Flipping Houses vs. 1st Position NPN?

Question

I know it's difficult to estimate in a spreadsheet due to so many variables but for people have flipped houses AND who invest in 1st position NPN, which results in the best overall after-tax ROI?

I know the first response is, "Well, there are so many note exit strategies that it depends" but I'm looking more for the average.  If you flip or have flipped houses you have an average ROI you've received over a large sample size.  Same with notes.  Some will reperform.  Some fill foreclose.  But, on average, what are you seeing as your annualized returns on each?

The reason I'm asking is that I've done some flips and I've JV'd on some NPNs and I'm trying to figure out which strategy is going to provide the best ROI.  Obviously, I would do my own NPNs rather than JV'ing in the future but I know that my sample size on flips and notes is far too small to draw any hard conclusions.

Personally, I like flips because you turn the money over so quickly.  I like notes because they just fit my personality more (i.e. I'm not a construction guy.  Day job involves a lot of sitting in the office and pushing papers).  Hoping to get a real world ROI data point to help push me in one direction or the other.

Mike Hartzog · Answer

Flips by definition are a short term strategy.  Most NPN deals are essentially flips in that the exit is achieved within the first year or two, so IMO one does not have tax advantages over the other since the intrinsic tax advantages of holding RE over the long term don't come into play.  Given this, tax advantages for either can be found by using self directed retirement accounts.  The cleanest approach is to invest in the projects of others, i.e., hard money lending or private placement in the case of an equity deal for RE projects  The typical NPN JV fits into this model as well.   One can use checkbook SD retirement accounts to take on entire projects as well, but in my experience this gets messy for notes and is a non-starter for flips unless you are doing the whole thing with cash.  (Financing and SD retirement accounts don't mix well.)

Chad U. · Answer

Yes I was referring to before tax in both cases.  But as far as I'm aware, you generally can't receive long term capital gain tax treatment on Notes since this is considered an active business.  However, if you JV'd with someone as a truly silent non-active or passive investor, and you hold for more than one year, you may be able to take advantage of long term capital gains on the delta between purchase and sale but not any payments received in between.

I am by not by any means an accountant, so best to check with yours to get a proper opinion. Or check with someone like @Brandon Hall

Carlos Simmons · Answer

Mike, it is my understanding that as long as I am not in the business of buying/selling notes (merely an investor) that a note held over a year would be taxed as a long-term capital gain.  I have a full-time job and don't live off my investments in any way (currently).

Given that most flips don't take a year to complete and many notes can take up to a year to remedy and sell that there might be a tax difference.  So, let's say that you're turning your money over twice a year flipping and paying ordinary income tax on the proceeds vs buying a NPN and it takes 366 days between purchase and sale. I'm curious in regards to how this actually plays out for most investors in terms of after-tax ROI.

That was one of the reasons for asking this question to people who have done it.  On paper you can make any scenario look good.  You can probably make it look like you can turn your money over flipping 4 - 6 times per year but that seems entirely unrealistic in practice.

Carlos Simmons · Answer

This was exactly the kind of response I was hoping for.  Thanks for sharing.

So, let's say you turn your money over 2x per year and average 15% per flip.  That's 30% annualized.  And you pay regular income tax on that.

With a note, you're saying your averaging a 40% annualized return?  Is that before or after tax?  If before, notes seem to be the clear winner on ROI alone.  When you factor in paying long-term capital gains vs paying higher short-term gains on flips, the differential only widens.

These numbers in line for others?

Chad U. · Answer

@Carlos Simmons

In my opinion, one can achieve a far better ROI and annualized return on NPN's than can get flipping.  I've slowly transitioned from flipping to NPN's for this very reason.  On flipping, I would make bids on properties to achieve a 15% ROI or 30% annualized return assuming a 6 month turnaround time.  Does 15% and 6 months always pan out, not usually and there is almost a downside due to unexpected surprises encountered on flips.  Other downsides are there is basically one exit strategy with flips, and the capital outlay is much higher and therefore prohibitive.  So my average annualized returns on flips have resulted much less than 30%.

With NPN's there are multiple exit strategies and the capital requirements are lower, so one can therefore purchase several with the same amount of capital which mitigates your risk.  On the past 8 NPN deals I've been involved, the average annualized returns are 40%+ (actuals and projected), with ROI's ranging from 14% to 70%, purchase to disposition  ranging from 6 to 21 months and average hold time 13 months.

Flipping Houses vs. 1st Position NPN?

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