I would like to know people's opinion on an idea I have below. I have some (but not a ton) of experience renting and selling properties and would like to know if something is flawed in my logic. Of course I would do all my due diligence on any decisions made and would like to know if there's anything materially wrong with what I'm suggesting below.
I am interested in buying a property that needs to be fixed up but is in good enough condition to rent. I would buy a house that suggests I will buy at a favorable price to rent ratio AND a favorable resale value if flipped.
My intention is to buy the house all cash and rent the house for one year. During this year of course I would being collecting cash flow. Then after a year I would fix the house up and resell it at a profit. The point of waiting a year is to avoid short term capital gains tax thus paying long term capital gains tax.
Another advantage of selling after a year is to avoid getting "stuck" with a house because housing prices go down. In the course of one year a house typically won't increase or decrease materially.
The plan would be to do this over and over again if successful. This would also be side income for me as this would not be my day job. Besides all the typical rental and flip risks that I'm well aware of are there any major downsides I'm not thinking of?
@Chris Lidfeldt , this is generally what I do. I keep a stable of about 15 rentals. Usually, when I buy a house, I'll do a light reno, if needed, add it to the stable, and then sell it after 1-3 years. Before selling, I'll do more, such as granite countertops and updated fixtures.
When I started out, I would sell two houses for every one I kept. I was short on funds, and the two I sold would fund the one I kept. But I was in a pretty low tax bracket, so short-term flips didn't cost much more in taxes than long term holds. Fast forward 3-4 years, and my businesses have really taken off. I'm now in the 40% tax bracket. So if I have a 40,000 profit on a house, the difference between LT and ST capital gains (40% vs. 20%) is $8000 - fairly significant. Plus, in my market, values have usually increased a few percent over the 1-2 year hold period. (That won't last forever, of course.)
You do have to take care that you don't overspend by doing a two-phase renovation. I try not to over-renovate in the first phase and try to make sure the things I do won't need to be redone in phase 2.
This strategy really isn't necessary when you're in lower tax brackets, but as you get into the higher brackets, it makes a big difference.
@Chris Lidfeldt You should consult a CPA or tax attorney. I think if you buy a property with the intent of selling it, it is not a Capital Gain, rather it is considered Ordinary Income.
Thanks for the quick reply Michael! I'm in a similar position; high tax bracket and would love to save money in taxes while also generating cash flow through renting for a year.
I would hesitate to do any rehab (unless absolutely necessary) before renting because you know how renters can treat a property sometimes!
With that said, what are the biggest factors you look for when making a purchase? Do you can more about price to rent ratio or ARV for flipping? I would think ARV is more important because the total profit in flipping is going to be more than 1 year of cash flow from renting.
I too employ a similar strategy and it's worked great... I especially utilize this strategy in gentrifying areas where prices are going up. I have also found that the investors who stand the test of time do so because of their residual income... so it's always wise to have some rentals cranking in that cashflow!
Originally posted by @Chris Lidfeldt :With that said, what are the biggest factors you look for when making a purchase? Do you can more about price to rent ratio or ARV for flipping? I would think ARV is more important because the total profit in flipping is going to be more than 1 year of cash flow from renting.
Chris, I do some of both. I look for good opportunities either way. With a tight market and loads of new investors bidding up properties, it's hard to find deals in DFW that generate huge rental income. But there's one particular area of the Metroplex where I can still occasionally buy a property for $40-50K, put $10K in it, and rent it for $950-1100. When I see those opportunities, I buy they, even though the area I'm thinking of doesn't have much appreciation.
Mostly, though, I look for good ARV and a property where I think I'll make money on the exit. As you point out, that's typically far more than the gain from 1-2 years of rent.