Plan Refinement For The Buy And Hold Investor

Congratulations! You have made a good decision. You want to be a buy and hold investor. You understand the wonders of exponential growth in value in a leveraged investment. Maybe you have done a few acquisitions and are pleased with yourself. You should be. You have even taken the time to develop a long term strategic plan with numbers in it (i.e. my article: “Getting Started With Your Investment Plan Using A Spreadsheet”). But, now what? Refine your plan!



Many experts recognize three levels of planning (and decisions) —Strategic, Tactical and Operational. Understanding these and how they interact may make it easier to reach your goals and manage your enterprise with greater ease. Strategic Planning and Decisions are usually done at the highest level of an organization ( in this case, you!). They usually have long term impact and involve large amounts of capital. Often they involve decisions about acquisition of large assets. For you this is the selection of property location and the acquisition and sale of such properties. Tactical Planning and Decisions are usually done at a middle level of an organization (could be you!). They usually involve how the assets are deployed. With real estate you often know how the assets are to be deployed. You could certainly change usage such as converting a warehouse to office suites, but often the deployment is the selection of tenants. Operational Planning and Decisions are usually delegated to a lower level of the organization (again, possibly you, but hopefully you can find leverage). For real estate it is the day-to-day tasks associated with management. Remember that quote: “We don’t buy real estate for the thrill of management”.



We will concentrate on refining your plan at the strategic level. You want your plan to serve your wants and needs and address your situation. You also want to make corrective modifications based on the evolution of your enterprise. Consider where you live an what resources you have and what you are comfortable doing. Since I have a full-time job that I very much enjoy and two part-time teaching positions, finding properties on my own at 50% of FMV near where I live in CA is not something that has a high yield return for my invested time. Some feel that if they can’t drive to a property in 20 minutes they won’t own it. Resources and comfort levels will certainly play a role in strategic planning. Keep in mind that the more limiting your constraints are the fewer opportunities you will find.



Refinement can come just by recognizing two classes of markets—appreciating markets and cash flow markets. These may not only be segregated by geographical location, but also by investment type. Sometimes we get lucky and find properties that give good cash flow while enjoying excellent appreciation. This is usually transient and short lived. The reason is that in appreciating areas, the appreciation grows much faster than the rents that must support the acquisition loans. The rents in Las Vegas did not go up 40% in a year when the Housing Price Index did.



You can use these two market classes interactively. You can invest in appreciating markets and then trade these into properties that give cash flow. You can time this to fit your needs – according to your refined plan! You will also find more financially distressed opportunities in the high cash flow market, i.e. rehabs, REOs, pre-foreclosures, etc. This may sound like 1031 exchange 101, but we are not done. Certainly, we can also do the reverse. We can either trade or more advantageously, use the cash flow from high cash flow markets to fund acquisition of properties in appreciating areas. A very interesting 1031 exchange strategy is to exchange into several properties where some of them are highly leveraged high appreciation properties along with one or more high cash flow properties. This way the replacement package is net positive cash flow.



Additional advantages can be gained by studying the market cycles in different parts of the country. This is further refinement. You may want to catch the next appreciation wave. There are several resources at your disposal. The Office of Federal Housing Enterprise Oversight (OFHEO) publishes Housing Price Indices (HPI) for over 200 Metropolitan Statistical Areas (MSA). This data is compiled quarterly and for many areas, goes back to the 1970s. You can also find plenty of data on population changes along with maps. Besides government data, owners, realtors and property management companies are excellent sources. You might want to look closer if a realtor says, “Starting last year we have seen a number of California investors”. Obviously, you want to do some detailed due diligence on an area before buying, i.e. Rental markets, neighborhood conditions, local market history, construction. Robert Kiyosaki’s tapes state that the neighborhood is more important than the individual property. You can fix properties, but not neighborhoods.



Are there other strategic elements? In my opinion the main other element is loans. Structuring and restructuring loans should be part of the strategic planning process. These also can interact with your property acquisition strategies. After all, the size of the loan in a leveraged investment is close to the value of the acquired asset. You can use seller assisted financing to get more leverage. You want to be sure that you can hold a property indefinitely. The 1980s saw people get into properties with two year balloons with the belief that appreciation would bail out any loan. They were wrong. I won’t have any loan with a balloon less than 5 years unless it is very small. Most of my seller carry-backs are in the 10 year time frame. Institutional financing is a large topic by itself. When using loans that ultimately get indexed to some short term rate, plan carefully. It may be that your plan to hold a property for only 5 years, however, you do not know what the market conditions or the interest rate will be in 5 years. Your 5 year ARM may bite you! This is where your global plan comes in. You may be just fine if you have enough cash flow and 30 year loans to carry some adverse rate changes. Another factor is retirement. Many of you have goals of being supported by your RE income in several years. If you are not working and your overall income is not what you hoped, you may be cut off from institutional refinancing – not good if your ARM jumps to 10%.



Your loan strategy can interact with your acquisition strategy. High cash flow properties can help pay off older loans so you can have some free and clear properties and additional cash flow. The reverse works also. Equities can be refinanced to acquire more properties. Keeping an eye on the equity profile of your portfolio is a big plus if this is a source of acquiring more properties.



What about Tactical and Operational Planning? Remember that these occur lower in the organization. This is where delegation comes in. Property management is almost a necessity if you own remote properties. There may be some areas where you want to maintain control. These are primarily the systems involving cash transfers and information flow. One of my friends is totally hands off. His property management companies write his mortgage payments and real estate taxes. If I were sleeping with my property manager I might be comfortable with this. I don’t and I’m not. If you are like me this means that you will need systems that handle some of the operational and tactical elements of your enterprise. This is where planning comes in. Your planning will be in the design or selection of systems that will serve you as you grow. The two indicators that will trigger you is if you feel you are losing track of information or you see bottlenecks that begin to take a great deal of your time. You might decide that you need an accounting system or bookkeeper services if you decide to buy a large apartment building and you realize your shoebox full of receipts is no longer a good idea. A visit to my banker has led to new more efficient systems on a few occasions. At the tactical and operational level it is more decisions than planning. Improvement of documentation such as leases is part of the refinement process.



In closing, we might ask what numbers are important in planning. You can certainly identify many that you might like to see. The three that are the most important to me in descending order of importance are cash flows, asset values and equities. It is cash flows that are going to look after your well being. Asset values are a measure of the size of the engine that is producing your income. Equities can be traded or sold.