Is it Smarter to Flip Homes or Become an Investor?
There are two strategies for those who want to build wealth in the real estate field: Flipping and investing. For our purposes flipping a property involves purchasing it at fair market value or below, usually adding some renovation, and then quickly selling it for a profit. Investing means purchasing a property, perhaps renovating it, as well. However, the investor holds the property for an extended period and collects the rent. Here, wealth is built over time as rental income comes in and, based on history, the value of the property will likely increase over time. Here are some of the pros and cons of each:
Flipping Pros:
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Faster return on money: This advantage is realizing quicker gains on your money which frees up capital for other investments.
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Potentially safer investment: Unlike the stock market which can take wild swings in a week or even a day, the real estate market prices move more slowly. This offers predictability. Therefore, capital is at risk for a limited amount of time.
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It also lacks the management and leasing risks that investing requires. The time and expense of finding tenants, collecting rents, and maintaining the property are not issues either.
Flipping Cons:
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Costs: Flipping houses adds certain costs that being an investor doesn’t. Transaction costs are high on both the buy and sell sides. The flipper must pay both in short order which can seriously hinder the profit margin. If you have a regular job that you rely on to pay bills, flipping is very time intensive. There is significant research necessary, visiting multiple properties before making a final choice, and the renovations that are also necessary to raise the value of the property.
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Taxes: The taxes involved are higher than for the investor. Swings in income for the year can seriously raise you tax bill. This is especially true when you buy and sell in less than a year, when you cannot take advantage of the long-term capital gains regulations.
Investing Pros:
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Ongoing income: Owning an investment property provides regular income. Besides buying and holding real estate is a widely accepted method for amassing wealth.
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Increase in property values: While there are ups and downs in all investments, real estate investing (using history as a guide) has always been a profitable tool over the long term.
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Taxes: Rental property is taxed as investment income (long term capital gains) which has a lower tax rate. The investor can also write off expenses including repairs, maintenance, paying a property manager, Et al. You can also write off expenses, including repairs, maintenance, or upkeep, paying a property manager, and driving to or from your property.
Investment Cons:
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Vacancy Costs : Being unable to find tenants is one of the risks of owning rental property. That is true whether you do it yourself or hire a management company to do it for you. If your property sits empty for months, you are, of course, still responsible for covering the mortgage during that period. Before investing in a buy-and-hold property, you'll want to make sure your budget will cover three months of vacancies per year.
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Management and Legal Issues: Long-term real estate ownership is a management-intensive endeavor that is outside the skill set of many folks. Some investors, especially first-time rental property owners, are ill-prepared or ill-equipped to deal with the responsibilities and legal issues that come with being a landlord. The process of finding quality tenants and meeting their needs can be a stressful and time-intensive undertaking. However, careful property management is necessary to ensure ongoing cash flows from the investment.
Bottom Line:
Flipping is a dangerous game. It involves intensive research, multiple visits to various properties being considered, and the capital for renovations to raise the value of the property. The long-term investment strategy, on the other hand, is a time-tested method of accumulating wealth. History proves this. Further, investors can use the equity built into their initial investment to finance future investments. Eventually, the investor hopes to cash-out in an up-market, realizing a healthy profit.
Finally, be leery of those shows on HGTV, other TV stations, and infomercials that make flipping look easy and very profitable. It’s much tougher and riskier than it looks.