In a recent post I laid out 10 things to help folks stay focused and stop feeling overwhelmed as they begin their real estate investing careers. One item on that list was to select and focus on one of the three main real estate investing strategies, buying and holding, wholesaling or retail flipping. In this post, I want to expand on that a bit and describe some of the pros and cons of each strategy.
Selecting and focusing on one of the three is a wise course of action for anyone just starting out. Trying to “do it all” can spread one too thin and actually lead to failure. Further, each strategy offers different benefits and requires differing combinations of skills that will appeal differently to each investor. Hopefully this post will help someone to decide if a particular investing strategy is the right one for them.
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Buy & Hold
The buy and hold strategy is exactly what it sounds like. You buy a property (house, office building, land, whatever) and rent it. Usually these properties are held for at least several years, if not decades.
So what are the benefits to this strategy?
- Monthly Income: Hopefully the rent you charge will be more than your expenses and you will have positive cash flow every month.
- Steady Income: Sure, rentals go vacant every once in a while, but for the most part you can count on a steady monthly income.
- Income Tax Benefits: Depreciation can be a wonderful thing. So wonderful it can drop your adjusted gross income to zero.
- Wealth Accumulation: This is a great strategy to accumulate wealth over time as you pay down the loan and gain appreciation in value.
What about the negative side?
- Tenants: Do I really have to say more here? Dealing with tenants can be a real challenge.
- Management Costs: Don’t like tenants? Then there will be management costs and management headaches.
- Maintenance: You have to maintain these properties, and that costs money.
- Capital Needs: Most times you will need some sort of capital to get started. Banks or other lenders will rarely lend 100% on a property. Plus, some reserves are needed for those maintenance issues mentioned above.
This strategy involves finding a property and simply turning it over to another investor very quickly for a fee.
Here are the pros:
- Low Capital Requirements: You do not need much money with this strategy, as you are likely not going to close on the property. This fact makes it great for those starting out with little or no money.
- No Tenants: Need I say more?
- No Contractors: You are not going to be the one fixing it up, so you do not have to worry about finding, hiring and paying contractors.
And the cons:
- Finding the Properties: Not as easy as it is often made out to be.
- Marketing: You need to do a lot of continuous marketing to be truly successful here.
- False Leads: You will have to explore a lot of dead ends before you find one that works.
- Negotiation: You need to have or develop decent negotiation skills to deal with both sellers and buyers. This could actually be a pro for some.
- Buyers: You must have some credible buyers lined up before you get a property under contract, or you just might be stuck with it.
- Tax Consequences: That $5,000 fee you collected is considered active income, and you will pay self-employment and income taxes on it. I hope you did not spend it all come April 15th.
Finally, there is the retail flip, where an investor purchases a property, fixes it up and sells it to a retail buyer for (hopefully) a nice profit.
- Chunks of Cash: This strategy’s greatest benefit is the large chunks of cash you can make. It is not uncommon to walk away with $20,000 or more at the end of the day.
- No Tenants.
- Pride: It’s fun to transform an ugly house and make such a large project come together.
- Large Capital Requirements: You will need money to buy, fix and hold for a while. This could be quite a bit of money depending on the scope of the project
- Retail Buyers: Retail buyers can be very picky and selective, and it takes the right type of personality to deal with them.
- The Wait: You may be waiting a while for the right buyer to come along and thus for your payday.
- Contractors: You will have to hire, manage, fire and pay the contractors. Are you up to this task?
- Project Management: A property rehab has a lot of moving parts that you are going to have to coordinate and keep moving. Are you up to this task?
- Tax Consequences: Your income will again be considered active, and thus the IRS will want its share.
- Competition: The competition for these properties can be fierce depending on the market.
So there you have a quick list of some of the pros and cons of the three major investing strategies. Over time as you learn more about the real estate business and gain some experience, you should be doing a bit of each. But usually our personalities and circumstances direct us to focus on one or the other.
Which one is or was right for you? Why?
Please share with your comments.