I have found in my 20+ years of investing that the process of purchasing real estate is the most significant part of the ownership cycle. Selling is straightforward in the right market, and the only time in the property transaction you become accountable for commissions and capital gains tax. It can kill the whole deal if done improperly and at the wrong time.
Your goal in property investing must be to develop as much equity as you can in the property while still having enough passive income to get you there. So long as you own the property, you’ll have the extra advantage of tax sheltering that you cannot obtain from any short term methods. THIS is the basic reason that explains why the Buy and Hold methodology is king.
Most people fall within the 20%-36% income tax bracket, and for all you Californians out there, California has one of the highest state tax rates. What’s even scarier is that most individuals work the first 4 months of each year simply to pay their taxes!
The reality is, you will never get ahead financially until you learn to shelter your revenue from taxes. The rich population in this country understand how to shelter their income from taxes, which is why many of them practice the Buy and Hold technique and own rental properties of their own.
As time goes by and you pay off your loan, you get the advantage of additional cash flow which is very useful in retirement. One option you have is to do what is referred to as a 1031 Exchange into a bigger, more valuable property that produces heavier cash flow. The beauty of a 1031 Exchange is it defers the capital gains tax (which just increased on January 1, 2013) into the future and allows you to transfer more of your equity to your new purchase. This is another benefit to building wealth in real estate only the Buy and Hold strategy offers.
Traditionally, properties have doubled in value every 7 to 10 years going back 50 years in time. Imagine your equity position if you hold a property for 20 or 30 years!
If you sell, you not only lose out on future appreciation, but you must pay commission and capital gains tax. I look back to some of the first properties I owned and wish I’d never sold them. While I sold them for a decent profit at the time, their value today is 2 or 3 times as much. It made no sense to sell and let the subsequent owner make all that appreciation. I managed not to sell one property I bought many years back and finally paid it off. The cash flow on that one property today is over $1200.00 per month after expenses. That’s more than the average social security check, and rents have gone up thanks to inflation. (I never pictured myself liking inflation till I started owning real estate!)
At a recent event, I was seated at a table next to a man who’d been buying rental property since since 1999. He never sold any of the homes he purchased. Many of these properties have doubled in price and he is now thinking about using 1031 Exchanges to move into bigger properties. The cash-flow and tax shelter he received over time have been an important asset to him, and now for estate planning purposes he is consolidating his holdings into bigger properties to one day will to his heirs. His plan was to leave a legacy to his kids and grand-kids. The Buy & Hold strategy permitted him to realize his dreams.
If you are tempted to make use of your properties as an ATM machine, it will not permit you to develop equity and true wealth over time. Real estate is meant to be a “retire rich” program, not a “get rich quick” program. In my opinion, the single reason to take money out of a property is to put a down-payment on another. Even then, you have got to be careful that the rental income on the property you are refinancing has increased enough to cover the new higher payment. You do not need to build a house of cards by weakening the structure of your portfolio.
True wealth in real estate is realized through equity growth and appreciation. Cash flow, although a must, is the glue that holds the deal together to permit you to wait until the value grows. Let your tenants cover your payments and make you rich!
