Buy and Hold – 10 Second Overview
Probably the most widely used real estate strategy is the long term “buy and hold” strategy. The strategy involves buying a property with the aim of holding on to it for the long term (often many years) in the hope of capital gain. Holding costs can be offset by rental income, and depending on the tax laws, there may also be taxation benefits gained by negative gearing.
Buy and Hold – The Detail
The implementation of the buy and hold strategy that is used by most people is generally along the lines of the following:
- Buy a property that they like the look of, in an area they like
- Hold the property for an extended period of time, while collecting rent from a tenant
- hope that the value of the property goes up (didn’t I hear that property doubles in value every 10 years!?!?)
The strategy is not in itself a bad strategy – it is used by many sophisticated investors as a means of generating cash flow, but there are variations on this strategy that in my opinion are better than others, and there are definitely methods of making it more successful than the “hit and hope” approach that is taken by most investors.
Negative Cashflow/Gearing
The negative gearing approach to the buy and hold strategy is one that has been incredibly popular in Australia for many years, but I can’t help but feel that it may not have a great future (and in my opinion, it hasn’t even had a great past). This variation sees buyers purchasing a property with the expectation that the holding costs will exceed the income generated from the property.
Now whilst this seems ridiculous on the surface (buy an investment that is going to lose money???), it has been incredibly popular for a number of reasons.
The first is that the deals are incredibly easy to find – walk into any city, and you should be able to find a negative cashflow deal within a matter of minutes. The simplicity appeals to many people (but I am assuming that since you are reading this, you may not be one of those people who are just looking for simple).
The second reason is that negative gearing has been spruiked by many investment advisors and accountants etc as a great way to minimise the tax that you have to pay. Many people have bought into this – take my father as an example. As a teacher, my father was very keen to reduce his tax liability, and so he looked to negative gearing as a method of doing this. He was so sold on the theory, that as soon as his properties started becoming positive cashflow (generally as a result of increased rent income over time, and by paying down the mortgage), he would actually sell them so that he could buy something else that he would be able to negative gear in order to reduce his tax bill!!! For me, I would rather be paying tax on a profit than getting back a percentage of what I have paid!
Thirdly, ask many real estate investors about capital gain, and they will probably tell you that property doubles in value every 10 years. Based on this, many people plan to hold their property (and keep paying out to cover their losses) for 10 years or more, in the expectation that the property will double in price, and that is where they will see the profit. The reality for many is very different. Property prices doubling every 10 years is at best an average. I have seen many suburbs where they have had more than 10 years of basically zero (or in some cases negative) price increase, so be wary of using this as the basis of your investing strategy.
Depending on your circumstances, negative gearing can be used as a wealth creation strategy, although I see it more as a method of enforced savings than a method of quickly accumulating wealth. If combined with good research to determine areas with good potential for growth, then it can be successful, and it is a very passive strategy requiring very little effort.
Just remember, as my accountant once reminded me, if you are holding a negative geared property, and it is not going up in value, you are just losing money.
Positive cashflow
The positive cashflow variation of the buy and hold strategy involves finding properties where the income from renting the property exceeds the costs of holding the property. As the owner, this results in additional money in your pocket, so can be very appealing as a means of working towards supplementing or replacing your job income.
In contrast to negative geared properties, positive cashflow properties can be more difficult to locate, and at times can be practically impossible to locate in major cities. If you are looking for positive cashflow properties, you may need to venture a little further afield to regional or mining areas, where prices are lower or the rents are higher. Commercial property is another investment that often has better chance of being positive cashflow.
Positive cashflow investing does bring its own challenges though. Because the positive cashflow may only be small, it can take many properties to develop a decent income. In order to purchase these properties using bank loans, it is necessary to keep finding deposits, so quite a lot of capital may be needed. I know I originally started out with the vision of replacing my income by purchasing positive cashlow properties, but it wasn’t long before I realised I didn’t have the capital required by the banks in order to keep purchasing properties. This was when I started to seriously look at what I needed to do in order to replace my income using property investing.
Improving Your Chances of Success
I am more of a fan of positive cashflow than negative gearing, but no matter what you choose, there are a few things to keep in mind to increase your chances of success when looking at the buy and hold strategy
- know your goals – if you don’t know what you are looking to achieve from property investing, it is very difficult to know the best strategy to choose
- understand your strategy – whether negative or positive gearing, understand what it will take to make it successful. For example, if looking to negative gear, you may find that the depreciation available on a newly built property may make it work better for you, so you may wish to target new properties
- buy well – no matter if you are looking at positive or negative gearing, buying well can make a huge difference to your success. All buy and hold strategies benefit from strong capital growth, so researching to find areas with good potential can improve your results dramatically
Enjoy the journey!