Real Estate Investment: The Buy and Hold Strategy.
What does it mean Buy and Hold? It means investing in a single-family home and renting it out to a tenant. You just keep renting this one home out to tenants each and every year. Your tenant pays you enough rent to cover your mortgage payment, property taxes, and insurance. You probably won’t be making a lot of money each month with this strategy in the beginning, but the long-term wealth-building opportunity is incredible.
Each year, you’ll be able to raise your rents a little. Over time, your cash flow will increase, while your monthly payment stays the same. To keep the numbers simple and very conservative, let’s assume you buy a nice $350,000 home. This home has three bedrooms and one and a half bathrooms. To invest in this home, you go to the bank and get a typical investor loan requiring you to have a 10% down payment.
Let’s review the numbers on this investment:
Purchase Price $350,000
Down Payment $35,000 (10% Down Investor Loan)
Mortgage Loan $315,000 (Fixed 4.5% Rate, 25 Year Loan)
Monthly Loan $1,750 Payment (rounded)
Monthly Property $400
Taxes Monthly Insurance $70
Monthly PMI $130 (Private Mortgage Insurance)
Total Monthly $2,350
Payment Monthly Rental $2,500
Income Monthly Positive $150
Cash Flow Based on the example above, you as the investor would be earning $150 each and every month from this single-family home. That doesn’t sound like a great deal of money, does it? It doesn’t really seem like it’s worth all of the trouble. Invest $35,000 and get $150 each month…. If that were all that you earned, it probably wouldn’t be a great deal.
However, this one home really is a wealth-building machine. This one home would provide you with four income streams. By investing in one single-family home, you would be adding the financial security of four income streams.
Here are your four income streams:
1. Monthly Positive Cash flow – In the example above, you’d be earning an extra $150 each month from this investment. You can take the $150 and go out to dinner and a movie. OK, maybe just a movie or a dinner.
2. Mortgage Loan Reduction - I also call this Equity Build-Up. What I mean is that each month the tenant pays the rent; you send a mortgage payment to your lender. A portion of your mortgage payment is reducing the loan balance. Every dollar in a loan that is paid down is wealth to you. In fact, your tenant is paying off your debts. Not too bad. In this example, about $600 dollars of your payment reduces your outstanding loan. This in another income stream to you each month.
3. Appreciation – Each year that you own this rental property, its value will be increasing. If your $350,000 home appreciates at 4% a year, your home would be worth $364,000 after the first year you owned it. That $14,000 increase is another income stream. If I divide this $14,000 increase by 12 months, it would amount to $1,167 each month.
4. Tax Savings – At the end of the year, your rental property will show a loss on paper for tax purposes. The reason is that the IRS and CRA allow you to include an expense called depreciation on your tax return. You don’t have to pay for this expense. This extra expense creates a tax loss, which you can use to reduce the amount of taxes you pay for the year. Let’s assume that this loss saves you $1,000 in taxes. $1,000 divided by 12 months is $83 dollars each month.
One single-family rental home at the example cost of $350,000 provides you with these four income streams. If I added up these four income streams, they would total the following: Monthly Positive Cash flow $150 Monthly Loan Reduction $600 Monthly Price Appreciation $1,167 Monthly Tax Savings $83 Total Monthly Return $2,000 Not bad if you ask me. But really this is just a simple example showing a house at the cost of $350,000.
What happens when you have a house at $400,000, $500,000, or more? You guessed it; your returns are much, much higher! But what is the real reason real estate is such an incredible wealth-building machine? The Majority of this Monthly Profit is Locked Up Of the $2,000 in Monthly Return in our simple example, you can only mess up by spending $150 each month. The rest is locked up, so to speak. It’s very difficult to spend your monthly loan reduction or your monthly price appreciation. Each month, you are getting richer by $2,000. This $2,000 monthly income occurs without you saving any money out of your pay-cheque or investing in your retirement plan.
If you had a different investment that paid you the $2,000 in cash, you might be tempted to use that money to buy “Toys” (Toys are TVs, computers, and vacations.). Getting wealthy and creating extra income is very hard if you are spending all of your profits. You don’t have to fight the urge to spend your income because you can’t get at it. If you are having a bad month, you are unable to withdraw cash from your house, which protects your income! In my opinion, having your monthly profits locked up is what makes real estate incredibly powerful. All a person has to do is buy one home and rent it to a tenant. Well, I guess you would have to make sure that the tenant paid their rent and that you paid your monthly mortgage payment, taxes, and insurance, too. This one investment would provide you with an invisible $2,000 monthly wealth-building machine.
This is a book excerpt. Source: Income for life for Canadians by. T&N Karadza