Fix and Flip, or Buy and Hold? 8 Questions to Help You Decide
If you want to get into real estate investing, the first thing you need to decide is what kind of investor you want to be.
Most real estate investors fall into one of two categories: house flippers and buy-and-hold owners. You can profit as either one if you acquire the right property, but choosing the investment strategy best for you will depend on your goals, finances and personal preferences. We’ll go over each strategy and help you answer eight simple questions to point you in the right direction.
Why Invest in Real Estate?
Simply put, the vast majority of properties increase in value over time because people will always need somewhere to live. Unlike most stocks, land is a tangible asset that you can improve, rent out for monthly income and use to qualify for some sweet tax benefits. For these reasons and many more, real estate has outperformed the stock market by almost two to one since 2000. When you consider the housing bubble of 2008 happened in that stretch, it’s hard to deny the long-term stability of real estate investing.
What’s the Difference Between Fix and Flip or Buy and Hold?
The fix-and-flip approach is meant to turn a big profit fast. House flipping involves buying discounted properties – like old homes and foreclosures – and renovating them to sell at a profit. Sometimes investors use contractors to do the upgrades. Those with experience flipping houses will often do the work on their own.
Investors who buy and hold a home are thinking long-term, typically renting out a property to generate monthly income. This strategy also includes building equity as the mortgage is paid down and the home appreciates in value. Many buy-and-hold owners typically wait five years or more before selling a rental property for a profit.
Fix and Flip Properties: Pros and Cons
House flipping shows can make it look so easy. Find a worn-down gem of a house, perform some makeover magic and voilà: a revitalized home that sells for a healthy profit. Fixing and flipping a property can be a quick process that is highly rewarding, but it’s important to consider the risks and potential obstacles that don’t get as much screen time on HGTV. Here are a few of the biggest pros and cons involved with flipping houses.
Fast Money – There just aren’t many ways to make a year’s salary in a matter of months. If you find a discounted home that needs mostly cosmetic – as opposed to structural – repairs, you can turn a massive profit for a relatively small investment.
Networking – If you work in an industry that involves contracting, or plan on investing in real estate in the future, flipping houses will help build a list of connections in a hurry. Chances are you’ll work with real estate agents, contractors, attorneys, inspectors, material suppliers, insurance agents and many other professionals-worth-knowing in a short amount of time.
Flexibility – Unlike long-term investments, house flipping doesn’t tie up your money. Your capital and profits remain fluid, so you can invest in other opportunities quickly. You also don’t have to worry about dealing with tenants or maintenance. Fixing and flipping is all about getting in and out.
Complications – People and houses can be unpredictable. Even if you get an inspection (and you need to get an inspection), it’s tough to know the exact time and resources you’ll need to get a home sell-ready. There are often unforeseen flaws that need fixing, contractor and permit delays, and any number of stressful surprises that can throw your schedule off.
Tax Hit – Any profits you make on the sale of a home can be subject to a hefty capital gains tax. Depending on where you live and your circumstances, there are ways to limit or even eliminate the tax hit. In many cases, however, there’s no avoiding it.
Resale Risk – You could be in a scorching hot market; your renovations could make a home look brand spanking new. There’s still no guarantee you’ll instantly find a buyer willing to pay your asking price. Each month that your property sits on the market, you need to be able to handle the mortgage payment, utilities, maintenance expenses, etc.
Buy and Hold Properties: Pros and Cons
Buy and hold investing is a strategy that can grow your net worth by a much larger margin than house flipping. By getting the best possible financing on a rental property and maximizing your returns as a landlord, you can generate substantial monthly income and a sizable profit when you eventually sell the property. Still, dealing with the responsibilities and risks of managing a property isn’t for everyone. Let’s look at the pros and cons of the buy and hold strategy.
Easy Income – Most of us dream of making money while relaxing at home. If you rent out a property to a tenant who doesn’t cause you any grief, you can do exactly that as a buy and hold investor. Every rent payment you receive that exceeds your expenses is pure profit. Plus, as you collect rent, you’re also paying down your mortgage and building equity. That means you can sell the property for much more than you paid originally.
Tax Advantages – Real estate investors have it pretty good when tax season rolls around. You can benefit from all kinds of deductions: mortgage interest, mortgage insurance and property taxes to name a few. Depending on which state you live in, you can also benefit from “green” tax credits if you use renewable energy sources.
Appreciation – Unlike flipping houses, time is on your side when you buy and hold. The housing market always recovers from past bubbles, and no matter where your property is located, chances are it will increase in value over the long haul. Plus, inflation is a good thing for rental property owners. As the price of living goes up, so does the rent you can charge. Meanwhile, your mortgage rate stays the same.
Problem Tenants – Tenants can be wildcards. If you get one who doesn’t pay rent on time, not only is it a hassle, you’ll also have to cover the mortgage payment out of pocket. The more frequently you need to do that, the deeper in debt you might sink. There’s also the possibility that a tenant is a chronic complainer who frequently demands your attention. If you struggle dealing with people, you might want to think twice about becoming a landlord.
Property Damage – Even if a tenant pays up every month, they might cause other problems, either to the property or the surrounding neighbors. Damage can also result from fire, flood, wind, etc. You’ll have to determine your liability and responsibility when it comes to covering repairs, and having top-notch insurance is a must.
Costly Vacancies – If your property sits empty for two or three months, you’ll take the hit on a lot of expenses: mortgage payments, utilities, maintenance costs, etc. Before you take on the responsibility of owning a rental property, you’ll need to make sure you can handle the financial burden of two homes for an extended period of time.
8 Questions to Help You Decide
When it comes to deciding which type of real estate investing is “better,” there’s no one-size-fits-all solution. That’s the bad news. The good news is that there is an answer to this question that’s specifically right for you.
Ask yourself these eight questions to figure out whether you’re better off flipping your investment property or holding on to it for the long haul.
Question #1: Do you need the money now or later?
Flipping your investment property will put a handy sum of money in your pocket in the short-term. However, you stand to make even more money long-term if you hang on to the place for several years: the value of your property will most likely increase, and once you pay off the initial investment, you’ll be bringing in passive income – which means you don’t have to labor for it. Since the meaning of short-term and long-term can vary, check out the rate of return for various investment strategies.
Question #2: Is the market heading up or down?
You can actually flip a house and make a profit regardless of what the market is doing, because property values aren’t really going to change that much over the course of a few months. However, you don’t want to sign up for a buy-and-hold investment in a market that’s projected to go down over the next several years.
Usually, property values increase faster than the rate of inflation. That’s one of the things that makes buy-and-hold investments a good idea. But if property values are heading in the wrong direction, it undermines a big part of the value proposition. You’re better off flipping if you find yourself in this kind of situation. Research real estate trends in the area online, from a dependable source and see which way things are heading before you make your choice.
Question #3: Do you have enough capital to flip a house?
Unlike a buy-and-hold property, it takes more working capital up front to pull off a fix-and-flip. Beyond the repairs themselves (which can get very pricey), you also have to foot the bill for contractors, carrying costs, and a host of other expenses. You don’t want to start a flip only to realize that you don’t have enough capital available to finish it.
Question #4: Can you cover vacancies, financially, if you buy and hold?
Buy-and-hold investment properties will usually come with their share of vacancies. Are you in a stable enough position that you can compensate for those vacancies with personal savings or other income, when they come up? If not, you may want to think about building up some savings with fix-and-flips before you move to buy-and-hold investments.
Question #5: How old is the investment property?
When you buy and hold, you’re going to be responsible for maintenance and upkeep. Newer properties will have fewer problems than older properties on the maintenance front. If it’s an older property, fixing and flipping it may be the way to go.
Question #6: How far away is the investment property from where you live?
If you’re buying and holding, the odds are good that you’ll be visiting your investment property quite a bit—especially if you’re planning on managing it yourself. You could end up regretting a buy-and-hold investment that’s located farther away than you want to drive on a regular basis. On the other hand, with fix-and-flips, distance doesn’t matter as much. Even if you’re not crazy about the commute, you’ll only have to put up with it for a little while: once the place is sold, you’ll never have to drive over there again.
Question #7: What tax bracket are you in?
This is a big-picture question that could come back to haunt you if you’re not careful. Depending on your tax bracket, some kinds of real estate investing will leave you with more money in your wallet than others come tax season. For example, if you’re in a high-income tax bracket, you’ll probably end up paying more taxes from a sudden influx of fix-and-flip cash than you will if you are in a lower-income tax bracket. Think ahead on this one.
Question #8: What would you like to do more?
This one is more important than you might think. Remember, the goal is to bring in money, not headaches. Some people really enjoy the intensity and thrill of flipping a house; others can’t handle the stress. On the flip side of the coin, some investors enjoy the steadier and more predictable challenges that come with managing tenants, while others just don’t have the patience for it. The bottom line is that if you’re going to make money, you may as well have fun while you’re doing it!
Which Investment Strategy is Right for You?
Now that you’ve considered the pros and cons of the two most common real estate investing strategies – and hopefully figured out what’s possible after factoring in your finances – deciding which one is right for you boils down to what will make you happier. Do you love diving into home improvement projects and bringing dream homes to life? Would you rather kick back and pile up profits from afar? No matter which strategy you choose, we’ll help you hit the ground running with 10 tips for new real estate investors.
This article has been republished for educational purposes. This information was originally published on Auction.com, LLC, the nation’s leading online real estate marketplace. Kristine Serio, who is not employed by ForSaleByOwner.com or its affiliates, specializes in writing about business and real estate. This article has been updated from its previous submission on Aug 22, 2018 to reflect updated information.