How to Build Wealth Over Time with the Buy and Hold Strategy in Real Estate Investing
Are you looking for a long-term investment strategy that can help you build wealth over time? Look no further than the buy and hold strategy in real estate investing. By holding onto properties for the long-term, you can generate passive income, build equity, and take advantage of tax benefits that can help you maximize your returns.
In this post, we will explore how the buy and hold strategy can help you build wealth over time and why it is an effective investment strategy for those looking to invest in real estate.
If you are starting out in real estate investing or just thinking about it and would like to learn more check out my Ebook here!
The buy and hold strategy
The buy and hold strategy is where you purchase a rental property and you rent it out to tenants over a long period of time. This assumes that the total of your monthly expenses (mortgage, taxes, insurance etc.) are lower than your gross rental income resulting in a positive monthly cash-flow. Long-term investing can not only generate passive-income, but also build wealth. This is by way of the equity you accumulate when the value of your property increases over time while the amount you owe on the mortgage decrease, assuming you are financing your properties. You may also deduct property taxes, mortgage interest and closing cost also if you are financing. Therefore, the buy and hold strategy is an effective way to build wealth over time.
Leveraging Your Money to Increase Returns
One way to increase returns when investing in real estate is by leveraging your money. This can be achieved by using a mortgage to finance the purchase of a property. By doing so, you can generate a higher cash on cash return, which is a measure of the annual return on your investment. This is different from return on investment (ROI), in the sense that you are able to invest with a lower cost to you.
The formula to calculate return on investment (ROI) is:
ROI = (Net Profit / Cost of Investment) x 100
Net Profit = Total revenue - Total expenses
Cost of Investment = Total amount invested
The result is expressed as a percentage. This formula provides a clear picture of how much profit an investment has generated relative to its cost.
The cost of investment would be the total purchase price of the home. The net profit would be how much gain in value the home acquired over time. We’ll say a year. Let’s say you purchase the home at $130,000 all cash and it makes you $700 in cashflow after all expenses are paid. Annual cashflow is $8,400. Your ROI would be:
($8,400 / $130,000) x 100 = 6.4%
Compare this to cash-on-cash return when you leverage your money with financing. You would only need to put 20% with a mortgage, which drops your cost of investment to $26,000. However, a mortgage comes with more costs and also decreases your net profit. Let’s say it significantly drops your net profit and you only see $200 a month after mortgage, taxes, insurance, and property management. This gives you $2,400 a year. Your ROI would be:
($2,400 / $26,000) x 100 = 9.2%
You get a higher return by leveraging your money.
Investing in Real Estate vs. Other Investments
When comparing the returns of the stock and real estate markets, it is important to consider more than just market returns. While stocks historically have higher returns than real estate, they also come with higher risks and capital gains taxes. Real estate has tax advantages and allows for leverage, but also requires time and money for property management and maintenance.
The performance of the stock market can be compared to the real estate market by examining their indexed performance over time. From March 1992 to March 2022, the US average growth rate was 5.3%. During this period, the S&P 500 returned 9.65% annualized, and the inflation-adjusted appreciation on the Dow Jones Industrial Average was 5.565% per year, or over 8% with reinvested dividends.
In comparison, a $100 investment in the average home in the fourth quarter of 1975 would have grown to about $928 by the first quarter of 2022, while a similar investment in the S&P 500 at the beginning of 1975 would yield approximately $19,351 in 2022 with reinvested dividends.
Real estate investments also have benefits beyond market returns, such as tax advantages, income yield, and the ability to leverage a purchase. However, the possibility of housing crashes and the time and money required for property management and maintenance must also be considered.
While the performance numbers provide insight, it is important to recognize that stocks and real estate are fundamentally different assets. Stocks represent ownership in a publicly-traded company and serve as liquid security instruments, while real estate serves tangible functions as people live in houses and businesses operate out of commercial property. Existing real estate structures may lose value over time through wear and tear, but new structures may be more valuable on the basis of structural and functional improvements.
In conclusion, the buy and hold strategy is an effective way to build wealth over time in real estate investing. By holding onto properties for the long-term, investors can generate passive income, build equity, and take advantage of tax benefits. Leveraging your money by using a mortgage to finance a property can increase returns, resulting in a higher cash on cash return. When comparing the returns of real estate and stock investments, it is important to consider more than just market returns. While stocks historically have higher returns than real estate, real estate also has tax advantages and allows for leverage. However, it requires time and money for property management and maintenance. Ultimately, the decision to invest in real estate or stocks should be based on individual goals, risk tolerance, and personal preferences.
If you are starting out in real estate investing or just thinking about it and would like to learn more check out my Ebook here!