I buy 10 to 15 fix and flips a year, and I also own 16 long-term rental properties. I buy many properties a year and I have certain guidelines I use to determine if I will fix and flip a house, or hold it as a rental property. There are many factors I take into account, but I have much more strict criteria for my rentals than I do my fix and flips.
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I first wrote this article just after purchasing my 7th long-term rental property. I purchased this home in April of 2013, I paid $113,000 for it, and I estimated the ARV (after repaired value) to be $160,000 to $165,000. This article will discuss this particular property, and although I could have flipped this house, why I kept it as a rental.
Will fix and flips or long-term rentals make more money?
There is plenty of profit potential to flip rental property number 7, but I am choosing to keep it as a long-term rental. I do many fix and flips, 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 offer passive income. To see my rental property strategy, check out my complete guide to investing in long-term rentals. Here is an article that discusses how much money you can make with rental properties and another article that discusses how much money you can make with fix and flips.
What are the basics of fix and flipping?
Fixing and flipping, can be a great source of income for real estate investors. I use income from my fix and flips to help fund the purchase of my long-term rentals. I describe a fix and flip and I am working on in this article; fix and flip case study #1. Basically a fix and flip is a home that an investor buys, fixes up, and sells as quickly as possible for a profit. Great fix and flip properties are not easy to find, and it is not easy to make money on them by any means.
The biggest challenge when flipping a house, 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 to find a property cheap enough to flip. It is not just repair costs you have to figure when buying a flip, but carrying costs, selling costs and opportunity costs.
What are the financing cost of a fix and flip compared to a rental property?
If you don’t have the cash to buy 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 of a home. 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.
What repairs need done on a fix and flip versus a rental property?
Fix and flips must have top-notch repairs 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 to make sure everything works properly and was repaired right. By no means am I suggesting a landlord should skimp on repairs, but there are certain things that may not need repaired right away on a rental, that will need to be repaired on a flip. Here is an article that details my repair strategy on a flip versus a rental.
What are the holding costs on a fix and flip versus a long-term rental?
Holding costs are more on a fix and flip, because it usually takes longer to sell a home than it does to rent a home. If you rent a 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. Every day that home sits vacant, the owner is paying interest to the bank or hard money-lender, and losing profits.
What are the costs associated with a fix and flip versus a rental property?
There are many more costs in general associated with a flip versus a rental. When selling a home, you have to pay a real estate commission to the agents selling it for you. We often pay 3 percent 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 percent of the selling price (all commissions are negotiable). Here is a more detailed on article that describes how much it costs to sell a home.
After all is said and done, it may cost 10 percent 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 percent.
Long-term income from a rental property vs. the instant profit of a flip
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 profit vs buy and hold income 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
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 percent 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 $500 a month cash flow after it is rented. That is $6,000 a year in income and it would take just over three 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. With the flip I would have to pay short-term capital gains taxes, which is taxed the same as ordinary income.
How do I choose whether to fix and flip or buy and hold a house?
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 reason I like long-term rental properties is the cash flow. 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. Here is a much more detailed on article on how I decide whether to fix and flip or buy and hold a rental property.
For more information on how to fix and flips homes including how to find properties, how to finance them, how to repair them and how to make the most money fix and flipping, check out my new book Fix and Flip Your Way to Financial Freedom. The book is $7.99 and available at Amazon as a 171 page eBook or in paperback as well!
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 fix and 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 place 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 buy do not have the rental potential to create the cash flow I need.
For more information on how to buy the best rentals which will make the most money, check out my book: Build a Rental Property Empire: The no-nonsense book on finding deals, financing the right way, and managing wisely. The book is 374 pages long, comes in paperback or as an eBook and is an Amazon best seller.