, we can help with the planning.

Return On Investment You don’t get rich just by making money. You get rich by managing and keeping the money you make. You need to make an adequate return to cover your expenses, depreciation, repairs, and other costs. However, you also need to be aware of the competition. Unless your building or house is significantly better than the surrounding offerings, you can’t get away charging higher rents for very long. At the same time, you don’t want your rents to be too low. People may get the idea something is wrong with the building, or you will simply leave money on the table (and in other people’s pockets). I like deals where I don’t have any of my own capital tied up. I am then able to earn an infinite rate of return. If you do put your own money into deals, a target return of 10 percent is not only reason-able, but usually achievable. For example, if you put $10,000 down on a deal, you want to generate $1,000 back in annual cash flow to achieve the goal of a 10 percent return (before taxes). If the property you are purchasing is a rental, you can often raise that return considerably when you factor in depreciation. Just remember that this is a long
term goal. You may have a few years of

negative cash flow when you get started, depending on how much money you have to buy your property with. I personally hate negative cash flow. My advice is to be creative in structuring the transactions to create immediate positive cash flow.  However, some rapidly appreciating markets make this especially hard. In some markets you can use conventional financing for 100 percent of the purchase price and still rent for more then the payment. This is especially true in my current Utah market. In other areas of the country, particularly many of the coastal markets, you’ll need 30 percent down or better and still not see break even cash flow. That is when creativity and split-funded deals are especially helpful.  As you evaluate the property, look at the following factors that influence your final cash stream: quantity, quality, and duration.

Quantity. How much does the property generate each month? Does that quantity meet your needs?  If it doesn’t cover current costs, can you work with a negative cash flow until it does?  Quality. What is the certainty of receiving the monthly income? Do you have a non-cancelable lease with a large company, or month-to-month with an apartment tenant? What are historical vacancy rates? What is the current demand for rental property of this type?
Duration. This is the length of time the income stream from the property will last. What is the projected physical lifespan of the property? Duration is one aspect that makes residential real estate so attractive for the average person. Housing generally maintains economic viability for decades, if not centuries, when properly maintained. Commercial properties become obsolete much faster due to constantly changing business practices.  I use the following form in evaluating Cash Flow from properties. (Note: This does not compute any tax advantage. This is just looking at the straight cash flow of a given property)

The example below is for a single family home, purchased for $180,000.

Monthly Annual Gross Scheduled Income   $1,700.00 $20,400.00 Less Vacancy factor -5% -$1,020.00 Less Costs (itemized)

Small Repairs/ Maintenance $50.00 -$600.00 Utilities (tenant)

Property Taxes $83.00 -$800.00

Legal / Professional -$300.00

Insurance $30.00 -$360.00

Advertising -$100.00

Misc. $30.00 -$360.00

Net Operating Income $16,860.00

Less Debt service. 863/mo -$10,356.00

(80% LTV, $144k 30 yr fixed 6%)
Seller Carryback 210/mo -$2,520.00
(20% for $36 K at 7%, interest only)

Net Cash Flow (Before taxes) $3,984.00

Your return on this investment is unlimited since this is a 100 percent financed purchase with no money out of your own pocket.  Lets look a little deeper into the above example. 

Gross Scheduled Income: The Gross scheduled income is the income that you hope to derive from the property by renting it out. This may or may not be the actual income. Oftentimes when you are looking at investments, rents are low. This happens for a variety of reasons. Even when market conditions are improving, landlords are sometimes reluctant to raise rents for fear of losing their ten-ants.  When I am buying property I try to use the actual rental history in my negotiations and my initial analysis and not the scheduled or projected amount. Realtors almost always use scheduled income because it looks better and puts the income higher. I use the argument that if the seller couldn’t get the higher rent why should I expect to. I also try to find out when the last time was the landlord has raised rents. Many times you can increase the value of a property just by getting rents to market rates. This especially holds true with multiple units. Request a rent roll or rental history for a property. Sometimes they are tough to get out of a seller but I make it a condition in the offer.

Many times when you buy single family homes, rental histories are not available because the property may be vacant when you buy it. I personally don’t like buying existing single family rentals (SFR) because they tend to be more beat up and maintenance might be neglected. I like buying bank REO’s if I can get them enough under the market or in distressed seller situations.

Vacancy Factor: When qualifying for a loan, lenders almost always will figure in a vacancy factor when they compute their debt coverage ratios.  Even if a property is full they will factor in 5 or 10 percent, or even more, depending on market conditions.  It is a good idea for you to factor vacancy into your cash flow. Even in a perfect market, ten-ants move out without notice and you may end up vacant for a few weeks or months. You don’t want to be operating so close to break even that a loss of rent for a month or two will jeopardize the property.  Operating Costs: These obviously vary by market and property. Some of the more general expenses are:

·    Administrative
·    Management
·    Repairs & maintenance
·    Legal and professional
·    Advertising
·    Insurance
·    Taxes
·    Utilities
·    Telephone
·    Trash
·    Replacement reserves
·    Contracted services
·    Landscaping

When managing property you have your month-to-month expenses that are relatively fixed. But you will also have unexpected repairs, like water heaters, clogged sewer lines, garage doors breaking or a roof repair. These kind of expenses can be deferred for a time or you may even have your tenant paying for most of them, but at some point you will have to deal with them.

It is a good idea to get on the front side of it, meaning put some savings aside. A percentage of gross income each month that is earmarked for improvements is a good idea, say five percent. You may need to increase it if your property is really old and in disrepair. Then, when that nasty eviction results in the unit needing a $5,000 remodel it won’t be so devastating. In my experience one of the most frustrating things is not having sufficient funds set aside for unexpected repairs and then having to pull from a personal account or funds set aside for a different purpose.
For multi-family units, a general rule of thumb for operating expenses (excluding debt service) is about 35 percent of gross income. Actual expenses may be down around 28 percent, but the lender may use a number closer to 35 percent when computing a debt coverage ratio. Single-family homes may be less, as is the case with lease options and with other properties where the landlord does not pay any of the operating expenses.  The same is true of triple net leases in commercial properties.

Net Operating Income (NOI): Your net operating income or (NOI) is what is left over prior to debt service, after you subtract operating expenses form the gross income. The net operating number is critical because that is the number you can safely count on to assist with paying a mortgage, if any, and dividing up profits. It is also the number many investors will use to determine a cap rate of a property. Comparing cap rates is a way of comparing different investment opportunities.  In the above example there was a net operating income of $16,860, or $1,404/mo.

Debt Service: This is the amount of money needed to make the monthly mortgage payment. This number is subtracted from NOI. With multi-family units where thelender is looking at the property to repay the loan, the lender will use the required monthly payment with the NOI to determine a debt coverage ratio. The debt coverage ratio is the amount of money available to repay the monthly debt. A debt coverage ratio of 1.2 would mean $1.20 of income is available to pay every $1 of monthly debt. A ratio of 1.05 would mean $1.05 of income is available to cover every $1 of monthly debt. Debt coverage ratios are used in connection with loan to value ratios to determine the amount a lender will loan against a property.  In the case of single-family residences (SFR) the lender typically looks at the credit worthiness of the borrower for repayment. If the SFR is going to be a rental they will often request copies of leases in the loan application process or projected lease income.

Net Cash Flow (before taxes): This is the amount left over after taking NOI and subtracting the debt service. If this number is positive, good news! It’s time to go to the mall and buy something. If this number is negative, you need to come up with money out of your pocket to make the deal work.  Even if this number changes to positive after taxes, it is a lot easier to make it every month when you don’t have to fork over your own dollars. You can’t buy groceries with depreciation.

If you do have losses, they typically will carry forward year to year to adjust against regular income.  Check with your tax professional because tax laws change and vary from individual to individual. Cash Flow (after taxes): Even if you have a break-even real estate deal, you may pick up substantial tax savings against other income when you factor in depreciation. For example, an investment that nets zero in monthly cash flow shelters $5,000 of other income resulting in an after-tax savings.  Don’t Forget Appreciation: This is one of the hidden boons in real estate investing. It is almost as good as monthly cash flow. Even if a deal just breaks even in cash flow with minimal tax savings, you may be making money every year when the property appreciates 5-10 percent or more in value. You won’t realize these gains until you part with the property—or refinance it down the road—but these gains can be huge. It is another reason why real estate is such a great investment.  3 great reasons to own real estate:

1.    Cash flow
2.    Tax savings
3.    Appreciation