There are cycles that occur in the real estate market that dictate methods and strategies that are most useful for growing wealth through real estate ownership. Now is one of those times where a prudent investor should take stock of the market conditions and consider an inclusion of a traditional methodology. Of course, I refer to the strategy of “Buy and Hold.”
Yea, though I walk through the valley of the shadow of death, I will fear no evil: for thou art with me; thy rod and thy staff they comfort me. [Psalm 23:4]
I had to borrow this quote from scripture, but not for a religious reason, but because I know that my writing here is in the very den of the home of real estate flipping, but I am about to preach the religion of long term real estate holdings. Heaven help me.
The Real Estate Buy And Hold Strategy Is Back
Way back when (before 2002), you could monitor your local real estate market and occasionally find portfolio properties, the kind that you pick up a little below market, and that you plan on holding for a long period of time. Your primary ROI would be in the leveraged appreciation that you would attain over time, but the cash flows were a nice spiffer and they worked to build a reserve for rainy days.
But once the market boomed, finding the right gross rent multipliers were nearly impossible. Properties were trading at prices far above what a long-term hold investor wanted to pay. So we stopped buying. And the smart ones waited for their day to return.
I now see evidence that their day has returned. Indeed, we are now acquiring properties that will conservatively yield annualized ROI in excess of 25%. In order to demonstrate this, I will (over the next few blog posts) break down a specific property and show how the return is achieved. But before we look at returns, we need to look at the foundation of the real estate buy and hold strategy.
Buy Low, Sell High With Real Estate Buy And Hold
Simply put, the real estate buy and hold strategy is no more difficult to understand than buy low, sell high. Unlike property flipping, the long-term hold investor believes in a competent market, and while purchases can occasionally be made slightly below market, only traders should enter the highly competitive market of property flipping. The buy and hold strategy is for true, fairly passive real estate investors.
For this strategy to work, the investor needs to understand long term cycles in the housing markets. By monitoring supply and demand, this investor knows that the time to buy is at the end of a buyer’s market, when the glut of supply is moving towards balance, but before the market has realized it and values are low. Conversely, the buy and hold real estate investor knows that the time to sell is at the opposite end of the far cycle, when supply is scarce and properties are trading higher than replacement cost values.
How To Identify A Good Buy And Hold Housing Market
There are three fundamental rules that must be true for the real estate buy and hold strategy to work. They are not difficult to understand, but they are mission critical:
Rule #1 – Long term population trends must be rising. For real estate values to rise over the long term, the law of scarcity must exist. Nothing ensures scarcity of homes better than a growing population. There will always be a correlation between population size and home sales (for example, Phoenix, Arizona will see more home sales every year than Two Egg, Florida).
Rule #2 – The cost of construction will continue to rise over time. Much like rule #1, we assume that all of the associated costs of building new homes will rise over time. Considering the large rise in minimum wage last year, you can bet that long term costs will be greatly affected, though not readily seen until a housing market recovery begins to appear.
Rule #3 – Normal rules for supply and demand will dictate value in the housing market. All free markets move this way, but socialism could put a large damper on this. The prudent buy and hold investor never takes his eye off of the political climate, but regionally and nationally.
If you believe these fundamental rules are sound, and you are in the type of market where these rules are readily applicable, then you might make a good candidate for a long term hold strategy. Look to my next post for a case study in the Real Estate Buy and Hold Strategy.