Is it Better to Fix and Flip Houses or Buy and Hold Rentals?

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I buy from 10 to 15 fix and flips a year and I also own 8 long-term rental properties.  I buy many properties a year, but how do I determine whether I will hold a rental or fix and flip it?  There are many factors I take into account, but beleive it or not, I have much more strict criteria for my rentals than I do my flips.

I first wrote this article just after purchasing my 7th long-term rental property; the details can be found right here.  I purchased this home in April of 2013 and I paid $113,000 and I estimated the ARV (after repaired value) to be at least $155,000 and probably closer to $160,000 to $165,000 (8 months later is worth $175,000).

There is plenty of room to fix and flip this property and take home a healthy profit, but I am choosing to keep it as a long-term rental.  I do many fix and flips with my father and they are a large part of my income, but income alone will not make me wealthy.  Long-term rental properties are what I am counting on to make me wealthy, because they provide passive income.  To see my rental property strategy, check out my complete guide to investing in long-term rentals.  Below I will discuss whether it is better to fix and flip houses or buy and hold rental properties.

Fix and Flip basics

Fixing and flipping can be a great source of income for Real Estate investors.  I use fix and flips to help fund the purchase of my long-term rentals.  I don’t go into much detail on the fix and flip side in my blog, but I do have one article that breaks down the numbers on a flip I am currently working on here.  Basically a fix and flip is a home that an investor buys, fixes up and sells as quickly as possible for a profit.  Fix and flips are not easy to come by and are not easy money by any means.  

The biggest challenge when flipping is finding a property cheap enough to make money.  Our market is improving every day and owner occupied buyers are having trouble finding great deals; it is even tougher for investors.  You have to remember it is not just repair costs you have to figure when buying a flip, but carrying costs, selling costs and opportunity costs.

The cost of a fix and flip compared to a rental property

If you don’t have cash to purchase a fix and flip, short-term financing can be expensive.  Average hard money lenders may charge 15% interest plus 4% upfront points on the purchase price.  It is much easier and cheaper to get long-term financing on a rental property than a fix and flip.   The banks like long-term loans, because they will be receiving interest for years.  With fix and flips the banks will not be getting paid interest for nearly as long as a long-term rental, so they charge more interest and fees.

Fix and flips have to have top-notch repairs in order to get top dollar.  Renters can be much less picky about homes, because they aren’t tied down to the house.  Renters aren’t worried about furnaces, roofs, plumbing and the bones of the house, because if anything breaks they aren’t responsible.  On a flip the buyers are paying a lot of money for a house they will own for years.  They will get an inspection and make sure everything works properly and was repaired right.  By no means I am suggesting a landlord should skimp on repairs, but there are certain things that may not need to be repaired right away on a rental, that will need to be repaired on a flip.

Holding costs are more on a flip, because it usually takes longer to sell a home that it does to rent a home.  If you rent the home, many times a renter is ready to move in immediately and will pay you rent and the deposit right away.  If you are selling the home, it may take a month or two before an acceptable offer comes in and then you have to wait for the new buyer to get their loan, complete inspections, etc.  It can easily take three months or more for the flip to sell after it is repaired and put on the market.  That is assuming the flip was priced right and the sellers aren’t being greedy.  Every day that home sits vacant the owner is paying interest to the bank orhard money-lender and losing profits.

There are many more costs in general associated with a flip over a rental.  When selling a home, you have to pay a real estate commission to the agents selling it for you.  We pay 3% commission to other agents who sell our homes.  We don’t have to pay a listing commission, because we are Realtors, but a non Realtor would have to pay that as well.  You have to pay title insurance, recording fees, company closing fees and sometimes buyer closing costs, which can be another 3%.

After all is said and done it may cost 10% or more of the selling price to sell a fix and flip.  If I keep the home as a long-term rental I am not getting the instant profit of a flip, but I am also not giving up that 10%.

Long-term income from a rental property

With a long-term rental I am going to keep receiving monthly cash flow as long as I own the home.  I can also refinance the home after I have owned it a year and take cash out.  The longer I own the home, the better chance I have of the home appreciating.  I have the opportunity for rents to go up and the mortgage will decrease the longer I own the home.  If I can put off the instant gratification of the income from a flip, I will make much more in the long run from a rental.

Fix and flip versus buy and hold with rental property number 7

If I were to flip long-term rental number 7, here is my profit potential.  I use rounded off numbers to make the math simple and remember I am a Realtor so I have less costs.  I will even assume we are paying cash on the flip to make it even easier

Repair costs                                                                                            $15,000

utilities, insurance, taxes while repairing and selling            $2,000

Real estate commission on $160,000 selling price                $4,800

Title insurance, closing fees, recording fees                              $1,500

Buyers closing costs of 3%                                                                 $4,800

Total costs                                                                                                 $28,100     

Selling price $160,000 minus $113,000                                     $47,000

Profit                                                                                $19,000    

A $19,000 profit is not bad, but remember that is with no loan costs, which would add at least $5,000 after paying interest and points.  The figures also only include 3% for commissions, because I am a Realtor.

If I were to hold rental property number 7 instead, my costs will be much different.  Many of these figures are taken from my detailed post on rental property number 7 so I won’t rehash them.  I will have about $34,500 cash into the home and $700 a month cash flow after it is rented.  That is $8,400 a year in income and it would take just over two years for me to make the money back I would have made on the flip.  I still have all the equity in the home I had with the flip and I am paying down my mortgage every month as well.  I also don’t have to pay as much taxes with the rental property, because I can depreciate the home as a rental property.

How do I choose whether to fix and flip or buy and hold?

Even though I think it makes more sense to buy and hold properties for long-term wealth, I still fix and flip homes.  There are some homes that work great as fix and flips and some homes that work better as rentals.   The biggest factor to take into consideration is the cash flow I can get from a rental property.  Many properties will provide great cash flow, but not very much income if I were to flip the homes.  Likewise, many fix and flips can provide great income if repaired and sold, but not much cash flow if rented.  The area, bedroom count, cost of the home all must be taken into consideration on whether the house will be a better fix and flip or buy and hold rental.

Conclusion

My plan is to hold this property for the long-term.  I will keep bringing in more income every year from the property as it appreciates and the mortgage gets paid down.   With enough long-term rental properties the income becomes very significant.   With the flip, I have the $19,000 profit before taxes and that is all.  I have to keep finding more properties, fix them up and sell them to make another profit.  But the rental is a cash-cow continuing to produce every year.

I do flip about ten houses a year and use much of that income to buy rental properties.  When I flip houses I have a much less strict criteria for properties.  I am not searching a very specific location for four or five bedroom homes, built in the last 40 years.  With flips I am looking for any house that will give me a good profit margin, preferably at least 20 percent of the final selling price.  Most of the flips I purchase do not have the rental potential to create the cash flow I need.

 

http://investfourmore.com/2013/04/19/is-it-better-to-fix-and-flip-houses-or-buy-and-hold-rentals/

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