Everyone wants to be a landlord.
OK, blanket statements like that don’t hold any water, but the majority of people who participate in this site are interested in buy and hold properties. That’s awesome — that’s what I want to do, too.
If you live in a hot market where housing prices have far exceeded rent, it can be a losing proposition to be a landlord. Cash flow means you make money every month after you account for expenses. If your rent doesn’t even cover the mortgage payment, you just bought yourself a job.
This is the case in my local market. You know that 1% rule? The one that says you should be charging 1% of the purchase price of the home for rent every month? I’m seeing .66% on the HIGH end.
Have you ever thought about flipping?
Landlords would rather buy homes that are already in great condition. Properties don’t start making money until they are rented out, and good luck finding a tenant who will pay for the privilege of living through construction.
Homeowners want that already-finished house, too. Living through a rehab is dirty and quickly saps your spirit.
When buy and hold numbers don’t make sense, analyze your market to see if flipping is a better option.
Know Your Market
Your local market is different than any other market. Location, location, location — remember? People want to live next to the ocean and will pay a premium to do so. They are less apt to pay high prices to live in the middle of the country — at least the parts with nothing cool nearby.
If you find yourself living in those higher-dollar areas, rental numbers just don’t seem to make any sense at all. You’re not supposed to count on appreciation, but sometimes that’s your only hope.
My own local market in the Denver area is insane. On my street in the last three months, two properties have come on the market. Let’s ignore that they went for over list price and sold in days to cash buyers who were going to rent them out and didn’t need to perform an inspection. The duplex sold for $330,000. Rent totals are $2,050.
The other house is a single family. It sold for $265,000 and rent is $1,200. A 30-year mortgage at 4% with 20% down shows payments of $993, not including taxes. Our taxes are really low, but this thing is losing money every month when you factor in CapEx and property management.
Keep an Open Mind, But Follow the Rules
Buy and hold seems to be the top real estate suggestion for building passive income streams. But buy and hold isn’t 100 percent passive, even if you hire a management company to do it for you.
Flipping isn’t passive, either. I’m not suggesting that it is. But hiring the right person to run your job — or running it yourself and hiring true professionals who know what they are doing — can be a great, mostly passive source of income.
There are all different levels of flipping, from basic paint and cleaning to full gut rehab down to the studs.
There are three keys to flipping that will determine your success or failure.
- Buy right. If you pay too much for the property when you purchase it, you find yourself behind the 8-ball from day one. Run your numbers based on what comparable properties already fixed up have sold for recently. Make sure you are using comparable properties. Location, remember?
- Make (and stick to) an accurate budget. After you have the property, you need to rehab it before you can put it back on the market for big bucks. The easiest way to erase all profits — and even find yourself in the red — is to go over budget. If you budgeted $3/sq ft for flooring, choosing a flooring material that costs $5/sq ft is going to throw that line item out of whack. Your budget should be able to withstand tiny overages here and there and still bring you a profit. But if you go over budget on every single line, your profit just flew out the window. Remember, you don’t have to love the finishes — you’re not going to be living there. The finishes just have to be stylish and installed correctly.
- Hire quality contractors. This most important factor of your success is also one of the most difficult to accomplish. Many a post has been written on the best way to find a contractor. One of J. Scott’s top tips is to talk to the guys who are at Home Depot at 6:00 and 7:00 a.m. Those are the guys who are up early, preparing for the day’s work. He also recommends not talking to the guys who are there at 10:00 and 11:00 a.m. Those are the guys who are either just crawling out of bed or who forgot some key component for that day’s job.
Houses in hot markets need bigger work to make a profit. Ugly but livable homes don’t look nearly so bad to people who can’t find anywhere else to live. In hot markets, the value you add needs to be significant.
In my hometown, there’s a guy who is an agent and flipper. In the past couple of years, our market has really taken off, and small-scale flips aren’t worth the effort because the homes in their “ugly” state are selling for top dollar.
Enter our local hero, who purchases these top-dollar ugly homes and then adds value. A LOT of value. He routinely puts $75,000-$100,000 into each home, but then turns around and lists the property for at least $200,000 more than he paid just a short time before.
Of course, the houses look completely different. High quality finishes in the latest styles force his homes into bidding wars. He knows the comps intimately — mostly because he created them!
Not every property makes a good candidate for flipping, but if your market prices have outpaced the rents, perhaps it’s time to shift strategies and look for new sources of income.
Have you successfully jumped form one niche to another?
Share your experiences below!
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.