Holding Real Estate Assets Forever: An Investor’s Look at Benefits & Costs
I used to think once you own a piece of real estate, you should hold it forever. As many of you know, real estate offers quite a few benefits, including cash flow, appreciation opportunities, tax deductions, inflationary hedge and so on. However, when I start thinking more about real estate in the long run, I have to start thinking about weighing the benefits and costs of real estate a bit differently. Let’s take a look at some of these factors.
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Cash flow is the holy grail of the real estate investment. If you have a cash flow positive property in your portfolio, you are doing awesome and all is well. On the other hand, cash flow returns aren’t fantastic. I mean, some of you may be situated in great markets and you are achieving that 2% rule, but in general, in most markets you are not looking to get above a 10% return in your rentals. In my particular market, you can maybe get a 5-6% return. So even if you’ve got cash flow, unless you’ve got a lot of it, it is hard to call it a day. Your capital is working hard, but is it achieving its best return?
Appreciation is a tough game. Even though we have had a fantastic rebound from 2011 to now, we rarely see opportunities like that. At best we can think about 3-5% appreciation if we are lucky and situated in a good city. After all, in Las Vegas, for example, I’ve seen homes during 2011 to 2012 selling for the same prices as they had sold for in the 1990s. So if you kept your real estate all this time, you better have a strong stomach to endure the horrors of the housing crash. You also need to have a strong stomach to not be tempted to sell during the highs of the 2006 market.
Mortgage interest costs are tax deductible. You can also depreciate your house for 27.5 years. Both of these factors create fantastic tax benefits during your ownership. However, once you've finished paying off your loan and you've fully depreciated your asset, your taxes are likely to go up. Not the end of the world, I guess, since you'll be fantastically happy that you've paid off your mortgage anyway.
Seeing how the Vegas market played out during the past decade, we can’t really say houses can be an inflationary hedge, as they can be susceptible to major price fluctuations. Nevertheless, it is a piece of asset that you’ll have, and people always need shelter.
Holding real estate for too long, however, has its costs too. The longer you own a property, the likelier you’ll be faced with major capital improvements that can take a chunk out of your wallet at one time. Say the roof starts leaking, the AC goes down, the last tenant leaves the laminate flooring in tatters, etc. Houses have age too. As Ben Leybovich has written in great detail about depreciation and capital improvements here, you will always have to have a significant cash reserve when your property breaks down.
Economic Changes in the City
I don’t mean to bash on Detroit, but cities are very dynamic. Over the course of US history, many cities that have once played a major metropolis have now become a shadows of themselves. Some towns have become ghost towns. Towns may get rich through an oil boom, but then experience an oil bust. There are numerous factors that you can’t control once you decide to set your roots down. If in the city you own, the piece of real estate starts declining, do you stick to your guns or do you want to find something else? How about the next opportunity? Who wouldn’t want to buy in Shanghai before it became THE Shanghai?
The point of this article is simply to make you think about whether it is worth it to hold your property forever. Personally, I am still at a stage where I am willing to take more risks, and I am still seeking out other opportunities. So keeping all my assets in real estate doesn’t sound so attractive to me anymore. What about you?
How do you approach your real estate investing: Do you plan on holding your assets indefinitely? What would you add to my pros and cons list?
Leave a comment, and let’s talk!