When you think about investing in real estate it might be because you know it can be less volatile than putting your money into stock and bonds, depending on current market conditions.
Popularized by HGTV shows, flipping houses, as it appears on TV is quick, easy money. Is that true?
These reality shows make it look like you can simply buy a house that looks like it belongs in a trash heap, hire a top-notch contractor, wait six weeks, stage it and boom! Watch the profits roll in.
What’s happening in real estate now?
According to a recent article on CNBC, more people are flipping houses now than ever before in the U.S. The big difference is that many more people are using cash instead of financing everything that is needed to buy and renovate the property.
Cash is king in this case because interest rates for loans for investors that plan to flip may be as high as 12 percent. In contrast, homeowner occupied properties that will be held for longer will get a much lower, competitive interest rate.
One big key to success in the flipping game is finding a distressed property before it even gets officially listed. In a thriving market, these sorts of properties are hard to find. When they are discovered, they may be snapped right up once they are listed on RMLS, Zillow and other sites where people look for inventory.
Your results will also vary depending on what state or country you plan to flip in. Florida, for example, is a hot place to make good money flipping houses.
Patch of Land’s site lists seven under the radar states that have plenty of potentially profitable homes available for flipping as well.
While flipping houses has its own set of advantages and disadvantages, there is another choice if you are looking into investing in real estate.
So what is this less glamorous way to invest in real estate? It’s known as the buy and hold method. That means you buy a property at a modest price and hold on to it until it appreciates and then sell it for a profit. During that holding time, you may rent it out or live in it yourself.
First I’ll talk about the advantages of flipping property. Then I’ll dive into the perks of choosing to buy and hold instead.
Flipping as a real estate investment strategy
Obviously, choosing a property that is priced under the current market value is a way to make money on a flip. You may find a short sale or foreclosure through your real estate agent or at auction. After your purchase, you may plan to invest in fixing it up in a short period of time and then putting it back on the market, hoping to make a quick profit.
In essence, finding a fixer-upper that you can make a low ball offer on works well in this situation. You’ll need to asses how much money will be required for a remodel and what the comparables will be. This will help you determine if this will be a profitable property or if there is potential to lose money. Always plan a cushion for renovations because they can often wind up being more than you originally planned on.
Another important part of the flipping business will be finding a general contractor you can trust. Getting at least three bids is ideal. Once you’ve found a contractor that can stay on budget and hire a crew that shows up and does a terrific job, you’ll be able to breathe easier.
The beauty of flipping houses is that your investment capital is tied up for a short period of time. Because the goal is to sell quickly, that means you will also be pocketing a profit in a much shorter period of time.
If you are buying distressed property and flipping in a hot real estate market, you know you are more likely to make a sizeable and quick profit.
Whereas, if you buy and hold and need to sell during a year-long real estate slump then you are stuck waiting things out or losing a chunk of profit by selling in a buyer’s market.
Another great advantage to flipping houses is that you won’t have to deal with tenants like you would with the buy and hold method.
Once you buy a property and decide to hold it and rent it, either you have to deal with getting leases sorted, finding and evicting tenants or you have to hire a property management company to do it for you. This can possibly be a long-term hassle.
All that sounds nice but flipping does have some downsides. There are tax issues, like short-term capital gains to consider with such a quick turnaround. Also, ensuring there is enough cash flow to get to the finish line on renovations can sometimes be a problem.
Buying and holding as a real estate investment strategy
Buying and holding property is a successful way to invest money for many who are looking for a good yield and ROI over time. Even as the market rises and falls (like in 2008) it eventually rebounds. If someone can be patient and whether the potential fluctuations in the real estate market, this can be a smart way to invest.
Cash Flow Diaries had an interesting infographic that compares buying and holding with flipping. It illustrates that if you are looking to buy and hold it can be easier to find a good deal. You can get conventional financing and benefit from cash flow if you make your newly purchased property into a rental.
There are more tax deductions available and you’ll benefit from long-term capital gains. The infographic also concludes that while flipping is like having a real job, buying and holding can feel more like passive income.
In US News and World Report there was an article encouraging millennials to invest in real estate and hold onto it. Amanda Lawson said, “Perhaps the strategy’s most significant benefit for younger investors is capitalizing on their greatest asset: time. “Investors with decades in front of them have a huge opportunity to take advantage of compounding interest,” says Amanda Lawson, communications specialist at Matson Money in Scottsdale, Arizona. She says a millennial who invests $100 a month and generates a 12 percent average rate of return from holding investments long term could have a portfolio worth nearly $2.4 million by age 65.”
How to handle a rental property
If you decide to purchase a property and rent it out for years until you sell it, there are many things to consider. What will you do if one tenant moves out and you don’t find another one for a few months or more? Will you be able to get by with a loss income if that happens or a tenant decides to stop paying their rent?
There are competent property managers that can help do the grunt work involved in renting and maintaining your property but of course, paying them that will cut into your profits.
Another consideration is that renters don’t always leave a property in the same condition as they moved in. Not only that but over time repairs and small renovations will be required. Even if you just replace the carpet and the washer and dryer every five years, it will require a decent chunk of change.
Renters who are paying a steep rent may also have high expectations of moving into a nice place. Just because they are renting, doesn’t mean they are going to be excited about moving into a place with ratty carpet or twenty-year-old toilets.
If your prospective tenants have been renting for a while they may ask for certain upgrades and you will have to decide if that makes financial sense and if keeping the current tenant is worth the upgrades they requested.
A few last words about flipping vs. buying and holding
Every investment has some risk. Whether you are looking at stocks, bonds or real estate, you’ll have to decide how much risk you can tolerate and afford. Study the pros and cons of flipping vs. buying and holding.
Buying and holding may be the best choice for the more risk-averse person with enough time to wait out unpredictable markets.
You’ll need to do your research and decide which one is right for you. A trusted real estate professional can be your greatest asset regardless of which path you choose to pursue. They can help you figure out what properties might be available before some of them are even listed. Also, they will compile a list of comparables so you can decide which property is most right for you.
Evan Zener is the founder of Strong|Edge Realty Team. Feel free to get in touch if you need his help finding your dream home or if you have any questions about the current temperature of the real estate market in your area.