Fixing and flipping houses looks cool on “reality” TV, but in actuality, many are finding that it isn’t nearly as profitable as what it is perceived to be.
House flipping TV shows have caused an epidemic. There are thousands of aspiring new investors out there, including my Uber driver, who are rushing to try their hand at it, after equipping themselves with a few episodes of a television series. Both the data and my personal experience seem to show that it isn’t nearly as profitable as many believe. In fact, it can be a highly risky venture.
How to Estimate Rehab Costs!
Estimating rehab costs accurately can make or break your real estate business, and it takes years of experience for even the best rehabbers to master the art. However, you can expose yourself to less risk and get more accurate with your projections by learning how the pros think when estimating construction costs.
Investors Are Losing Money on House Flips
One of the first things experienced investors will notice about these TV shows is that the rough numbers shown at the end don’t always appear to factor in a lot of the costs. That means even in these silver screen scenarios, the actors are typically pocketing a lot less than they are made out to be.
New data from ATTOM, the leading provider of real estate and property data, shows that many are losing money, too. The latest Home Flipping Report reveals that average house flip profits are declining. The number of flippers using cash has also dropped to an eight-year low. RealtyTrac says that 21% of transactions show a gross profit of less than 10%. That means once all numbers are added up, these deals likely lost money. That’s in addition to 8% of flips that sold for less than the property was purchased for.
None of these numbers track the much larger pool of new investors who have bought properties, have gotten stuck on rehabs, or have over-improved—and are still sitting on these liabilities costing them money every month.
The Tax Issue
I have flipped properties in the past. Honestly, I enjoyed it. However, investors need to differentiate between getting into an expensive hobby and investing for a positive return.
One big flaw in the house flipping model is taxes. Uncle Sam takes a huge chunk of the profits in tax on flipped properties. It’s extreme. Most overlook the fact that they are going to have to give up 20% to 40% of their profits in taxes. If flippers have already spent the money by the time they get their tax bill, a vicious cash crunch cycle can kick in. Most won’t enjoy being chased down by the IRS for $50,000 or $500,00 in past taxes.
This is all in addition to the speculation involved in flipping houses. Even if you really know your property values and market, there are a lot of factors outside of your control. That includes neighboring foreclosures, natural disasters, interest rates, and the media. All of these can impact your ability to resell for more within a given window of time. Millions lost out on this strategy in 2008.
Why I Like Buy & Hold
I like the buy and hold model. It means that when I renovate a property, I know I will get a tenant in it who is paying rent and providing me with income. That property can keep on generating cash profit regardless of property values and the market.
The income on long-term rental properties is taxed at a lower rate than you get with flipping, too. By using 1031 exchanges or self-directed IRAs, you can defer taxes or make returns tax-free.
For me, buy and hold also checks two of the most important boxes that people invest in real estate for in the first place. Those are time and location freedom, which come from the passive income provided by good property management. You just don’t get that if you are rehabbing houses and are trying to flip them yourself.
We’re republishing this article to help out our newer readers.
What’s your strategy of choice—buy and hold, fix and flip, or something else?
Feel free to defend flipping in the comments!