If you’re starting out in real estate investing, you’re probably thinking about flipping a house – most likely influenced by all the reality TV house-flipping shows. The reality is that flipping houses (i.e. finding a house that needs work, fixing it up, and selling it to a new owner for profit) is just one exit strategy of many that you can use to make money in real estate.
Next to flipping, the second most common exit strategy is called buying and holding, or put more simply, renting your property and becoming a landlord.
So which exit strategy is better?
That’s a hard question to answer and, of course, depends on the individual circumstances of each deal. Whenever I buy a house, I usually have at least three exit strategies up my sleeve. Flipping and buying and holding are usually the first two.
Let’s dive in and take a look at both strategies:
House Flipping Made Simple
House flipping, as I mentioned earlier, is finding a house at a deep discount (usually because it needs some rehab or is seriously ugly), transforming the house into an object of beauty, making a new buyer fall in love with it, and selling it for a profit.
To get the biggest profit possible, it’s essential that three criteria are met:
- The house is purchased at a deep discount.
- Rehab costs are kept within your budget.
- The house is “flipped” as quickly as possible.
When flipping a house, time is definitely your enemy. Every day that your house isn’t ready to sell, money is from your pocket. While your property sits vacant fees for financing charges, utility bills, property taxes, and home-owner association fees are still piling up. That’s why house flippers do their best to flip the house as quickly as possible. Usually, the less time you own a house, the more money you’ll make from the deal.
Money and Time: You can get into a property and then out again in a short period of time. It’s less hassle, plus your money and/or equity in a property are not tied up for extended periods.
Quick Cash Injection: When you can find, fix, and flip a house in less than six months and make a healthy profit in the process, this is a great way to supplement or replace your annual income. And when you can do it in less than 6 months and make $30,000, $40,000 or $50,000 in the process, that’s when flipping houses starts to get seriously addictive!
Lower risk: The real estate market changes over time, neighborhoods transition, the local economy changes. When you flip a house, your risk lasts for a shorter duration than if you’re buying and holding.
No Landlord Headaches: Tenants can be a nightmare if not chosen carefully and managed properly. Happily, flipping doesn’t involve them. A definite pro in my book!
No Capital Appreciation: Holding a property for longer term means you get to enjoy capital gains as the property (hopefully) increases in value over time.
Having The Right Rehab Team is Critical: When time is money, the skill and speed of your contractors is essential for flipping. It’s not nearly as important when all you’re looking to do is rent the property out.
Higher Tax: I’m not a tax attorney or a tax expert, but be aware that you’ll pay more tax when your real estate profits are made in the short term (less than a year) rather than over the longer term.
For the Love of “Landlording”
Buying and holding a real estate deal, on the other hand, involves buying a house (not necessarily at a deep discount, although that’s always nice), making some improvements, and then renting the house to some responsible tenants to pay the mortgage, taxes, and utilities for you and get the property to cash flow. That means their rent payments are more than your financing costs, taxes, and maintenance costs on the house.
If your monthly costs are less than the rent collected, it’s a beautiful thing. You have just created a passive income stream for yourself!
Building Long-Term Wealth: There’s no question that great wealth has been amassed through buy-and-hold real estate investing. Although anyone getting into the real estate investing market over the past five years may not think so, it’s well documented that real estate values increase over the long term. All things being equal, the longer you hold the piece of real estate, the greater your potential for appreciation. Some of the wealthiest individuals in the world made their great fortunes through buy-and-hold real estate investing.
Passive Income: Owning multiple properties that all produce solid and steady rental income is a very appealing way to build a reliable stream of income. Although you can get this same kind of income with house flipping, you’ll need a steady stream of house flip deals, usually one right after the other. For the part-time investor, this may be a disadvantage or an advantage. A sporadic infusion of cash is a very nice thing to have, but a reliable, steady, and dependable monthly income is an attractive feature of buy-and-hold real estate investing.
Dealing with Tenants: I could write an entire book on this subject. Finding good tenants can be about as easy as trying to nail jello to a tree, but they are out there! Finding them requires time, energy, and loads of patience. And once you’ve found them, you’ve got to keep them happy so they don’t leave. If you don’t get your tenants right in the first round, you have to deal with them until you can either evict them or they provide you notice. Make no mistake, being a landlord is not for the faint of heart!
Finding a Good Property Management Company: To truly build long-term wealth, you have to be able to scale your real estate investing model and outsource a lot of the day-to-day responsibilities. Managing your properties is definitely a job you’ll want to outsource (either to a property manager or by using property management software like Rentler), but that doesn’t mean that you’re hands-off. Now instead of managing the tenants, you’re managing the property management company or using tools to manage the property yourself.
Which Strategy Wins?
Although I use both strategies, which one you choose should depend on your immediate and long-term goals. Flip for the short term and quick transactional income, and hold for the long term to create passive income streams. Let me know what your thoughts are by commenting below!