Buy and hold real estate investing is the process of acquiring real estate, particularly rental property, to own and profit from over a long period of time. It involves careful selection of investment properties, financed well, and managed well, with an eye towards monthly income potential and potential long-term gain.
If you have a buy-and-hold opportunity and are looking to finance the purchase, check out Visio Lending. They provide 30 year term loans for single investments as well as portfolio loans for 3-7 properties. Get up to $2MM with rates as low as 4.9%. Get prequalified online.
5 Benefits of Buy and Hold Real Estate Investing
Buy and hold real estate investing can extremely beneficial for long-term investors. Specifically, there are 5 benefits that you can realize by investing in buy and hold properties. Some of these benefits include passive income, tax deductions, equity buildup and more.
Here are the 5 benefits of investing in buy and hold real estate:
Each month, any rent that exceeds expenses provides you with income. Plus, that income is a sort of holy grail. It’s passive income, meaning the income comes in month after month…indefinitely without you having to labor for it.
There are tremendous tax advantages that come from owning real estate and being able to write off certain expenses like depreciation. In fact, we’ve written an ultimate guide on the key rental property tax benefits and deductions.
3. Equity Buildup
With buy and hold investments, your tenant is paying down your mortgage for you, meaning the equity in your property increases each month. Further, tenants will even pay your interest expense, which is tax deductible. It’s therefore important to find good tenants who make prompt and on-time payments. You can read more in our ultimate guide on how to find renters.
Even though your properties can fluctuate in value, it’s a safe bet that a good property, in a good area will go up steadily in value over a long period of time. This is in contrast to short-term rehab investors who might renovate a property with the expectation that appreciation will happen more quickly.
Since you can borrow money to buy rental properties, you are able to multiply how many properties you can buy. With only a modest down payment, you are able to purchase a valuable property. Further, you can leverage existing equity to take advantage of home equity loans and lines of credit.
While flipping a house can generate a profit, it doesn’t create any passive income, doesn’t have any tax advantages, doesn’t build long-term equity, and leverage doesn’t have much of a long-term effect. For the person looking for long-term wealth creation, buy and hold wins hands-down.
How to Find Good Buy & Hold Properties
A property is a good candidate for buy and hold investing when it has both rental potential as well as the potential to go up in value over time. Additionally, a good candidate property will be located in an area with a pool of available and qualified renters who will occupy the property, thus generating steady rental income.
Finding such a good long-term investment candidate requires three simple filters: 1) choose good neighborhoods; 2) locate good properties; and, 3) ensure the purchase makes financial sense.
Choose The Right Kind of Neighborhoods
The best rental properties are located in solid working class and middle-income neighborhoods. This is where 3/4ths of the population lives. Look for good schools, available shopping, and communities where people care about where they live.
Be Wary of Bad Neighborhoods
Don’t be tempted to buy cheap properties in war zones. You’ll pay for those – literally – in the long run. There’s very little opportunity for appreciation, repairs will cost you dearly, and rents will not likely rise over time. A good rule of thumb is, if you wouldn’t allow a family member to visit the property after dark, you probably don’t want to buy there!
Luxury Neighborhoods Can Cost You
On the other end of the spectrum, luxury properties generally produce negative cash flow (more on that later) because the mortgage costs will far exceed the rent the property can command. While appreciation might be good, negative cash flow will probably eat up all the gains. Again, stick with properties where the majority of your community lives.
Invest in Your Own Backyard or Elsewhere?
Lately, it’s getting popular for investors to buy rentals outside of their own areas. That’s certainly possible, but it requires experience and good systems to do it successfully. If you are a beginner, stick with your own backyard.
If you’re looking to invest outside your area, there are turnkey companies that promote “turnkey” real estate all over the country. They claim to do all of the work for you – from selling you the property to acquiring tenants to managing the units, giving you a passive buy and hold investment strategy. For more information on these opportunities, you can read our ultimate guide on turnkey real estate as well as our buyer’s guide on the best turnkey real estate companies.
Locate Good Properties
Once you have an area in mind, the next piece is determining what kind of property to acquire. The types of properties you should consider include single-family, multifamily, and/or apartment buildings in good condition. Let’s now take a look at some of the housing-specific features you should consider when buying long-term real estate.
Single Family or Multi-Unit Properties?
Many investors wrestle with the decision over whether to buy a single-family dwelling or a multi-unit property. Experts typically agree that single-family units are generally best for the new investor.
Yet, small multi-unit buildings such as a duplex can be wise purchases because they generate some rent even if a unit is vacant (keep in mind, when a single-family property is vacant you get no rent!). Apartment buildings and multi-unit properties with over four units require more intensive management and are best suited for seasoned investors.
For more information on buying a multi-unit building, you can read our ultimate guide on how to buy a duplex, triplex, or fourplex.
Buying a property in rent-ready condition is the obvious choice; but, be prepared to pay a higher price for it. On the other hand, a fixer-upper may offer a really good deal, but you’ll have to spend time and money getting it ready to rent.
What About Land or Commercial Buildings?
You might also be tempted by potential buy and hold deals involving vacant land or commercial real estate. Both of these are best left for experienced investors. Land purchases do not generate any income but they do have expenses, and that can be a problem. Commercial property has many complexities best left to the pros.
Ensure the Purchase Makes Financial Sense
As you look at a property, keep an eye on the financial factors. To begin, don’t be afraid to negotiate a good deal. Getting a discounted price may not seem important for a rental but price affects your monthly carrying costs. More importantly, a good price means you are making money going into the deal.
Be sure you also know the rental rates for the area you are scouring. Is there a market for rentals there? Can potential tenants afford the rent you are expecting to charge? And, will the expected rent cover the expenses of running the property? You don’t want to impulsively buy a property and end up with monthly losses you can’t afford.
Using an Agent Versus Finding Deals Yourself
Locating a good property can be done with an agent or on your own. With an agent, you have the benefit of the Multiple Listing Service (MLS) which shows all the agent-listed properties in your area. That can make quick work of finding a good property, although most will be at market price.
If you search for deals yourself, you may have a better chance of locating a below-market deal but there will be fewer units from which to choose. If you prefer to search on your own, Craigslist is a good choice as are the various for sale by owner (FSBO) sites like ForSaleByOwner.com and BuyOwner.com.
Cash vs. Financing Your Buy and Hold Property
When you purchase a property to hold, there are two ways to fund the purchase. You can either pay cash, which will provide immediate cash flow. Or, you can secure a mortgage or other financing which will allow you acquire properties even if you don’t have the full cash amount to buy.
1. Pay Cash
There are definite advantages to paying cash for a buy and hold investment property. The clearest benefit is you start making monthly income right away. Since you don’t have a monthly mortgage payment, any monthly cash flow is yours to keep. And, if the property is ever vacant, you won’t have a large mortgage payment to make out-of-pocket.
Additionally, with cash in-hand you might be able to negotiate a better deal with the seller. You might also be able to close more quickly since you won’t have to wait for loan approval.
The clear disadvantage to paying all cash is that it can deplete your cash reserves. If you’ve sunk a tremendous amount into the purchase of the property, then you may have very little left over for monthly costs or financial emergencies for the property.
2. Take Out a Loan
Most people don’t have the money to pay all cash for a rental property; so, financing is a must for them. Yet, there are certain advantages to using borrowed money. As long as you have the needed down payment, the creditworthiness to borrow, and the purchase makes financial sense, you have the potential to acquire a loan for your next property.
Plus, financial leverage creates greater returns. You are using a small amount of money (your down payment) to get the benefit from a large asset. Think about it — for only $10,000 or $15,000 out of pocket you may be able to purchase a $100,000 rental property and get all the financial benefits from it. In other words, you are benefitting from the $100,000 investment, not just the $10,000 down payment.
There are disadvantages to financing, though. The biggest monthly expense is going to be the mortgage payment which can eat up much – and in some cases, all – of the rent. If the property goes vacant, you’ll have to pay that mortgage payment out of your pocket. And, the loan itself comes with costs – both the costs to obtain the mortgage and the interest you pay for borrowing the money.
If you are looking for investment financing, check out Visio Lending. They offer long-term loans for both single property and portfolio investments (3-7 properties). You can finance up to $2MM with an LTV of 75%-80% and interest rates as low as 4.7%.
Buy and Hold Investment Financing Options
Financing for buy and hold rental properties comes in 3 basic forms: conventional loans, government loans, and seller-financing. Each of these loan types is typically right for a specific type of investor. Each of these 3 financing options below is a good fit for specific types of buy and hold investors.
Below are the 3 best buy and hold investment financing options:
1. Conventional Loans
These originate from banks and other financial institutions and can include portfolio loans or blanket mortgages. These can be easier to qualify for, but the interest rates and fees may be higher than with other options. Further, many conventional loans require 20% or more as down payment.
2. Government Loans
Loan programs such as Federal Housing (FHA) and Veterans Administration (VA) loans generally offer lower down payments than with conventional loans. FHA loans typically require 3% down, and qualified veterans can be approved for $0 down payment. Terms are typically easier, and interest rates lower than with conventional loans (FHA and VA are both currently averaging under 4%).
However, government loans can be harder to qualify for and are intended for one’s primary home and not investments. Although, both FHA and the VA allow borrowers to purchase 1-4 unit properties as long as they intend to live in one of the units. What’s more, some types of SBA loans can also be used to purchase commercial real estate for a buy and hold strategy.
Your state may also offer their own loan programs, so it’s worth checking with a mortgage company to see what is available in your area.
3. Owner Financing
This refers to asking the seller to take monthly payments instead of expecting to get the full amount of the sale at closing time. Sellers may agree to this because the monthly payment usually includes interest, so it provides a good income for the seller.
For sellers who don’t need all their cash out at the time of the sale, owner financing can be attractive. You may also find sellers willing to be flexible with the terms and interest rate which can help keep monthly costs in check.For more information on owner financing you can read our ultimate owner financing guide.
If you are looking for a way to get owner financing, check out Visio Lending. They offer long-term loans for both single property and portfolio investments (3-5 properties). You can finance up to $2MM with an LTV of 75%-80% and interest rates as low as 4.7%.
Managing Buy and Hold Real Estate
Be advised: a buy and hold investment is not passive and it requires ongoing management. There are fundamentally two different ways you can manage your holdings: you can hire a property manager or manage the building yourself. Hiring someone costs more but requires less of your time, while managing the property yourself does the opposite.
Hire a Property Manager
Let’s cut to the chase – a property manager will cost in the neighborhood of 7%-10% of your monthly rent. Plus, you may end up paying a month’s rent for placing the tenant. That cost often scares off inexperienced investors, and it’s understandable. But, that doesn’t make using a property manager a bad situation.
Consider the realities. For even 10% of your rent roll, you are getting 24×7 management of your unit. The manager will advertise the property, show the property, screen tenants, take rental payments, and coordinate the repairs. No 2 AM calls about a backed-up toilet! If the tenant is late with their rent or disturbing the neighbors, the management company knows how to handle it.
Still, using a manager doesn’t mean it’s a fully hands-off process. There’s a certain amount of “managing the manager” necessary. One of the most common mistakes buy and hold investors make is thinking they can put their property in the hands of a property manager and just sit back and collect rent checks each month.
The truth is, a lot of work goes into selecting a good manager. Then, you need to periodically check with your manager, stay apprised of the status of the property, and make sure the manager is doing their job.
Manage the Property Yourself
If you prefer to keep the money you’d otherwise pay to a property manager, you’ll have to take on the tasks the manager would handle. You’ll have to advertise the property, show it to prospective tenants, screen them, collect rents, handle repairs, and do the bookkeeping. To help, you can read our article on landlord checklists and download our free checklist template.
If you decide to self-manage, you’ll still need the services of various professionals. First, while not required, consider using a real estate agency to list the property on the Multiple Listing Service (MLS) and their affiliated sites like Trulia. The largest pool of qualified tenants is going to turn to local real estate companies to find a rental. Even though you have to pay an agent a month’s rent in commission to secure a tenant, you’d probably cost yourself that much (or more) in vacancy and other expenses trying to get the property rented yourself.
You also need a good address book of tradespeople – a handyman for repairs, plumber, appliance repair, etc. And, a lawyer, experienced in landlord tenants relations is a good idea for crafting your lease and those times when an eviction is unavoidable.
Luckily, there’s software available that can help with this. Read our buyer’s guide on the best property management software for more information. One of our top recommended providers is Avail. The first unit is always free.
How to Get Tenants
The key to long-term success with buy and hold properties is in getting good tenants to occupy your units. This starts with good advertising and marketing of the property. Then, potential tenants must be carefully screened to find the best candidates. Finally, you need to have a strong lease in place.
Marketing to Get Tenant Leads
Whether you use the services of a real estate agent, a property management firm, or do it yourself, you want to fill a vacant property as quickly as possible. That means robust marketing to draw a pool of potential renters. This is where the Multiple Listing Service (MLS) and other sites like Trulia or apartments.com are immensely helpful. Fortunately, you don’t need to be an agent to use services like Trulia yourself. Another fine tool is Craigslist.
Once a property is listed, either you or your agent/manager will need to show the property. The more people who see it, the more likely you will end up with a qualified prospect.
Fledgling investors are often so anxious to get their property rented that they will take anyone who’s willing to fill out the paperwork. That’s typically a disaster waiting to happen! Instead, carefully screen your prospects. You’ll want to verify their employment and income, check their credit, do a criminal background check, and get references from prior landlords.You can read our article on how to screen tenants for a rental property for more information.
If you are uneasy about anything during the screening process, it’s probably best to forego that candidate and move on to another. It’s probably better to forego a month’s rent while you wait for a better candidate than to get a potentially bad tenant who will cost you more in the long run. Some warning signs might be unverifiable employment or extremely bad credit.
At the same time, make sure you don’t overstep the law – ie. illegally discriminate. If a tenant is qualified, they are qualified. Luckily, there’s also software available to help you screen and find the best tenants. You can read our buyer’s guide on the best tenant screening software for more information.
Have a Good Lease
Once you have a qualified tenant who wants to move in, you must have a solid lease for them to sign. Don’t make the mistake of trying to download some random template from the Internet. You need a rigorous lease that protects you, while still being legal and fair to your tenants. Your agent or property manager will have one available. If you are managing the property yourself, consider getting your lawyer to provide your master lease. At least, consider paying for one from a legal service like RocketLawyer.
Maintaining a Buy and Hold Property
You will incur expenses with your rental property, so you must be prepared for them. The older the property, the more likely something will need to be fixed. While some of the items may be reimbursed out of tenant’s damage deposits, you still need to budget for maintaining the property.
While you might fully expect to pay for insurance and mortgage payments, an often overlooked expense area is periodic maintenance. Carpet wears out, units need to be repainted, and appliances break down. There are no hard and fast rules for how much repairs are going to cost because there are simply too many variables. But, it’s safe to say that repairs will probably be more than what you expect.
Because it’s hard to predict repair costs, it’s important to maintain some reserve funding for each property. You don’t want to learn that the air conditioning system has completely failed and have no idea how you are going to pay the $3,000 cost to replace it. The beginning of a bad financial situation is needing to turn to your credit cards to pay for something like that.
Instead, keeping a reserve fund for each property is important. Again, there are no hard and fast figures for how much, but building a reserve of 3-months of rent is a good start.
Understanding the Numbers for a Buy and Hold Investment
Every investor needs to be comfortable with the basic numbers involved with their investment. For a buy and hold property, these figures are gross income, vacancy rate, net income, expenses, and cash flow – and how they work together. It’s also important to understand the role that appreciation and tax advantages play in holding a property.
Numbers You Need To Know For a Buy and Hold Investment
- Gross income – gross income is simply the annual total of the monthly rent. You multiply the monthly rent by 12 to give you the annual gross income.
- Vacancy rate – this is a percentage for how long a unit is vacant. Vacancy averages 10%-15% across the country. Your local rate may be higher or lower. That means, on average, a typical rental unit is vacant for approximately one month.
- Net Income – the income figure left over after factoring out vacancy
- Expenses – this figure covers interest, taxes, insurance, maintenance/repair, homeowner’s fees, professional services (like legal), property management, and advertising. Most investors like to look at expenses on a monthly basis
- Cash flow – Cash flow is what’s left over from gross rent after paying expenses. Typically, cash flow is calculated monthly.
Here’s a basic example of calculating cash flow:
Cash Flow Calculation Example
|Gross Income ($1,000 monthly rent x 12)||$12,000|
|Less Vacancy Rate (10%)||-$1,200|
|Net Operating Income||$10,800|
|Expenses ($800 per month x 12)||$9,600|
|Cash flow ($10,800-$9,600)||$1,200 annually or $100 monthly positive cash flow|
Understanding the Characteristics of Cash Flow
Cash flow can be a positive figure (you made money) or a negative one when you invest in real estate. If you’ve paid all cash for the property, the chances are overwhelming that you’ll have a positive cash flow. If you have a high mortgage, it’s likely you’ll have a negative cash flow.
Negative cash flow certainly isn’t desirable, but it’s not necessarily a losing situation if you can afford to pay for it. Keep in mind, your tenant is paying down the mortgage, and that’s just deferred profit. What you may not be pocketing each month may be building up like a savings account in the property.
Another key point is that rents naturally follow inflation. Periodically, you will be able to raise rents which will increase your cash flow. Even if you experience negative cash flow early on, it can eventually break even and turn positive if you’ve picked good investments.
Profiting From Appreciation and Equity Buildup
The above means, in addition to monthly cash flow, equity buildup eventually builds your wealth. If you’ve selected a good piece of property, appreciation will raise its value over time, while the tenants are paying down your mortgage. So, between appreciation and mortgage paydown, your equity in the property increases each month just like a bank account.
Tax Benefits From Holding Real Estate
Rental properties offer many tax advantages. Depreciation for rental property is one of the best remaining tax advantages available to you. Even though a property will typically appreciate, you can treat it as if it’s wearing out and going down in value(depreciating). Depreciation amounts can be used to reduce your taxes.
Here’s a question…do you keep a rental perpetually or sell it down the road and cash out the equity? That is a question you will ultimately have to answer. Keeping it provides a perpetual recurring income – one that can carry over as a legacy to your children. But, you don’t gain anything from the equity buildup until you sell. If you are willing to forego the monthly residual income, you can sell a few years down the road, and possibly gain a windfall from the sale.
Things That Can Go Wrong With a Buy and Hold Rental
Holding a property is not without its complications, and you need to be prepared for the possibility of things going wrong. These can include rent collection issues, problem tenants, mismanagement, and situations requiring serious repairs.
Problems Collecting Rent
Even a good tenant may occasionally be late with their rent. On the other hand, there are tenants who treat paying rent as a low priority and that can create a problem for you. Since you probably have a mortgage to pay, if the rent is late, you have to pay that mortgage payment out of your pocket. The longer that goes on, the deeper in your pocket you’ll have to dig.
In every state, there are legal procedures for handling delinquent tenants. You’ll be able to use a specified series of late notices and remedies that may unfortunately (if the tenant doesn’t pay), lead up to eviction. Don’t be timid in using them. Too many newbie landlords try to be the good guy only to find their tenant gets 2 or 3 months behind in rent, with very little likelihood of ever collecting it. Use the legal processes available to you to stay on top of rent payment.
Property management software is a good way to avoid problems collecting rent. Avail, for example, can be used to collect rent, sign leases, schedule maintenance requests, and more from a single platform. Your first unit is always free.
You may have a tenant who regularly pays rent, but who is still problematic. Perhaps they are destructive to your property, disturb neighbors, or regularly violate lease terms, ordinances, or local laws. Just like with rent, there are legal procedures in your area you can employ to either curtail the problems or if need be remove the tenants. Don’t be afraid to use those laws.
To avoid this problem, make sure you have solid tenant screening software in place. You can read our buyer’s guide on the best tenant screening software services for the best providers. Choose the one that best suits your needs.
What if Your Manager is Not Doing Their Job
Despite your best efforts, your property manager may not live up to your expectations or they may suddenly get inattentive to your property. Confront them about their responsibility for diligence and care of your property. If they don’t conform, it’s time to fire them and engage another manager. Poor management can be as costly as bad tenants, so get on top of any deficiency quickly.
Handling Major Repairs and Serious Events
There may come a time when you face a major event such as a weather incident or the breakdown of a major system at the property. Examples include fire, flood, or something like a roof in need of undeniable replacement. Such things can be financially catastrophic if you are not adequately protected. Two items will safeguard you under such circumstances: good insurance and your reserve fund.
Robust insurance protects you against what are called “perils” like flood, fire, wind damage, and so forth. So, have a conversation with your insurer about setting up a good landlord’s policy with adequate coverage.
Your reserve fund will help you tread water against unexpected costs like protracted vacancies or substantial repairs and even the unexpected financial outfall from an insurable event.
The Bottom Line
Buy and hold investing offers multiple financial benefits, including the potential for ongoing income. To be successful, you want to always pick good properties, in good neighborhoods, which make financial sense. Whether you choose to manage those properties yourself or employ the services of a professional property manager, you must be prepared for the ongoing responsibility of ownership and oversight.
If you need financing for a buy-and-hold real estate investment opportunity, take a look at Visio Lending. They provide 30 year term loans for single investments as well as portfolio loans for 3-7 properties. Get up to $2MM with rates as low as 4.7%.