Can a SIMPLE Strategy lead to Wealth?

[Don Konipol]

For the past few years I've been periodically posting about complex, somewhat hard to implement, and time consuming strategies and tactics that I've used and can be used to "accelerate" wealth building in real estate. I've received a number of responses from investors essentially stating that they use a simple buy/rent/hold approach in small residential properties, and have accumulated net worths in the 1 - 3 million $ range starting with just one mortgaged SFR.

Granted, they had the benefit of relatively low purchase prices relative to rental income; low interest rate loans they were able to refinance into and (generally) rising house values.  So, two questions arise; 1 - can this strategy work in a NORMAL period of economic activity, and 2 - can this strategy work in a difficult economic period?   

The answer to the first is definitely.  As long as the investor does not expose himself to negative cash flow for long periods of time, over any 5 year and definitely 10 year period the real estate market in general should recover enough to provide a positive value change for most real properties.   Rents tend to rise over time, amortization steadily increases equity, incomes rise, so the investor has a lot of “cover” for unfortunate timing or operating “mistakes”.

Number 2 - periods like 1932 - 1941 and 2008 - 2013 are much harder on this strategy.  Values drop, sometimes drastically, rents go down as quality of tenant declines; cost of operstimg properties increase, and governmental interference, especially in the form of rent control, can slash values and profitability severely. 

Over all, a portfolio of DIVERSIFIED (as to residential areas) properties utilizing a buy and hold strategy should provide an adequate risk adjusted return without utilizing any other "opportunistic" strategies to "gig" the ROI. However here are the three big risks that can devastate any investors portfolio.

1. Investing in the "wrong" area. Everything is clear after the fact. Investing in Detroit in 1950 seemed like a solid bet. Detroit was a high tech area!(really) the city was growing, and the rate of unemployment was negligible. Further, Detroit was running a large net in migration. All factors seemed favorable. Yet, this was the exact moment Detroit peaked. Its population reached 1,700,000. At first Detroits decline was in very small increments. Hiding it somewhat was that it ebbed and flowed with the fortunes of the auto industry. So each recession seemed like an adjustment rather than a long term decline. Today Detroit is a city of 600,000 people. In 1950 a nice SFR in a good blue collar neighborhood in Detroit sold for $9500. In 2012 a friend of mine purchased 100 of these houses for $300,000. Inflation adjusted his $3,000 per house was $400 in 1950 dollars. But it's not just the 2 or 3 large cities, almost every city or ,metropolitan area contains areas that have and areas that will be in decline. If your unlucky enough to invest in these areas your "wait" for a rebound might be quite a long time - or forever.

2 - Governmental Regulation  - Rent control, rental use regulations, property taxes, zoning, etc. In the Bronx, NY in the 1950 - 1980s property values of rent controlled building dropped to 0!, as property owners just abandoned their properties.  The response of the government was to REQUIRE property owners to continue to provide housing ,eating minimum standards, even as they were losing money.  The property owners IN MASS burnt down their properties, which, since they did not file insurance claims was actually the only LEGAL way to free themselves of the continuing negative cash flow of these buildings.  Which leads us to 3

3-  Assault on property rights.  Continuing with the example above the government then decided to provide an alternative to setting the building ablaze.  The property owner could fix up the property to a minimum standard and then deed the property over to the Governmemt.  The Governmemt then “sold” individual apartments to their occupants or other interested parties for $500. So the effect is a confiscation of private property and a transfer of the property for no cost from the landlord to the tenant. 

What do you think?