Is It Better To Buy-and-Hold or Fix-and-Flip ?
Andrew J. Matella.
Everyone has heard that real estate is among the most common ways millionaires are made. It's difficult to go on any social media network these days without the gurus pushing numbers and stats on all the millionaires real estate has made. But the million dollar questions is: which real estate strategy is the BEST way to become a millionaire?
I get asked a lot whether it's a better strategy to buy-and-hold properties or fix-and-flip. Like almost everything the short answer is: IT DEPENDS. Each strategy has its own advantages and disadvantages. Knowing which strategy suits your needs depends on your current or projected financial stability, risk tolerance, and long-term goals.
Everyone’s preference is going to vary wildly depending on their experience, time available to dedicate, knowledge and/or capital base, long-term and short-term goals, business model, etc. But I will outline some of the advantages and disadvantages of both strategies below.
The Buy-and-Hold strategy
1. Long-Term Wealth Through Appreciation Upswings
Generally, housing prices increase year over year. When you buy a house and hold onto it, as time passes you are becoming wealthier from the property's appreciation in value. This means your net worth is also increasing over time and if you buy property at significant discount, you'll be getting hefty returns when it comes time to sell.
Let's give an example. Suppose you buy a house for $60,000 and after all repairs and expenses you have $100,000 into the property. It's value today is $120,000. But after commissions, holding costs, interest and/or profit sharing, your resale profits are going to be marginal when you flip. Oh, and I forgot to mention that this is all before taxes.
When you hold a property however, that resale value is going to be higher (in theory) than what it is today. How much that value increase/return will be depends on how bullish your market area is, what kind of improvements you do to the property, and how good of a deal you buy it for. Some of the houses i've held increased over 250% in value over a three year period with little if any improvements. Some only increased 10-20%. That is keeping in mind they were purchased when housing prices were still recovering from recession, but you can still find good deals in today's market if you're patient enough and have a solid set of criteria to find deals.
Holding onto property long term does not come without its risks. For one, there's no way to tell if the state of the housing market is going to be good when it comes time for you to sell. Are you strong enough financially to ride the storm if the market does by chance become bearish? Can you dig into your own pocket to cover your mortgage and holding expenses when market rents decrease and monthly cash flow spreads get tighter? Can you afford to pay out of pocket during vacancies? What financing terms are you loaning at? If your loaning on an adjustable rate mortgage can you afford to continue paying at higher rates of interest if rates jump and you can't refinance your property during a market decline? These are all considerations to be had when holding and financing properties long-term.
2. Tax Advantages
With long-term properties, your income is not in one lump-sum but rather in smaller consistent installments. You can also deduct operating and financing expenses such as mortgage expenses, maintenance and management fees, property taxes, insurance, etc from your monthly operating income. Also, if you've held the property for a long enough period of time, you are taxed at capital gains tax rate, which is a big saving for most investors.
3. Cheaper & Easier to Finance
It is much easier to get a 30 year, fixed rate loan for a rental property than it is for a flip. Forget any kind of prime rate bank financing on a flip property unless you're taking out a HELOC (Home Equity Line of Credit) loan or using cash leveraged from another rental property. This makes buy-and-hold investing a good starting point for beginner investors who don't want to stay out till midnight putting out "We Buy Houses" signs and the general grind in scoping out leads and pursuing wholesaling to build start-up capital.
The Fix and flip strategy
1. More Capital Build-Up & Higher Short-Term Income
Do you need working capital liquid and available today? Then the short term fixing-and-flipping strategy is probably for you. By design when fixing-and-flipping a house, you're only in it for (hopefully) less than 3-5 months. There are a lot of risks involved with fixing-and-flipping houses, and if you're not careful, flopping on your first flip can put you into a bad position really fast. Download a free copy of my guide to the "Top 10 Rehab Traps That Nail House Flippers Plus, How to Crush Them!" to find out just what I am talking about, and what you need to avoid.
Although there are unexpected surprises and hurdles that come with flipping houses, the short-term business model does have the advantage of more liquid working capital freed up because you are turning over properties quickly rather than tying up capital in long-term rentals. Most rental properties are not going to generate enough cash-flow for you to live off of the income. And aside from that, I DO NOT ever advise to depend on rental income to live off or spend. Even though you can refinance rental properties to pull your "cash-out", that does not mean that you'll have no money at all out of pocket when holding rental properties. You generally will need 6 months of rent safety reserve. And as good safety precaution I would recommend keeping at least an additional $10,000-$15,000 in reserve for each property to account for unexpected repairs down the line. When it comes time to replace a roof or an A/C goes bad, there goes your yearly cash flow. Having healthy amount of reserves is a necessary evil, but that means more money tied up long term. When in theory flipping a house you free up your money faster and move on to the next property.
2. Higher carrying costs, but less headaches
- No late-night maintenance phone calls. No long commutes. No dealing with tenants. After you've sold your flip property, you move on to the next one. If your flip is an hour away from where you live, you don't have to worry about midnight maintenance calls and the long commutes you're going to have to make (or PAY someone to make, which isn't cheap by the way) to fix those issues. You don't have to deal with the little things, which over time can compound if you have multiple rental properties and if you don't have the patience needed to deal with multiple tenants.
- Flipping houses requires more working capital. In general, you're going to have to put out more cash on the front end to acquire, improve, and hold flip properties. If you're buying flip properties from foreclosure auctions, you need to have the amount of the purchase price in cash available that same day. There are financing options you can take to build the capital to fix-and-flip a house using Other People's Money. If you have the cash, or have a family member or private money lender to partner up with that does, then great. If not, you're probably going to need to go through a hard money lender. Hard money lenders are great in that they are flexible and provide quick funding. The downside is that they are expensive because of the inherent risk of the loan. Expect to pay and account for at least 8-10% interest.
3. Less market risk exposure because of a shorter holding time period.
The likelihood that the housing market will dip to a 40% correction overnight within a 3-5 month timeframe? Doubtful. Over a 1-15+ year timeframe? More likely. Now a bullish market doesn't necessarily mean you'll lose your shirt on a long-term rental property. As long as your loan terms are good and you have the extra cash to ride out the storm and continue making payments when spreads thin out, or when a tenant isn't paying rent, or through vacancies, then you're going to be fine. But if the need arises to free up capital and sell your property, you're going to be in a bind. This is where flipping properties has an advantage. When you flip a property and hold it for less than 6 months, your chances of losing your shirt due to a market downturn are lower. If by chance the market does decline, you have the advantage of freed-up cash to buy even more properties at a steep discount and wait for prices to climb up again.
Putting It All Together
In sum, there is no one-size-fits-all investment strategy. Each strategy has its own advantages and disadvantages. Choosing the right strategy for you all depends on your goals, the types of risk exposure you're comfortable with having, and your financial strength/knowledge base. Whichever strategy you choose, be sure you fully arm yourself with the resources and knowledge necessary before pulling the trigger. Working with an experienced mentor can help you avoid big money mistakes and help streamline the process. Take your time and learn as much as you can before making the jump. There will always be houses in any kind of market. But knowing which houses, and which strategy, is the the right one for you will take time and a thorough well thought out plan tailored to your needs and short/long-term goals.