I have been getting a lot of questions lately about whether it is better to start your investing career with a flip or a rental. This is a really good question and is really hard to answer as well. There are pros and cons to flips and rentals, but they can both be amazing investments. I am working on 20 flips right now, but my ultimate goal is to buy more rentals. The income from the flips helps me pay for the rental properties. That is where the dilemma comes from. Should you buy a rental first and start earning cash flow or buy a flip first which could generate money to buy more rentals?
Can you generate cash with rentals like you can with flips?
When I bought my first rental, I spent about $30,000 in cash to buy it, repair it, and pay for carrying costs until it was rented. I bought my first rental in 2010 for just under $100,000. I put 25% down and ended up with a loan for just over $70,000. The house was worth at least $130,000 once I put a few thousand dollars into fixing it up. I had a lot of equity in that house that I did not use for many years. I think most people feel you have to leave your money in the rentals once you buy them, but that is not always the case. If I would have done things differently, I could have taken money out and bought more rentals more quickly than I did (it took me another year before I bought rental number 2).
The BRRR strategy has become very popular with real estate investors. BRRR stands for buy, repair, rent, refinance, and you can add another r for repeat. You can usually refinance an investment property for 75% of the value of the property. If my property would have been worth $130,000, I could have refinanced it for $97,500, and I would have gotten almost all of my money back out of the house. However, I would have had to wait 6 months or a year with most banks to take cash out on a refi. There are some ways to avoid this if you are using private money or hard money.
Is it better to refinance a rental or sell a flip?
Many people want to flip houses first so that they can generate income to buy more rentals, but there are some advantages to refinancing a rental over selling a flip:
- You pay no taxes on the proceeds from a refinance, but you pay income taxes on money you make when you sell a flip.
- When you refinance a rental, you are able to keep the property and still make money every month.
- There are tax advantages to keeping rentals as well.
I think rentals are a better investment than flips, but flips still can be a great source of income. I like to have a great source of income and make great investments. If you are getting the same amount of money from a flip as you are a rental, rentals are usually the better choice due to the tax advantages and you are keeping the property. It is not easy getting to a point where you can buy both flips and rentals at the same time.
It may seem like a long time to get your money back out of a rental, but it can take just as long to get money out of a flip. My average time to flip a house is about 6 months, but the big projects can take much longer. Flipping houses is not an amazing advantage over rentals because of the time it takes to flip and the costs to flip.
Below is a video I made on whether it is better to flip or rent first.
How much money do you need to buy a flip or a rental?
Another question to ask is how much money you need for each investment. A rental property will usually take at least 20% down plus repairs and carrying costs until it is rented. On a $100,000 rental, you may need from $25,000 to $35,000 in cash.
A flip can take from 25 to 0% down depending on the financing you use. You may be able to get some of the repairs financed as well. On a $100,000 flip, you may need from $10,000 to $50,000 in cash.
The investment that takes more cash will depend on what kind of financing you can get with the flips. It usually takes experience to get the really low-down-payment options with private money. if you are just starting out, it may be tough to find loans that have the low-down-payment options. The video below goes over how I finance my house flips:
Are you in a good market for rental properties?
This question could be a big factor in deciding what route to take. Not every market is great for rentals. My market used to be fantastic for cash flow and buying points. My market now is too expensive for residential rentals. I thought about buying rentals in another state but ended up buying commercial rentals locally instead.
If your market works for rentals, great; if not, flips may be your answer for now. You may not want to jump straight into commercial rentals right off the bat, and you may not find a bank that would help you with that anyway. While you figure where or how to invest in rentals, you could start flipping right away.
You can flip houses in any market, but the more expensive the market is the more cash you will need. If you live in a super expensive market and do not have a lot of cash, you may need to move or invest in a different market.
How do you know whether to keep the property or sell it?
The best thing to do is figure out all the things we have talked about:
- Are you in a good market for rentals?
- How much money you would have in each deal.
- How long would it take to get money out of each deal?
- How much money you have to invest.
- What is your long-term goal in real estate?
You may or may not get a clear picture of what the best investment is. If you are still foggy on what to do, start looking for houses. If you find a great flip, buy it; if you find a great rental, buy it. Learn from experience which is the best route for you. Once you start investing, you will get a better idea of what makes sense in your market and for your situation.
I also have books that go into more details on both rentals and flips:
- Build a Rental Property Empire: the no-nonsense book on finding deals, financing the right way, and managing wisely.
- Fix and Flip Your Way to Financial Freedom Finding, Financing, Repairing and Selling Investment Properties.
What if you are buying rentals or flips as an owner occupant?
It is also possible to buy a flip or a rental as an owner occupant. You must live in the house for at least one year, but after that, the house can be rented out or sold (you may be able to sell sooner in some cases). You can put much less money down when you buy as an owner occupant, which is a huge advantage. How do you know if it is better to keep the house as a rental or flip it when you are done? I think you should go through the same process we already discussed. Decide if it would be a good rental. If not, then sell it (if you sell after two years of living there you pay no income taxes). If it would be a good rental, then figure how much money you would have in the house versus how much you would get back by selling it. Real estate is a numbers game, and the more you write out the numbers and plan, the better off you will be.
There is no best way to invest in real estate. The more you can learn and simulate what you want to do in the future, the better off you will be. If you find yourself stuck trying to figure out what the best route is, buying a great deal is a good way to start. Your first investment does not have to be a perfect one, and going through the process of buying a property will teach you more than anything else.