I complete 20 to 30 fix and flips every year, and I also own 20 long-term rental properties. I have certain guidelines I use to determine if I will flip a house, or hold it as a rental property. There are many factors I take into account, but I have much stricter criteria for my rentals than I do my house flips.
I think you can flip houses in just about any market although you will need more money to flip when housing prices are high. It is harder to find great rentals in every market because rents tend not to keep up with home prices when values are high. This article goes over the pros and cons of buying and holding rental properties as well as house flips.
How does the market affect investing techniques?
I first wrote this article just after purchasing my 7th long-term rental property. I bought the property 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. I thought the home would rent for $1,300 a month after we fixed it up. This article uses this property as a case study because at the time there were good rentals and good flips in Colorado. I was buying both, but I had different criteria for each property type. I could have flipped this house but I chose to keep it as a rental and I am glad I did!
This same property is worth $300,000 in 2019. It rents for $1,600 a month and would not make a good rental (if I bought it today). This shows how different markets and price points can affect how well a rental property performs. I stopped buying residential rentals in my market because prices increased too much for rents to keep up.
I have kept flipping houses because the profit margins are still there on the flips. There are almost always opportunities to flip houses, but there are not always opportunities to make money with rentals. Although I stopped buying residential rentals in my market, I have been buying commercial properties in the last few years which do make money.
The market you are in will make a huge difference on if you can buy rentals that cash flow. I am not interested in buying rentals and hoping they go up in value for me to make money. I want to buy rentals that will make money every month from the very beginning.
What are the advantages of a good rental?
I love rental properties because when you buy a good rental it will make you money as long as you own it. There may be some months that are negative because you have a vacancy or maintenance is needed, but over the long run, it will keep bringing in cash. The money you make will increase over time because rents will increase, and you will eventually pay off the loan. The tricky part is finding rentals that will cash flow! Here are the advantages of rentals:
Cash flow is the profit you make every month after paying all the expenses including the mortgage. For example, I may rent a home for $1,300, the mortgage is $600 a month, the taxes are $50, the insurance is $75, the property management is $100, maintenance is $100, and vacancies are $50. That leaves $325 a month in cash flow. That money will come in forever as long as you own the property.
When you buy a rental it is fairly easy to get a loan. That loan allows you to put 20 percent down or sometimes less using the BRRR strategy, house hacking or other low money down techniques. You can make really high returns with the right rental and on mine, I shoot to make 15 percent cash on cash returns.
Rental properties have amazing tax advantages. You can depreciate the structure which means it is possible to lose money on paper, but make money in reality. You can depreciate or deduct almost all of the expenses including the interest on the loan. When you sell a rental you also pay long-term capital gains taxes most of the time which is lower than short term capital gains (flips).
Over time the value of a rental property will most likely go up. I do not count on appreciation to make money, but it is a nice bonus. When you use leverage to buy the rentals, the appreciation is magnified.
Buy below market
Just like with flips, you can buy rental properties below market value. I have gotten a great deal on every rental property I have bought. That allows me to have more cash flow, and I can refinance the property later on and take cash out to buy more rentals!
Rentals are an awesome investment, but they take money to buy and there are not great rentals in every market.
What are the advantages of flipping houses?
I have flipped houses for the last 17 years and love to flip. You can make a lot of money flipping, but it is also a lot of work and you have to constantly find new deals to make more money. I think if flipping as more of a job, than investing. I still have to make money somehow. I have expensive tastes, and rentals can be expensive to buy. House flipping provides an income that I can use to buy more rentals.
When I sell a house flip I can no longer make money from that property, but I do make a large chunk of cash from the sale. It may take me years to make the same amount from a rental property that I can make from a flip.
More Financing Options
I have more options to finance flips than I do rental properties. The reason is that I am holding flips for a short period of time. I can use private money, hard money, bank money, and partners to flip houses. Those lenders don’t mind short-term loans that are one or two years in length. Only banks like loans that have longer terms. I can use these other sources to finance rentals, but at some point will need to refinance into a long-term loan.
Less worry about the future
I try to sell all my flips within 6 months from when I buy them. That does not always happen, but by selling the flips quickly I am not as exposed to a changing market or changing neighborhood. I am very strict about where I buy rentals because the market could change and some areas are more affected by market changes than others.
More deals available
You need a lot of margin on a house flip to make money. That would make you think a flip is harder to find than a good rental property but that is not the case for me. It is easier for me to find a good flip because I do not worry about the neighborhood, the age of the home, or other factors that concern me with a long-term hold property. I do not like old rentals because they will have more maintenance and cost me more money eventually. I do not worry as much about buying older flips because I will not be holding on to them.
Can flip in any market
There will always be houses that can be flipped in almost any market. However, it is not always possible to find cash flowing rentals in every market. The higher the prices are in an area the tougher it is to cash flow with rentals. I am not concerned about what a flip will rent for which makes it easier to flip in expensive markets.
How does financing differ?
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 12% interest plus 2% 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.
While there may be more options to finance fips, the options are more expensive. There are other ways to finance a flip with bank loans or private money that can be cheaper. You can usually finance a rental property for less than 6% and one point on a long-term loan.
Repairing a rental versus a flip
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 to be repaired right away on a rental, that will need to be repaired on a flip.
You may be able to save kitchens and baths on a rental where you would have to replace them on a flip. You may not have to change doors, and light fixtures out, but you would on a flip. Generally, it costs more money to make repairs on a flip because buyers expect more than renters.
Does a flip or rental cost more?
The costs on a flip are usually more because it takes longer to sell a home than it does to rent a home and the repairs are more expensive. 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.
While it costs more to repair, finance, and hold a flip, you get that money back when you sell. You may not get the money back you invest in a rental right away. You will be collecting rent, but it can take a while to recoup your costs unless you refinance the property.
Is the profit more on a flip?
When selling a home, you have to pay a real estate commission to the real estate agents selling it for you. We often pay 3% commission to other agents who sell our homes (all commissions are negotiable). 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, closing company fees and sometimes buyer closing costs, which can be another 3 percent of the selling price.
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 percent. I also have to pay taxes on the profit I make with a flip. House flips are taxed at the short-term capital gains rate which is the same as your earned income rate (you could pay less with new tax laws if you have a corporation).
If I refinance the property, I can get most of my money back on a rental without paying selling costs or taxes.
With a long-term rental, I am going to keep receiving monthly cash flow as long as I own the home. 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 and pay fewer taxes.
Case study: flip or hold
Going back to the property I was talking about earlier. Let us see what the numbers look like if I were to flip long-term rental number 7. I use rounded off numbers to make the math simple and remember I am a Realtor so I have fewer costs. I will even assume we are paying cash on the flip to make it even easier.
|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|
|Gross Profit ($160,000 minus $113,000 purchase price)||$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% for commissions because I am a Realtor on list the house for sale myself.
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 that 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.
I average about $30,000 profit on each flip I complete so the rental property would not have made quite as much as I normally like to make. However, after taxes I would still make about the same amount as what is used in this case study. I was also able to refinance this property a year or two after I bought it and take all the money out that I used for the down payment and repairs. The property now rents for $1,600 a month and is worth $300,000. I would never count on appreciation like that, but it happened. I wish I would have bought more rentals back when prices were so low!
Which is better?
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.
If I had to choose between buying more flips and buying more rentals, I would buy more rentals. I love the long-term cash flow, and if you refinance them you don’t have to have that much cash tied up in the property. I still flip houses because I love flipping and it generates a lot of income. I can use that income to buy more rentals. My market is also much easier to flip in right now because of the high prices.
I complete 10-15 fix and flips a year and I also own 16 long-term rental properties. One of the most common questions I hear is “how do I determine whether to fix and flip or rent a house.” Many people think it is easier to find a rental property than a fix and flip, but I find it harder to find rental properties. I have very strict guidelines that my rental properties must meet; cash flow, cash on cash return, location, condition, age and more. With fix and flips I want to make sure I can sell the house for a profit in less than 6 months and I am not worried about the location, cash flow or cash on cash return as much.
How can you determine if a house will be a better rental or flip?
It is easier for me to find a property to fix and flip, because I have such strict buying criteria on my rentals. I buy my rental properties based on cash flow and I assume I will hold them for many years, if not forever. I want to make sure my rentals are great properties that will be easy to manage. I am very picky about the location, condition, and age because I am holding these properties so long.
I am looking at many more factors when I buy a rental property because with flips I only care about profit. As long as I know what my after repaired value will be, I can make money if I buy the property cheap enough.
I primarily buy fix and flips within a 40-mile radius of where I am located. I buy rental properties within 10 miles of where I live, although I prefer them to be much closer. The reason I buy flips further away is because I am selling them quickly and I am only concerned with when they will sell and for how much. With rental properties, I need to think about the long-term prospects of the area I am buying in, the future economy and the rental market.
I also buy house flips in small towns with less than 5,000 people. As a real estate agent, it is easy for me to determine the values on houses. Figuring rental rates is much tougher, especially in small towns. Since the small towns are farther away and have less certainty in the rental market I do not buy rentals in them. Small towns are also the hardest hit when the market goes down or vacancies go up.
Age of the home
I prefer homes that are less than ten years old for my rental properties. The newer the home the less maintenance and repairs a home will need. Honestly finding great rentals that are less than ten years old is not easy and most of my rentals are about 30 to 40 years old. I try to stay away from any rental properties that are older than 50 years.
When I see 100-year-old homes, I tend to get very cautious when considering them for rental properties. The older a home is, the better chance it will need major work at some point. I am also cautious when buying old homes as fix and flips as well, but I will not be holding the flip for years. There is less of a chance that I will run into a major problem with a flip than a long-term rental because I will be selling it quickly.
Amount of work
Every house I buy is bought below market value. You can’t flip without getting a great deal and it is hard to get great cash flow without a great deal as well. Buying a home below market value usually means the house needs work.
If a house needs a lot of work; new kitchen, new baths, carpet, paint, roof it can cost $20,000 to $30,000 or more to repair the home. I am already putting 20% down on my rental properties and adding $30,000 in repairs on top of the down payment means I may have $50,000 or more into a rental property. Having that much cash into a rental will lower my cash on cash returns and limit my ability to buy more rental properties. I can refinance my rentals, but I usually have to wait a year to take cash out.
Rent to Value
There are some neighborhoods that have great rent to value ratios. Rent to value is the amount the home will rent for compared to what I have to buy it for. I was lucky that the rent to value ratios in my town was better than the surrounding towns. There was a sweet spot for rent to value ratios in the $80,000 to $150,000 range.
Most of my flips are not in my town, even though I would love them to be! I think because I live in a bigger town, there is more demand for houses and less great deals because of that. Most of my flips are in different towns with less favorable rent to value ratios.
Should you flip houses or buy a rental first?
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.
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:
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.
Even though I think long-term rentals provide a better investment over time, I still do many house flips to generate income. I actually use much of the income from my fix and flips to purchase long-term rental properties.
For me to have the success I have had with my rental properties, I have to be very cautious about what I buy. When looking at the numbers on my rental properties, I could fix and flip many of them and make a profit, but I will make much more by keeping them as rental properties.