I just was talking with a real estate investor who was frustrated as it is the holiday season and she had a vacancy that needed to be filled.
Because of the holidays it is hard to find help to do the cleaning and painting between tenancies. Plus the tenants were not particularly good to the place so it needed some fix up as well.
Anyone who owns investment property understands this frustration. It is at this time we wonder why is it we do this business. This investor commented that I should just stick to financing properties as it is a much easier investment strategy and less concerns to worry about..
The benefits of buy and hold investing
She quickly then recalls why she puts up with the headaches that occasionally arise. For starters she understands that all investments have headaches and at the time of the headache it is always the most frustrating. Most importantly it is only the buy and hold investment model that provides all 5 wealth building principles.
When she finances property for other investors, she receive a nice interest rate which provides residual income to her. but that is where the investment ends. The total ROI is a rate of return. With buy and hold investing she indeed gets 4 additional income streams.
Whenever frustrations ensue do to challenges, it is always a quick way to be reminded why it is so worthwhile to put up with some set backs as the complete wealth picture at play with these 5 wealth building principles.
The 5 wealth building principles:
Income: Positive cash flow (in her financing of investments for other investors she only receives income from the interest she charges.
Deductions. A dollar saved is a dollar earned.. only buy and hold investor get to benefit from the depreciation offered to buy and hold investments.
Equity Build up: You… as your tenants essentially pay down your mortgage your equity position increases.
Appreciation: Only the buy and hold investor can capture year after year appreciation (national average is almost 6% per year).
Leverage: All these above benefits can be leveraged. As you put in a typical 20% down payment 80% of the growth in the first 4 wealth building principles is gained using other people’s money.
As you can see, the 5 income streams makes the buy and hold model second to none when comparing investments for long term investments.
A worthy note: Something I came to understand is that many people believe equity and appreciation to be the same. Indeed they are very different.
1. Equity buildup by way of debt reduction:
The typical investor will buy an investment property with a mortgage. Each month the tenant makes a mortgage payment to you the landlord, you in turn use part of the rent payment to pay the mortgage.
Let’s assume for this conversation that $300 of that mortgage went to pay down the principle of the loan. This $300 dollars each month that pays down the loan goes into building up the equity you now have in the property. Let’s say the original loan was for $100K and now has a balance of $99,700.
At the end of a full calendar year, that is (12) $300 debt reductions payments totaling $3,600 per year in equity buildup. This is money that is silently being added to your net worth.
2. Appreciation as a property appreciates in value:
The national average for the past 50 years has been a 6% annualized appreciation. On this same $100k example, the appreciation would generate you $6,000 ($100K x 6% = $6,000. This is also money that is silently adding to your net worth.
Combining these two benefits together you realize a total of ($3,600 + $6,000-$8,600) in (Silent) wealth building. Add together the benefits of tax reductions and the benefits of leverage and you can see how a buy and hold investment rapidly pulls ahead of other investments in generating wealth.
Maximize the ROI On Your Real Estate Investment
There are many who will suggest you only want to look at the cash flow to judge whether or not you will make a purchase. I totally agree that the cash flow is the paramount decision maker as to whether or not the purchase will be a good investment. If you do not have cash flow you do not want to buy, period.
You do however want to also consider that when you identify cash flow you also have these other forces at work for you. The tax benefits, the equity buildup and appreciation identified here are also wealth building principles working silently in the background that you definitely want to understand.
Appreciation is something that no one can promise you and therefore many suggest you should simply judge a property for the cash flow and use any growth as an added benefit should you realize the value growth. While I understand the premises to this, I do not totally agree with that. I believe it needs to be a consideration when investing.
You do not want the appreciation to be the deciding factor, however, appreciation is the largest of the wealth building principles. Look at the example above. The appreciation is larger than the equity build up, larger than the tax benefit and most often even larger than the positive cash flow. So with such a large wealth building principle at play, I believe your best investments are the ones you put a lot of strategic emphasis on finding investment properties in areas that are poised for growth.
When you do not put any focus on the appreciation you are too easily lured into just buying any old property that cash flows. I can assure you from years of experience the seasoned investors who win big are factoring all these wealth building principles into their decision making process.