One of the biggest questions that new real estate investors ask is: which kind of real estate investing should I do?
As has been written on this blog, there are over 100 ways to get involved in the real estate investing business…and probably even more if you really keep digging!
But out of those hundred, house flipping and long-term real estate investing are the most common.
But which one is better?
Probably because of the proliferation of television shows on houses flipping like “Flip this House” and others, house flipping has become incredibly popular in the past few years.
This may be due to the reality shows, but it also has as much to do with the fact that are still plenty of really good real estate deals to be had in this current market – even in spite of the recent signs of a turnaround.
On the flip side (no pun intended, by the way) there’s one of the oldest and steadiest forms of real estate investing known to all of us, namely: buy and hold real estate investing.
Still popular, still solid and always a good investment, long-term buy-and-hold real estate investing is been around for years and has has created untold millions, if not billions in dollars in wealth to its participants
Although I am a “house flipping guy” at the core . . . I actually do both.
House Flipping vs. Buy and Hold Real Estate Investing: Which One Is Better?
To get to an answer, it helps to explain each kind of real estate investing and put each one in its proper perspective.
House Flipping Overview
House flipping as you may already know, is the practice of buying a piece of real estate at a discounted price, improving it in some way and then selling it for a financial gain.
To gain maximum profit, this is preferably done within the shortest period of time possible.
A house flipper tries to buy, rehab and sell the property; all within the shortest time so that he or she can lock in profits and not get eaten up by their carrying costs. These “soft costs” as they are known, include monthly bills that accumulate over time. These include monthly financing charges, property taxes, condo fees (if applicable), utilities and any other maintenance bills required to keep the house in good financial standing.
House flippers do their best to not hold onto a house for a long period of time. Instead, they flip them quickly. The less time a house flipping professional owns the home, usually the better their profits.
Long-Term Real Estate Investing Overview
Long term real estate investing on the other hand, involves buying a house, possibly making some improvements and rehab, but then keeping the house for a longer period of time. To pay for the monthly costs of financing, taxes, utilities and other maintenance, the house is rented to a tenant.
If the monthly costs are less than the rent collected…voila – monthly profit and cash flow ensues.
In some cases, the real estate investor might buy the property with the purpose of selling it at some point in time, but usually not for a while.
The Pros and Cons
So at its core, the two types of real estate investing have their largest differences in the fact that one produces quick profits in less than six months (ideally) while the other creates monthly positive cash flow into eternity (best case).
So now that we’ve defined them, let’s get back to our debate and uncover some the biggest pros and cons for both.
House Flipping Pros:
Money and Time: The best part of flipping houses is the ability to realize a financial gain in a short period of time and not have you or your investor’s capital tied up for extensive periods.
Quick Cash: When you can buy, fix and flip a house in under six months and turn a nice profit in the process, this is really quick cash. And when you can turn a profit of $30-40,000 in less than six months of work, that’s when you realize that house flipping is a pretty cool way to invest in real estate! Does that happen all the time? No…but the more you do it, the better and more consistently you can get returns like these.
High ROI: The house flipper can make higher return on investment (ROI) if he/she can manage to flip the house in as short of a time as possible. This is in contrast to buy-and-hold real estate investing where the investor has to wait for longer periods of time before the property appreciates to make a profit when selling.
Less Risky: Real estate markets, although they do fluctuate over time, in the short term they do not fluctuate nearly as quickly as the stock market. With some careful research, you can roughly predict the direction of a geographic real estate market within the relatively short period of time that you hold it prior to sale. For us, this is ideally no longer than six months from purchase to sale. Because you are holding the real estate for such a short period of time, drastic local market fluctuations are less likely to affect your profitability.
Distressed Properties: This could be a pro or a con, but since most house flippers do focus their attention on distressed properties, oftentimes the money needed to make the initial purchase is lower and needs less financing than a traditional bank loan property. However, because you’re buying either physically or financially distressed properties, you can get eaten up quickly if you don’t know what you’re doing. Such things as unanticipated fixes, unclean title, bank related issues, septic problems, zoning issues…the list goes on and on. Any of these unanticipated costs can shrink your profits significantly if you don’t at least anticipate them from the start.
No Tenants: Perhaps best of all, house flippers don’t have to deal with landlord and tenant headaches. This, as a landlord in my state, as with many other states, can get very sticky. Typically in the geographic areas where real estate is the cheapest, there’s a greater potential for damages, eviction and chasing tenants for rent collection. As has been well-documented in this blog, if not managed well, tenant management issues have the potential to eat up lots of your time, your money, and create a tremendous amount of stress.
House Flipping Cons:
To Get Good, It Takes Time: You don’t get really good at house flipping by just watching a few reality shows and then claiming that you’re an expert. It takes time, study and first hand, real world experience to get really good at it. The good news is that you can’t get good added with the right kind of education and coaching. Many house flippers seek out mentors as well. But like anything, to get super proficient at it you do need to put in your “10,000 hours”, which comes from experience and education.
Unanticipated Challenges: Even when you do get really good at it, you’ll still encounter situations you never have seen before. It still happens to me almost every week on the house flips we have in progress. It’s amazing, just when I thought I do it all, so new situation pops up that although it may be related to something that I’ve dealt with in the past, is completely new and how it manifests itself. As a house flipper, you have to anticipate these curveballs – even expect them. It’s all a part of the business.
High Costs: Flipping houses does come with transactional costs on both sides of the equation. When you buy and when you sell, there are costs. Also, if you flip houses with no money of your own, you have significant finance and interest costs associated with private money lenders and or even hard money lenders. If you are lucky enough to get traditional financing, then your costs can be high here as well. These transactional and holding costs can adversely affect profits. But if managed well, you can still make a healthy profit.
Taxes: When flipping houses, you also have different kinds of tax implications that differ from those in longer term investments. The short term capital gains tax is higher in the United States than long term investment capital gains tax. So to accurately predict your margins, you’ll need to factor these costs into your projections as well.
Buy and Hold Real Estate Investing Pros
Wealth Creation: There’s no question that great wealth has been amassed though 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 amassed their great fortunes through buy-and-hold real estate investing.
Steady Income: Owning multiple properties all producing solid and steady rental income is a very appealing way to build a reliable stream of income. Although you can get this very same kind of steady 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 once you have properly bought, fixed up and sold your house flips. However, to have a reliable, steady and dependable source of monthly cash flow is one of the more attractive features of buy-and-hold real estate investing.
Pride of Ownership: When I first started buying rental houses, I would just drive by them on occasion and smile. Pride of ownership was a big thing for me. Also, it felt pretty good to be helping people in need of a good home to find a nice, clean and attractive place to live. If you have good tenants who pay on time and a house that requires little, if any maintenance and you’re also realizing a tidy monthly profit with healthy cash reserves, then buy and hold real estate investing is pretty sweet indeed.
No Need to Immediately Sell: A big advantage to buy and hold real estate is that if the real estate investor does not need to sell immediately, that he doesn’t have to. Unless it’s a dire emergency, the buy-and-hold real estate investor can wait out market downturns until market conditions improve. If you’re earning a tidy monthly profit and don’t need of emergency funding, but want to sell the buy-and-hold real estate investor only concerns themselves about resale when the time comes.
Buy and Hold Real Estate Investing Cons
Market Fluctuations: Of course, if hard financial times hit the buy and hold real estate investor and they need a quick infusion of cash, they can only sell their property at prevailing market values. They can’t hope for the market to recover at that point in time, they are stuck with selling at a price that the market bears. As we’ve seen over the last few years, market values have fluctuated considerably, and buy-and-hold real estate investors who dated quick cash had to sell at prevailing market rates, sometimes selling for less than what they bought the property for.
Legal Tenant Issues: Buy and hold real estate investing comes with its own inherent management and legal issues with regard to tenants. Depending on where you buy, there are a number of management related issues you need to deal with on a regular basis. This blog here is filled with so many examples, as they are almost too numerous to mention, so I encourage you to read them.
Newbies Beware: I find that many new real estate investors, who think that renting houses is the way to go, get in over their head very quickly. No doubt long-term real estate investing is a good hedge against the stock market, but I see many new real estate investors who are completely ill-prepared to deal with the responsibilities that come with owning rental property and struggle with being a landlord.
Finding Good Tenants: Finding quality tenants, servicing those tenants, dealing with state sponsored housing departments, managing upkeep, assigning payment responsibilities all can be incredibly stressful and time consuming if they are not managed well. Good tenants are very hard to find and finding them requires time, energy, and loads of patience.
To Outsource, You Need Scale: One of the main issues with buy and hold real estate investing is that in order to be in a position to outsource these everyday tenant issues to a full time or part time property management service, it often times requires great economies of scale to cover such expenses. In my experience, having a management company to manage my rental properties only makes sense because I have a number of them. So in most cases for the first time real estate investor, that property management responsibility falls squarely on their shoulders.
Longer Time to Appreciation: Most long-term real estate investors rely upon market appreciation and not capital appreciation to help them turn a profit on the sell side. Can you do both, rehab and market appreciation with long-term real estate investing? Absolutely. But most real estate investors who buy properties in this way, don’t rely on capital appreciation (i.e., rehab work) to dramatically increase the value of the property. This means that the value of a rental property is largely dependent upon the market itself instead of the landlord themselves. Each situation is different, but this is usually the case.
Which One Is Right For You?
It depends on a number of factors. But the biggest factor of all is: you.
Some of the many factors include: your personality, your tolerance for risk, your financial goals and your personal financial situation.
For me, I’ve done both. But for my personality, my personal situation and for my financial situation, house flipping dominates my real estate investing career. But do I necessarily think it’s the superior way to invest in real estate?
What do you think?
If you’ve read this far, please tell me what you think by leaving a comment below! It’s easy, just enter your name, your e-mail (not captured by anyone and we don’t spam you, BTW), and your website (only if you have one, you really don’t have to fill that part in) and leave a comment below if you think house flipping or buy and hold real estate investing is better!
Photo: Jamie Buscemi