Buy and Hold Forever or Continually Trade Up

[Wade G.]

After reading some recent blog posts on BP this topic has me at a crossroad. On one hand I can see where continually trading up may indeed build ones empire faster...I think. In regards to trading up SFH rentals there are significant costs associated with the trade up...realtor fees, make ready to sell rather than rent again, holding costs during the transaction, depreciation recapture and capital gains if not doing 1031. Of course on the other hand holding the property forever is a case of diminishing returns...eventually a new roof, HVAC, deteriorating galvanized pipes, cracked slabs, make ready between tenants, etc. Another consideration now is these low interest rates. One of my SFH has a 4% fixed 30 year loan. I almost hate to sell that property just because of the loan rate.

To me it does seem that keeping your money moving by purchasing, renting for a year or two and then selling and trading up is the more aggressive and more prosperous route. Now this is what I have done...buy, hold, wait, save and repeat. This is incredibly slow. The saving part is incredibly boring. Working a full time job also only allows for a certain amount of time to do all this. A lot of work and time can go into purchasing just one SFH. All this depends on market cycles of course.

I would like to hear from some of the successful investors and get their opinions.  Since we are in a sellers market (at least in Houston) I am trying to decide if it is time to start trading up.

[Account Closed]

@Wade G. 

Here's the problem with this exercise:  lets say you start off with one house, then you trade it for a bigger house.  Everythings going good so you trade the big house for 3 smaller ones, then up to 5 houses, etc etc.....always doing 1031s so that you don't pay tax, and always leveraging because thats how you get the biggest bang for buck and that's how the numbers work out best on paper.  Now just for fun, lets say we enter into a tough period perhaps like 2008.  Prices start to drop.  Rents start to drop.  People get laid off.  Your rents are under pressure.  And here you are, you have maximum leverage and maximum exposure.  So, with this scenario I saw alot of landlords go broke in 2008.

Now, you can get to the same dire ending, by starting with one house, borrowing the equity, plowing that into another house, always borrowing and buying the max amount you can.  So when that bad market scenario comes, you're fully leveraged again.  And in 2008 we saw alot of landlords in my area walk away from houses.

And of course, let me compliment you on having thought this through.  There are significant costs to sell as you pointed out.  Commissions and closing costs are large.  Just negotiating to sell will cost you something at times.

I've been through several declines of magnitude, California in the 90s.  And of course 2008.  And most people don't remember this one, but we had a very tough market back in late 70s early 80s.    And in each one of these periods we saw investors go broke.  Most of them we never saw again.

Now, I want to tell you about Harry Helmsley.  I saw him interviewed on 60 minutes a number of years ago.  He was the biggest real estate investor in the US at the time (married to Leona Helmsley, remember her?).  Anyway, he said he had never sold a piece of real estate.  He owned the Empire State building at the time.

So the key is figuring out how you're going to continue if you never sell a house.  Because in the end what happens is you run out of cash.  What Helmsley did way back then was get partners.  There's really nothing new in this business.

And what partners will mean is that you can continue to do deals, and you create the same type of leverage.  Helmsley had equty partners.  You can do it with debt partners as well.  And once you've used your own money to test the waters, created a track record, then you can start building your empire, with other people's money.  Just like it's always been done.

I think where you need to get to is where you own some houses free and clear.  Yes, it's not the highest return way.  But a free and clear house is a huge cash cow.  And, they reduce your risk.  I rode through the 2008 debacle watching my fellow landlords around me losing their houses, without a single issue, other than I had to reduce my rents for a while.  That was no problem though, because I had very little leverage in my properties.

Just remember this.  Don't only focus on how you get the highest return.  You also have to focus on what your risk is.  That's how you do this long term, figure out what your risks are.