This past week was spent catching up with friends we haven’t seen in awhile. When these old friends ask what we’re up to, they aren’t surprised to find out it’s real estate related, given that we began investing in real estate in 2001. While most have heard the stories of our crack house adventures in the early days, they are startled to learn that my husband Dave and I are full time investors.
A few made comments about how “lucky” we were to begin investing 2001 because we rode a really rocking wave of value increases on those properties. And a few commented on how they wouldn’t be buying houses right now because they think the values are going to go down again.
I tried to explain to a few interested folks that appreciation is icing on the cake but it’s not actually the foundation of what we do. But most people seem pretty hung up on house values and what the values will do in the future … and I suspect there are still real estate investors out there that get caught up in these thoughts too so I thought it was time to remind everyone of the basics of buy and hold real estate investing.
There are three ways to make money as a buy and hold investor and one big bonus many forget to think about too!
Appreciation is the way that captures an audience. Who doesn’t love hearing stories about home prices doubling and people making big bucks on a quick flip? It’s a great story.
But we never set out to make money through big property value appreciation. Because we do a lot of market research and carefully select the areas we buy in, we often see solid growth in the value of the properties we buy, but that is not our number one focus for making money. We’ve always focused on a more long term strategy which sees us making cash flow each month and building our wealth by other people (our renters) paying down our mortgages.
That’s it. Appreciation is obviously pretty nice but it’s not the foundation of what we do.
Let’s look at a basic example. Pretend you found a nice property for $100,000 two years ago, and you bought it for 25% down ($25,000). Today, here’s how your investment looks:
1) Depreciation: Bad news, your property went down in value by 5%. It’s now worth $95,000.
2) Cash flow: Rent each month is $1,000. Your mortgage, insurance, taxes and miscellaneous expenses are $800/month. Income minus expenses = $200/month. 24 months x $200 = $4,800 in income so far.
3) Other people’s money paying down your mortgage: Assuming you have a mortgage at a 5% fixed rate and 25 year amortization, at the end of the two years you will owe $71,805 on your $75,000 mortgage. You have now built an additional $3,195 equity into the property ($75,000 – $71,805 = $3,195) using the rent money you collected to pay down the mortgage.
Your property may be worth less than you bought it for, but you’ve still made $7,995 from it in two years (from the positive monthly cash flow and the principal your renters have paid down).
And – remember – you only actually realize a gain or a loss in property value when you sell the home so you really haven’t LOST the 5% the property went down. If you haven’t sold it and you’re still making money each month don’t worry about it!
Focus instead on the fact that you’ve made a 32% return ($7,995 divided by $25,000 invested) on your money after 2 years. And if you hold onto it, and ride the market cycle back up, when you do go to sell you’ll likely enjoy a nice lift in value to add to the other two ways you’ve made money on it.
On some of our properties we’re paying down as much as $1,000 per month on the mortgage using the rent money we’re collecting plus we make $500 to $1,200 per month in positive cash flow! Even if the value on those properties never changes we are making money each and every month through the cash flow and growing our wealth by $12,000 a year.
Plus, the big beautiful bonus of buy and hold investing is that you’ll have been enjoying some nice tax deductions along the way that can help offset income you’re making with this property and with other sources too!
I tried explaining this to some of our friends but they kept coming back to the question “What do you think house values will do in the near future?” so I eventually gave up and said my crystal ball is broken but they will eventually go up in most areas. Then I quickly changed the subject over to their jobs, kids and travels. It was easier … but for my fellow real estate investors remember that appreciation is just one way to make money with buy and hold real estate.