Buy and hold best Strategy

[Jose M.]

Hi, I’m a newbie real estate investor. I have a full time job, live in Texas and currently own 2 small multifamily properties and currently looking for a 3rd one. My current interest is buy and hold, and mostly multifamily. What’s my goal ? Mainly I do it thinking about financial independence or at least partially and thinking about my retirement. 

I’m kind of confused on what should be my overall real estate strategy. I realize there are many different ways to do it but I figured I should ask the expert or experienced guys from BP... because I haven’t been able to find an answer by myself

-BRRRR. Many people say this is the best way. I find it a little risky, underestimating the repair expenses, overestimating the ARV, Risk of over leverage, etc.

-Debt snowball. I’ve read this in a few websites. You buy 4 properties with a loan, 25% down or something. The cash flow that is left every year you reinvest it paying extra to the principal in each property. After property #4, you don’t buy a #5. Instead you use all your savings of that year, etc to pay off property #1. So you are back to 3 loans and then buy #5, going back to 4 loans. The idea is you never have more than 4 loans. In other websites they even say, don’t keep buying more properties, you may just stick to 4 or whatever your goal is and pay them off one by one. But then I thought you might lose the leverage factor, using other people money using this... and they say it might be slower which I don’t fully understand cause owning them free and clear getting that much cash flow this soon instead of 15-20 years from now and owning fewer properties does not sound like a bad idea, less work or “headaches” I guess. But I realize it would be thanks to money out of my pocket instead of using equity paid by tenants. Plus I might lose tax write offs, right?.

-Any other better strategies you may suggest.

Thank you guys in advance for all your insights and replies. 

[Ross Denman]

@Jose M. the best strategy depends on your resources and goals.

Most of my clients like their jobs and make enough money to stash some in savings or has credit access against the equity in their residence or income of their business. If you are fine with continuing to work and save money, them my recommendation is what I call equity growth mode. This involves using leverage to control appreciating assets while tenants carry the overhead, paydown the principal, and produce some cash flow. This can be achieved by conventional finance at acquisition (usually 20% down) or refinance after acquisition (up to 75%-80% appraised value.) Regardless of how leveraged you are, any net cash flow is seriously reduced by the cost of the debt service (mortgage in this case) so operating reserves are a must. All of my personal rentals have operating reserves of at least $6,000 and I also allow all cash flow to build in those accounts also.

When holding leveraged assets... appreciation of underlying asset is also leveraged. These are most predictable and desirable in the B- Class of neighborhoods. For instance... regardless of cash flow... if you purchase a $100k home at 20% down with no rehab needed, your investment is $21kish (closing costs, holding costs till tenanted, etc.) If the underlying asset was purchased with no equity (try to do better than this) but appreciates at a conservative rate of 2.5% the home value climbs like this.

$100k - year 1

$102.5k - year 2

$105,6k - year 3

$107.7k - year 4

$110.4k - year 5

$113.1k - year 6

$116k - year 7

$118.8k - year 8

$121.8 k - year 9

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The above appreciation is lower than what we've seen in our local, stable portion of the market, so these are very conservative numbers. This shows a $21.8k ROI on investment over 9 years. That's 11.5% annual COC ROI. If you cash flow anything and look at the principal paydown, you'll likely see a total IRR averaged to around 20% annual COC ROI.

If you purchased 2 homes each year for 9 years, you'd probably find yourself controlling over $2M in assets with about $180k invested in the standard Indianapolis rental market. At that point, you'd start working on repositioning to a cash flow model which will likely net around $9k-$10k/mo.

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If you're looking for cash flow now, then you have to find higher ROI units that you can hold in all-cash but not be in high-risk neighborhoods. Typically this is going to be more of a C Class investment area unless you can get in to the mid-large MF market. The cash flow is faster, but the equity build may not be especially since it's not leveraged. If you're living on the cash flow, I'd still ensure that reserves are set aside and filled before taking any cash from the accounts. I have several clients that hold some properties in cash (for cash flow) while building portfolio value by leveraging other properties for equity growth.

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I'm not familiar with the debt snowball strategy, but I have investors with commercial notes of 10+ homes and refinance the note every year and bring on a new home or more each year with their equity build. Basically, if you have 10 homes appreciate at 2.5% then the equity of your portfolio has grown by 25% which is enough for a downpayment on your next home.

I personally don't see an outright advantage to any strategy as long as you are capitalized, have good enough credit for financing, have money set aside for reserves, and don't buy pigs. I always recommend understanding the power of leverage but also the serious financial dangers of overleveraging. I've been caught up with this in the past and it will really set you back. Make a plan, create rules and criteria, and invest only according to your plan. Continue to educate yourself and evaluate your position and goals and update your plan as needed. Execution of the plan will start slow, but constant growth will build a financial fortress over time, especially if you learn to diversify in different markets, different housing types, and with all the different vehicles (rentals, syndicates, notes, tax-lien certificates, money lending, options, owner financing, etc.) available to RE Investors. For some people large financial changes can happen in a couple of years, but most people feel that they are much closer to achieving their goals between 6-10 years.