When you first start your real estate investment journey, you will have to make a decision on which strategy you will start with. The strategy that you choose will depend primarily on the financial goals that you want to accomplish. As you begin to progress in your real estate journey, you will create a specific criteria that you will use to determine if you will wholesale, fix and flip or buy and hold the property that comes across your desk. There are pros and cons to each strategy and each strategy offers different financial benefits. I will burst your bubble a little early here, honestly there is no better strategy it is going to completely depend on which strategy fits your goals better. Let's discuss.
Income vs Wealth
The main financial difference between flipping houses and rental properties is when you flip houses you are generating income (capital gains) and when you buy rental properties for cash flow, you are generating wealth and getting paid a return monthly. Flipping houses will give you the ability to drastically increase the income you generate on a yearly basis. Buying properties to hold as rentals will allow you to begin creating passive income and recurring revenue on a monthly basis. As you begin to move along your real estate investing journey, a typical road map is for investors to use the income they produce from flipping homes to purchase rental properties to begin generating wealth. As an investor, you will have decide if you want to take large chunks of income as flips close or take smaller cash flow payments on a monthly basis. As stated previously, once you master one or the other, you can begin the steps to take to get involved in the other strategy.
Time
Both of these strategies will require a time commitment on your end. The amount of time you spend on these strategies will depend on the tasks you decide to delegate throughout the process and the systems you are able to put in place to streamline the strategy. Flipping houses can become a major time commitment, if you decide that you, personally are going to be the one doing the work, gathering the material, putting together budgets, establishing financing, putting together scopes, managing subs, coordinating subs, meeting with agents and all the other tasks associated with flipping houses then you will find our fairly early that flipping houses can be a major time suck. However, if you treat flipping houses like a business, you can scale the operation, delegate several tasks, create systems and limit your time actually flipping the house but spend your time finding deals and arranging financing.
With that being said, it is very difficult to become completely passive in a house flipping business. Some have done it but it is difficult to achieve. Buying rental properties on the other hand is much easier to scale and management of these units can be delegated to a third party to limit your time in the business. If you have a great property management company, you will have limited time spend on these properties. For the sake of this blog post, we are speaking of residential rental properties (1-4 units) {Buying apartment buildings is actually the lowest time commitment after the property is purchased because scale is easier to achieve with more units). When you begin to buy more and more residential rental properties, scale is much more difficult to achieve. It puts far more stress on the property management company (or yourself) when it comes to efficiently managing these units.
Financing
For the sake of this post, we are going to talk about leverage and obtaining debt to use on both of these strategies. If you plan to use your own cash, god bless you but it is impossible to scale unless you have that type of bank roll and even then it is not a smart decision. Here are the possible financing options for the fix and flipper:
Private Money
Hard Money
Home Equity Loans
401K
No matter the medium you choose, having the ability to raise private capital will allow you to scale your operation. Private capital is the best financing available to the real estate investor and networking to grow your private capital community is very important.
Here are the financing options for the buy and hold investor:
Traditional Bank Financing (25% Down)
Private Money (Difficult to obtain longer terms with private lenders) - Refinance After Seasoning Period
Hard Money/Bridge Loans - Refinance After Seasoning Period
Home Equity Loans
401K
Even though, traditional financing is not available to Fix and Flippers. I would have to say it is easier to obtain financing for fix and flip deals because you are more likely to find Private Money/Hard Money that will lend on a short term basis then on a longer term basis. Once you begin to build a relationship with these lenders then they will allow you to use there debt as a bridge and possibly hold your notes for longer terms. Many may disagree with this because traditional banks like long term debt because they will be receiving interest for years. My argument is if you have the right network of private money lenders and you are buying right, you will limit your out of pocket expenses because you will have no down payment. (even though interest rates will be higher than a traditional bank)
Advantages of Rental Properties
Rental properties have the ability to make you money for years and years. If you buy the analyse the property, buy it right and manage it effectively, rental properties can be very lucrative. If your plan is to scale a buy and hold business, you will have the ability to create a scenario where you can live off the cash flow and create a situation of financial freedom. Owning rental properties is a longer term play and a wealth building strategy that several of the wealthiest people in the world utilize.
1) Cash Flow
Every rental property that you purchase, you will essentially be purchasing for the cash flow it produces. Cash flow is the profit you make monthly after all of your operating expenses and debt is paid for.
2) Tax Advantages
Owning rental property offers some serious tax advantages that are extremely beneficial to the real estate investor and benefits that are not applicable to the house flipper. For details on the new tax law and how the benefits it offers, check out this blog post.
3) Leverage
As we previously discussed, leverage through traditional banks is easier to obtain when purchasing a rental property. Regardless of the financing you use, you will be able to leverage other peoples money to increase your returns.
4) Appreciation
To start never buy a property based on potential appreciation. However, one of the benefits of holding a property for a long time is you have the possibility of reaping the benefits of appreciation. Over time the value of a rental property will most likely increase, if you keep up with the deferred maintenance on the property.
5) Discounted Purchase
This goes for both fix and flips and buy and holds and is not necessarily a benefit unless you execute. If you are able to buy rental properties at an extreme discount you have the ability to make these properties much more lucrative and magnify the returns that they produce. Sourcing off market deals is a business of it's own and if you can execute that business, you will further you investment efforts.
Advantages of Flipping Houses
Flipping houses is fun and it has the ability to produce a lot of income. You can make a lot of money flipping houses but you are essentially creating a high paying job for yourself. You have to constantly find new deals in order to get paid and since inventory is so low, finding a good deal to flip is difficult. House flipping will provide you with the income needed to cover your expenses and live the lifestyle you want to as well as give you the income to purchase your next rental property. Rental properties and flipping houses goes together like spaghetti and meatball : )
Income
Flipping houses has the ability to generate large chunks of income. Once you the sell the property that specific property will no longer produce anymore income for you but you will make a large chunk of cash from the sale. The income produced on a flip will take you years to produce on a rental property but as you can see the advantages are different.
Financing
As we previously stated it is easier to get commitment from lenders when you are only looking for short term bridge debt. These lenders prefer shorter terms and you will have more options available to you.
Market Forecast
Since you are only holding these properties for the short term there is less of a likelihood that a correction will take place during your holding period. You are far less exposed to a changing marketing or a change in the neighborhood.
Experience
When you flip a property you are essentially working through all of the facets of a real estate deal besides the actual holding and management of a tenant. It is very important to get experience in the construction industry, understand the lingo and begin building relationships with contracts and vendors. When you flip a house, the majority of the time, renovation work will be involved which will allow you to work through the construction process. Also, you will have to work through purchasing, negotiation and sourcing deals if you want to be successful in this space.
Which is Better?
This is a very difficult question to answer without knowing the specific investor's situation and goals. Both of these strategies offer there own benefits and work together very well. In your market, you will begin to garner an understanding of which properties are best to flip and which properties are best to hold based on location, market conditions, age, price and condition. For our specific situation, we prefer the longer term buy and holds, strictly due to the cash flow and tax advantages. The cash flow and tax advantages help off set our tax liability for wholesaling and flipping.
As you get further along in your journey, you will realize the benefits of owning rental property outweigh the benefits of flipping homes, especially as an investment and financial security for your family. There are certain ways to buy rental properties that do not require much cash outlay and will allow you to refinance out to get your cash back from the deal. Flipping houses is fun and can generate a lot of income, but as the deals slow and margins get tighter, your income will slow and problems will increase.
We suggest that you take a look at your current financial situation and determine which strategy is best for you. If you already make a large income then we would definitely direct you to buying rental properties for cash flow and long term wealth. If you do not have any income, we would direct you to begin flipping or wholesaling houses to generate income and gain the experience needed to become a real estate investor.
Wrapping It Up
In conclusion, both of these strategies can be very lucrative if executed properly and the both offer different advantages that will appeal to different folks based on there available time and current financial situation. There is no best way to get started in real estate. The more you can educate yourself on real estate investing in general the better of you will be. Continue to network with like minded individuals and with people who have already accomplished what you are trying to do. Focus on buying deeply discounted properties and creating a win win situation for yourself, no matter the strategy you try to use. Just get started, take the risk, gain the experience and get better on each deal that you do.