- Credit To Todd Bermont and his views on buy and hold.
The first strategy is the one I employed for my first IRA property and that is to buy and hold. Using this strategy the goal is to find a property that you can hold onto for many years and make a substantial profit.
The goal with the buy and hold strategy is to purchase a property with both good short term and long term potential and then ideally rent out the property for great long term gain and consistent income.
Now you don’t have to rent out a “buy and hold” property but it is usually advisable to find one you can. The only instance I can think of where you would not rent out a “buy and hold” property would be if you are literally just buying a piece of land in a location where you feel in the next five, ten or fifteen years, the value of that piece of property would skyrocket.
A great example of that might be buying a vacant oceanfront lot or a piece of land near where an airport is going to be built. In both of these cases, it may take some time for the property to increase in value but once it does… look out.
Another great place to bet on land appreciation is near where a new highway is going to be built.
Location… Location… Location
In Real Estate there is an old adage that the success of a Real Estate investment is determined by three things:
While that is not totally true because there are other factors such as buying right, good condition, etc., it really does hold true for the most part. In our example of buying land near a new highway project or an airport project are just some of the examples you can use to select the ideal location for your “buy and hold” property.
But, let’s look at perhaps a more typical “buy and hold” strategy and that is purchasing either an investment house, condominium, apartment building or a commercial space.
In these cases location is extremely important because you want to purchase a property that will likely appreciate in value and see consistent and stable rental income.
With my first IRA house, I purchased it near a major Air Force Base that according to all the research I did would be around for the long haul. My thought process was that there would always be families coming in and out that base that need rental housing.
Also, the house being about 30 miles outside of downtown St. Louis is in a decent location for someone looking for less expensive housing. It is amazing but the Illinois side of the river is significantly less expensive to live in than the Missouri side of the Mississippi River. My guess is that over time, people will get tired of the commute to the Missouri side of the river and explore living in Illinois instead.
Thus, when I considered my first investment the long term prospects looked good for appreciation and looked good for stable rental income.
When looking to make a “buy and hold” investment you want to consider five main attributes.
Five Attributes of Successful “Buy & Hold” Investments
1) Potential appreciation
One of the greatest reasons to invest in Real Estate is for the potential appreciation you will see in the value of your property. Regardless of what you are investing in you want to be as certain as possible that your property will increase in value.
This means you have to purchase a property with either a great location today or one that will be a great location tomorrow. You also need to buy your property right.
A secret little hint I have for you is if you start seeing big ads for a property you are considering in places like an airline magazine, run for the hills. Running big ads is expensive. These developers are not doing it for your health. They are running these ads for their health and wealth.
If everyone already knows about the area you are considering investing in, odds are it is too late to buy. The key to successful investing in Real Estate is to purchase properties that don’t have a ton of press but ones that have a great opportunity for appreciation.
Buy the cheapest property in an expensive neighborhood
Another old adage that holds a great bit of truth is in Real Estate one of the great ways to make an investment is to buy the least expensive property in an expensive neighborhood. The theory is that the value of the other properties will help yours appreciate as well.
This held true with the studio condominium I purchased. Back in 1996 I purchased a studio condominium in the “Gold Coast” neighborhood of Chicago. This neighborhood is located just north of downtown Chicago and is literally walking distance from some great beaches and parks along Lake Michigan.
I knew that this neighborhood, due to its proximity to the city would have a great likelihood of appreciation. But, I couldn’t afford to buy much at the time.
In 1996 I bought the condominium at 21 W. Goethe in Chicago for $65,000. I also got a commitment from the seller to agree to pay any special assessments in the first year. It was a good thing I did that because there was a special assessment around $1,800 about eight months later and the seller had to pay it.
For those of you not familiar with special assessments, those occur quite frequently in town home and condominium situations when a major expense is incurred to the common area where everyone has to contribute to fix the issue because there are not enough reserves to cover the expenditure.
But, I digress. Anyway, I bought the condominium for $65,000. I then invested around $10,000 putting in a new bathroom and sprucing up the rest of the place. So I had about $75,000 invested in total. I held the property for a little less than seven years.
In 2003, after I just got married and decided to move to the suburbs, I sold the property for $123,000. Thus, I saw an appreciation of almost $50,000 on a $75,000 investment is less than seven years. Not too shabby.
If I had held the property for another couple of years, I could have made even more money as I sold it prior to the real boom of Real Estate in 2004 and 2005. But even missing out on the boom, I still made a great return on my investment.
What made this investment so ideal was the fact that the studio was literally one of the cheapest properties in the Gold Coast. It couldn’t help but go up in value and it did.
Good neighborhoods = Good amenities and schools
One of the great things about investing in the least expensive properties in good areas is that your property likely will be surrounded by good schools and good amenities.
The quality of the local school district is extremely important in considering a long term Real Estate investment. Good schools mean good profits for you. Bad schools mean higher risk to you.
Also amenities such as proximity to highways, quality shopping, theater and public transportation are extremely important when considering a long term investment.
In cities like San Diego and Portland, Real Estate that was situated near their light rail systems appreciated at often a much higher rate than properties in other areas of town.
Especially with the price of fuel going up, being close to public transportation can be a very good then when considering almost any type of Real Estate investment.
Those people in Southwest Chicago who purchased commercial properties such as strip malls and office buildings as well as those who bought residential properties saw the value of their properties skyrocket when the Orange line of the CTA was built from downtown “The Loop” to Midway airport.
Future highways, public transit lines and airports provide a great long term target for IRA property. That is not to say there are not great investment properties in other areas as well. But the key is to focus on potential demand for the land in the areas you are considering.
2) Rental Income
The second most critical consideration to the buy and hold strategy is that there is a strong likelihood that you will generate a nice stream of rental income. Of course this is not applicable if you are just investing in a piece of land. But, for those of you who are investing in an actual property that will have tenants of some sort, you want to make sure you will have a strong opportunity to make a consistent revenue stream through rent.
The 5% rule
Ideally you want the annual rent that you will receive to be at least 5% or more of your purchase price. If your rental income is not at least 5% of the purchase price of your property then I would probably take a pass on the purchase.
The reason I say this is that as mentioned in the last chapter, you are going to have many costs associated with owning your property. These costs include everything from maintenance and upkeep to property tax.
From my standpoint, unless your annual rent is not generating at least 5% of the purchase price then the investment is too risky. In fact, ideally, I would suggest you strive to see numbers closer to 10% of the purchase price or even higher if possible.
Shop before you buy
Before you purchase an investment property you want to shop the local market you are considering to determine the competition for tenants and to determine what rent you can charge.
You can think your property is worth a certain value in rental income but the market might tell you something different. I shared with you a story earlier how just $20 a month made the difference between me renting and not renting my property.
Make sure you research using both the Internet as well as local Real Estate agents what rent the market is commanding for your particular type of property. To be safe, whatever number you think the market will generate, base your investment plan off of a number that is 10% less to be conservative in your estimation of return on investment.
If you can get the full rental value then that is great. But, if not, then at least you will still be alright with the investment you made by being conservative.
Large & consistent pool of tenants
When considering a potential investment property an important consideration is the access to a large and consistent pool of tenants. Unless you own an empty piece of land, having an investment property sit without tenants totally defeats the purpose of investing in the property to begin with. As a result you want to rent your property out quickly.
To rent your property out quickly there has to be a large and consistent pool of potential tenants that demand a property such as the one you are considering. The best way to gage the potential demand is to talk with a Real Estate agent who is an expert in the area you are considering.
The bottom line is you want to generate rental income quickly and the best way to do that is to invest in a property in a location that has a large number of potential tenants who might want to lease from you.
You might be able to buy a really inexpensive property in a place such as Youngstown, Ohio or Paducah, KY but if the local economy is soft and there is not a large pool of potential tenants, your property could sit on the market for years without renting.
I am not trying to discount those two cities. They may very well be a great investment right now. The point I am trying to make is that you must consider the size of the potential tenant pool before making any kind of a Real Estate decision.
3) Access to high quality property management firms
The third key aspect to any “buy and hold” strategy is to make sure there are at least a couple of reputable property management firms who can manage your property before investing.
Where I purchased my first IRA house there were at least three very reputable property management firms available. As you will see when we discuss IRA rules, it is important to find a good property management firm so you don’t risk running into trouble with the IRS. The IRS is very specific that you can not perform services to your IRA investment or invest non-IRA funds to advertise for renters or manage the property. As a result, it is much more effective to use a third party property management firm.
The firm I chose charged a very reasonable fee, 6% of the rent and also had their own handymen on staff.
By having their own staff of contractors if something needed to be fixed with the house, the property management firm could fix the problem and charge my IRA for the repairs or bill me against future rent.
You want to make sure there are at least two or three reputable firms in the area so that you are not dependent on any one firm. Companies come and go. You don’t want to be caught in a situation where the owner of one firm passes away or the firm closes and you are left with no one else to manage your property.
Also the more property managers there are in a given area the more competitive their rates are likely to be. This is one reason why I am personally against the “condotel” type of investment where you are investing in a hotel room concept.
In these cases usually one property manager has a monopoly on managing the property and as a result they typically charge much higher fees. When I was looking into these types of properties in Myrtle Beach, SC, I quickly got frustrated because these firms charged 45% of the rent and higher to manage the property.
I just couldn’t make my numbers work with a percentage such as that. Certainly these firms kept trying to sell me on the “appreciation” and “cash flow” arguments, but that is how so many people got into trouble to begin with.
I am here to say that if you can’t make the numbers work for you on day one that you own the property, without appreciation, then I suggest looking for an alternative investment property.
4) Stable & fiscally sound local government
Stability of the local government is extremely important when considering a “buy and hold” investment. Ideally you want to invest in areas where the government is strong and either operates with a balanced budget or ideally at a surplus.
This is extremely important because when governments start to operate at a deficit one of the first things they look to do is raise both property taxes as well as sales taxes.
Tax increases have a very negative effect on investment property. First of all, it is very difficult to raise rent at the same rate of inflation as tax increases. Where I live, the property tax on my house has increased over 32% since I purchased the house five years ago.
Now the county has told me when I have complained that there is a complex equation on how tax is calculated and that it is not that they have raised the tax rates as much as they have raised the assessed value instead.
Well, however they calculate it doesn’t matter to me. The bottom line is that the money I have to shell out for property tax has increased over 32% in just five years. I can tell you the value of my property that I live in did not increase by anywhere near that amount based on the sales data of houses in my neighborhood. In fact, I estimate that the value of the house I live in has only increased by about 15%.
And, you can’t base your “buy and hold” investment plan off of appreciation alone because you don’t get to realize appreciation until you sell the property. It is the annual profit of rent minus costs and taxes that will determine a great percentage of your return on investment. I can tell you if it wasn’t for the fact my family lived near by, there is no way I would want to stay where I am at and pay these high property taxes.
I can tell you that I certainly will not be investing in any property in the area I live in using my IRA because that kind of property tax inflation is unacceptable.
The problem is if you look at what it cost to rent a house or an apartment five years ago versus now, the rent has not gone up 32%. Thus, those who have investment properties where I live have seen their return on investment decrease significantly because of the rapid rate of property tax inflation.
Sales tax increases can also have an extremely negative impact on investment properties. There are countless examples across the country where when a city or county raises its sales tax, people defect to neighboring counties to shop and in some cases to work and live.
This is a major problem to investors who own strip malls and other types of investment properties, especially those who are located near other counties who charge a lower sales tax. Shoppers with the means and time to do it will always shop where the taxes are lower.
As more people shop in neighboring counties that lowers the value of the commercial property in the city or county that has the higher sales tax.
Soon, as more and more people defect the county for shopping they begin to defect there to live and work as well. So a sales tax increase not only hurts investors of commercial properties, it can also impact the viability of residential investments as well.
5) Strong infrastructure & schools
Investing in areas that have a strong infrastructure and schools goes hand in hand with strong local government. History has shown time and time again that the greatest appreciation in Real Estate has been seen in areas with a strong infrastructure and good schools.
Regardless of the type of property you are investing in, when all is equal, properties in good school districts will appreciate faster than those in poor districts. People want to live by good schools. Employers want to hire people from good schools.
It becomes a vicious cycle. If people want to live by good schools and employers want to hire people from good schools then the demand for retail and other types of commercial properties will also increase as a result.
Solid infrastructure is critical to long term appreciation
Additionally it is important that the area you want to invest in has a solid infrastructure that serves the area today as well as a strong plan to accommodate future growth.
Infrastructure includes roads, electricity, communication lines (cellular, fiber, etc.), airport access, rail access and public transportation.
Those areas with the best infrastructure typically see the best increases in property values. For instance, many municipalities have seen the tremendous increase in demand for data centers which are buildings that house thousands of computers.
Data centers require high speed and redundant communications, redundant and low cost power and access to other aspects of infrastructure such as airports and roads. Those State and Local Municipalities that realized this early on and invested in infrastructure have seen a huge increase in property values which has then increased their tax base.
That is just one example of how a strong infrastructure can impact property values.
Conversely, weak schools and poor infrastructure can have a very negative value on properties.
Regardless of what area of the country you want to look at, you can see areas that look desolate and decrepit. If you drill down further you will see that typically these areas have poor schools, poor infrastructure and often higher crime rates.
Please do not overlook the strength of schools and infrastructure when making an investment decision. That is not to say you can’t invest in a small town. In fact it wasn’t that long ago that Austin, TX was viewed as a “small town.”
But Austin invested heavily in schools and infrastructure and has seen a tremendous boom. There are towns from places such as South Dakota to Kentucky to Wyoming who have seen that when you invest in quality schools and infrastructure, people and employers tend to migrate there. Also, many of these same places seem to have a desirable local tax rate as well. Isn’t that interesting?
Buy & Hold Investments
- Single Family Homes
- Town homes
- Apartment Buildings
- Shopping Malls & Strip Malls
- Office Buildings
- Parking Lots