Commonly regarded as the sensible option for investors, is buy and hold ever not a sound strategy?
For many investors, buy and hold is the most appealing investment strategy available.
David Stafford, general manager – sales and marketing, Indigo Group, points out that property in Australia tends to double in value every 7–10 years, which means that the average person “should look to property investment as a 3–7 year strategy to realise good growth”.
Angelo Piazzetta, CEO and founder of The Property School, adds that buy and hold “is the best way to build long-term wealth”. But he warns that due to the negative cash flow in most situations it may restrict the number of properties you can buy.
“With buy and hold you are looking for long-term capital growth, so the focus is on properties that deliver that objective,” Piazzetta says. “Positive cash flow properties do not always fit into this strategy.”
How long should you hold on?
The longer you hold generally the better growth you will achieve, says Stafford. “It’s a matter of understanding the property cycle you have bought into and where it is at when you want to sell.
“A lot of experts say to never sell and simply leverage the growth in your property into another property or other investment. As long as you keep an eye on cash flow you should maximise every dollar in equity to make it work as hard as it can for you.”
Piazzetta agrees. “If you want to make the most amount of money then hold for as long as possible,” he says. “Time is your best friend.”
Opting to hold won’t guarantee you property riches, however, as Stafford explains. “Nothing is fail-safe and people do lose money in property,” he says. “But usually this occurs because they have over-extended their debt to an unmanageable level or tried to move in or out of property at the wrong time of the cycle without good advice.”
Timing matters
Timing is key, says Piazzetta, particularly for investors who have a short or medium-term strategy. “If the strategy is long term then the timing is not as important but the objective should always be to make as much money as you can when you buy, that is, buy the best value property you can.”
Stafford agrees that market timing is important, saying it plays a big part in turning a good property deal into an absolute winner. However, he believes that there is “never a bad time to buy property. How many people wish they bought into markets like Noosa Heads or Byron Bay 15 years ago and would have said then it’s too expensive or the returns aren’t high enough?
”Julie-Ann Cronin, director, The Home Straight, agrees. “There is nothing worse than looking back in years to come to see that a property you sold earlier would sell for $X now or be worth $X if it had been kept,” she says.
Cronin adds that buy and hold enables investors to ride the cycle and sell when they feel comfortable with the market value of a particular property. “With this in mind you don’t need to time your entry into the market,” she says. “Ideally you would not want to purchase at the top of the cycle as you will pay top price for a property.” Investors who do purchase at the top of the cycle need to ensure that they sell when the next cycle peaks to reap the benefit of maximum growth, she says.
One way of avoiding purchasing at the top of a cycle is to study the market Australia-wide and purchase in another state or area that is not currently at the top or nearing the top of the cycle. “There will always be an area that will provide you with a good buy if your research is substantial,” says Cronin.
Weighing up the costs
In terms of the comparison of cost involved in buying and selling versus buying and holding using equity there are many additional variables that need to be studied, says Cronin. Depending on the price of the bought and sold property, there are buying and selling costs that need to be taken into consideration. These include stamp duty, mortgage fees, building and pest inspections, agent’s commissions, conveyancing fees and the cost of any cosmetic renovations. If you can afford to hold, then it would be “far more advantageous” to do so, says Cronin, particularly if you’re able to use the equity to purchase again. “Equity is a powerful tool,” she adds. Ultimately, the decision on whether or not a property should be held onto is a personal one, but the fact of the 7–10 year cycle is unavoidable. “It is a fail-safe strategy unless the purchase was made in an area that does not provide the growth indicators, for example, population growth, infrastructure development and economic growth,” she says.
A different perspective
“For many investors, ‘buy and hold’ means buying a good asset such as shares or property and holding it for the long term and hopefully never selling, because in general good assets always go up in value over the long term,” says Bill Zheng, CEO of Investors Direct.
Most property investors have interpreted buy and hold as ‘buy and hold properties’. Zheng says this is not quite correct and he explains why.
“Over the last 20 years, if you did not borrow money to invest, statistics show that residential properties and shares performed pretty much the same. So it wouldn’t matter whether you bought and held shares or properties – you would have achieved similar results.
However, if you did borrow money to invest, the result could be quite different. Let’s examine how a property investor makes money over time.
Did you know that an average Australian home worth $400,000 today was valued at around $10,000 about 40 years ago? $10,000 in cash back then was a lot of money. But if you only needed to pay that $10,000 back today, it would have been a lot cheaper, because money loses its value through inflation. The amount of money that could have bought a house 40 years ago could only buy a double garage today.
Imagine someone had lent you the $10,000 to purchase a house 40 years ago, and all you had to do was to look after the interest repayment. Let’s assume the interest rate was 8% a year for the 40 year term.
The first year:
• property value = $10,000
• interest repayment = $800
• if inflation was 3%, the $10,000 you borrowed is now worth $300 less because of inflation. By not contributing $10,000 of your own (and maybe better using it elsewhere) you have saved this loss of $300. This is a difficult concept to grasp, but basically your lender has just lost $300 and you have saved $300 by not using your own funds
• so your interest payment is really $500 ($800 less $300 ‘profit’)
• rental income at 4% is $400
• so technically it has only cost you $100 to hold on to your property ($500 less $400). If your property increased in value by 10% in the first year, you would have an additional $1,000 in equity
The second year:
•property value = $11,000
• interest repayment = $800
• if inflation was 3% it would have cost the lender a further $300 – you saved this loss on your money
• you’re still paying $500 in interest ($800 less $300 ‘profit’)
• rental income = $440 (4% of the increased property value of $11,000)
• so technically it would only cost you $60 ($500 less $440) to hold on to the property in the second year. If your property’s value went up by another 10%, you would have an additional $1,100 in equity.
We can continue the example for 38 more years, but you should get the picture: each year, mortgage interest repayments look cheaper and the principal outstanding becomes less valuable, thanks to inflation.
Let’s take an example based on real data (national standard variable interest rate and the median rental yield and median price for Melbourne, over the last 30 years) from Residex and the RBA.
Assume that:
• you were renting a median price house 30 years ago and then secured a 100% mortgage on the property;
• instead of paying off all the interest and principal, you only pay the amount you were paying as rent to the lender (so your mortgage is not an additional financial burden); and
• the lender does not require you to pay any more off the mortgage and the additional money owed is accumulated into the existing loan.
The graph shows that the inflationary pressures on rent and house prices over the last 30 years mean that even if you only used your rental payments to service your mortgage, you would still have paid off your mortgage within 30 years … and generated almost $430,000 in equity.
The important point to understand is that money loses its value through inflation – this includes the money others have lent you.
Apart from the basic rule of supply and demand, you can probably see your profits being made in two ways:
- over time property prices and rental values gain monetary value due to inflation. This means that they become worth more (or more expensive); and
- over time your mortgage and . repayments lose monetary value due to inflation. This means that they get cheaper.
So property investors relying on supply and demand as their only strategy would have probably missed the main reason why property investors make more money than most other types of investors – because they can leverage inflation through the effective use of mortgages.
If you can find a way to effectively delay interest and principal repayments of a mortgage, you will make more money due to inflation alone. A simple way to delay repayment of the principal is to pay interest only forever and never pay back your mortgage or sell your properties.
An effective way to delay interest repayments is to use a ‘cash flow mortgage’ where you can delay a portion of your interest repayment.
Property investors will make returns similar to those of other types of investors if they only buy and hold properties, but they will make a lot more money if they buy and hold mortgages (which include interest repayments).
So for property investors, buy and hold properties is not an effective strategy, but buy and hold mortgages is.”
