Do you prefer to fix and flip homes or own rental properties and why?
The question of whether flipping or buying and holding is the best real estate investment strategy does not have one correct answer. You should look at the pros and cons of each option before making any decisions.
The Pros and Cons of Flipping
The most apparent advantage to flipping property investments is the ability to immediately realize gains and to have capital tied up for the least amount of time possible. Real estate markets are more easily predicted and can produce extended time periods that compensate investors for flipping properties. In this sense, flipping properties could be considered a safer investment strategy because it is intended to keep capital at risk for a minimal amount of time and because it lacks the management and leasing risks inherent in holding real estate.
There are two major types of properties that can be used in a buy/sell approach to real estate investing. The first is houses or apartments that can be purchased below current market value because they are in financial distress. The second is the fixer-upper, a property with structural or design issues, or condition issues, that can be overcome to create value.
Investors that focus on distressed properties do so by identifying homeowners who can no longer manage or sustain their properties or by finding properties that are at risk of going into default. Those who prefer fixers, on the other hand, will remodel or enhance a property so that it works better for homeowners or is more efficient for apartment tenants. Using this tactic, the buyer of a fixer is relying on investing capital to increase values as opposed to just buying property for a low basis in order to create high investment returns. Of course, it is also possible to combine these two strategies when flipping properties, and many investors do just that.
However, flipping properties can create cost and tax issues that one doesn't face with long-term investments. The expenses involved in flipping can demand a lot of money, usually large sums of cash on-hand, leading to cash flow problems. Because transaction costs are very high on both the buy and sell side, they can significantly affect profits. The quick turnaround in properties (and speed is everything in successful flipping deals) can create swings in income that can boost tax bills – especially if things move too fast to take advantage of long-term capital gains tax rules. Also, finding these opportunities can be difficult over a protracted, consistent period of time. For most investors, flipping properties should be considered more of a tactical strategy than a long-term investment plan.
The Pros and Cons of Holding
Long-term real estate ownership carries a myriad of management and legal issues that investors in stocks and bonds never have to contend with. Real estate ownership is a management-intensive endeavor that is outside the skill set of many investors.
Equity investors have to have the skills to analyze a particular market, a particular company and management's ability to execute its business strategies. A long-term real estate investor needs the same skills but has the added responsibility of creating and executing those business strategies for his or her properties. Many investors, especially first-time rental property owners, are ill-prepared or ill-equipped to deal with the responsibilities that come with being a landlord. The process of finding quality tenants and servicing their needs, along with handling the maintenance and upkeep of the property, can be a stressful and time-intensive undertaking, but successful property management is necessary for ensuring ongoing cash flows from one's investment.
The risks inherent in long-term real estate ownership are great, but if mitigated, the investor is well compensated for assuming them. Most of these risks, which include the transactional risks of purchasing and selling properties, risks to the well-being of the property and the risks of finding and servicing tenants are considered unsystematic risks, or investment risks that can be diversified away if an appropriate number of investments are purchased in a well-crafted portfolio. The problem for most investors is that real estate is so capital-intensive that the amount needed to purchase enough property to mitigate these risks is outside of their means, or abilities.
Choosing a Strategy
In order to decide whether flipping properties or holding them long-term is the most appropriate strategy, one needs to answer a few critical questions.
- What is Your Big Picture?
- Is this an investment that you want to be a permanent source of capital, or is it a means to an end?
- Does the Risk-to-Reward Ratio satisfy you?
- Do you have the appropriate Skill Set to take on the Management Responsibilities?
- Both types of investments demand a lot of attention, so it is important to recognise whether or not you have the resources and ability to see to what is necessary.
- Are you Prepared to take on the Risk?
- If the capital is not available to purchase a diversified portfolio, you must be prepared to take on unsystematic risk, including individual property risks and potential lack of demand for the property, whether by homeowners or renters.
- Do you have the Resources?
- You need money to make money. Do you have the cash to successfully make the investment, whichever method you choose?
The Bottom Line
The choice between the two strategies in question depends on your particular financial situation and investment goals. The long-term holding strategy is typically used by those using real estate as their primary investment. If you are hoping to amass wealth and to derive income from your real estate investments you could consider holding real estate for the long term, using the equity built into the portfolio to finance other investment opportunities, with the potential of eventually selling the properties in an up market. Flipping properties is a tactic that is best suited for investors wishing to realize short-term capital gains for as long as the present market will allow.