Real Estate Investing for Beginners: Is it Better to Flip or Rent?

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 fix and 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.

How has my market changed for flips and rentals?

I first wrote this article just after purchasing my 7th long-term rental property. I bought 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. I thought the home would rent for $1,300 a month after we fixed it up. This article will discuss this particular property, and although I could have flipped this house, why I kept it as a rental. I have bought many more rentals and flipped many houses since then.

This same property is worth close to $300,000 in 2018. It rents for $1,600 a month and would not make a good rental. This shows how different markets and price points can affect how well a rental property performs. I stopped buying rentals in my market because prices increased so much and rents did not keep up. I have kept flipping houses because the profit margins are still there on the flips. This article assumes you are in a market where there are good rental properties.

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. 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 neither are great rentals.   

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 the repair costs you have to figure when buying a flip, but carrying costs, selling costs and opportunity costs.

 

What are the financing costs 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.

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.

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 to be 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% 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 article that describes how much it costs to sell a home.

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.

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 fewer 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 $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 article on how I decide whether to fix and flip or buy and hold a rental property.

How to Buy Real Estate Below Market Value

are many ways to buy real estate below market value, including buying REOs, short sales, estate sales, HUD homes, off market properties, and even fair market sales. I have bought 20 long-term rentals, buy 20 to 30 fix and flips a year, and I must buy houses below market value to make money. In order to buy real estate below market value, you have to be patient, and willing to work hard to find deals.

It can take time, work and the ability to act quickly to get a great deal. Of course getting a great deal is only part of the equation. Check out my complete guide to investing in long-term rentals to see the other aspects. I have used the techniques listed below to purchase homes for long-term rentals and fix and flips. In the following article I will should you how to buy real estate below market value.

How do you determine market value on real estate?

It is not easy to determine market value if you are not a real estate agent. I wrote another article that gives some tips and tricks on how to determine market value here. I would not count on Zillow to give an accurate market value because they can be way off! Another thing to remember with market values is how to value homes that need repairs. I want to buy homes 20 percent below market value or more. If a home is worth $150,000, and it needs $30,000 in repairs; buying the home for $120,000 is not a discount. I would want to buy that home for at least 20 percent less than $120,000, because $120,000 is market value once you discount the repairs. There is no benefit to buying a home at market value minus the exact amount of the repair cost. I would rather buy a fully repaired home, and not have to hassle with the time and effort it takes to repair a home. The 70 percent rule is great for determining how much to pay for a potential flip.

How to buy bank owned properties (REOs) below market value

REO stands for Real Estate Owned, and is a bank term for properties that have gone through the foreclosure process. REO properties are almost always listed in the MLS (multiple listing service) by a REO listing agent. I am a REO listing agent myself, and I can tell you each bank handles their REOs very differently. Some banks will repair homes before they list, and others will not do a thing. Some banks are willing to negotiate quite a bit on their prices, and others will hardly budge. REOs can be a great way to buy real estate below market value.

If you have paid attention to the real estate market in the last two years, you have realized REOs are getting harder and harder to find. There are some great deals on REOs, but usually the deals are on homes that need a lot of repairs. Here is an article on how to find a great deal on a property. If you find a great deal on a REO, don’t be surprised if you find yourself in a highest and best situation. Many banks ask for highest and best when they receive more than one offer on a property. There is a ton of competition for REO properties right now, and seeing multiple offers is not rare. Highest and best, gives every buyer who made an offer a chance to raise their offer and hope it is good enough to get the property. In many highest and best situations, the winning offer is higher than the actual asking price. If you find yourself in a highest and best situation, I always suggest bidding the maximum price that will make the deal work for you. To make your offer more appealing to the seller, consider removing your inspection contingency or paying cash if possible.

Many banks will prefer a cash offer from an investor, and sometimes they will actually prefer an owner occupant buyer. Sellers like Fannie Mae, Freddie Mac and Wells Fargo, only allow offers from owner occupant buyers at the beginning of the listing period. This can be frustrating for investors looking for a good deal, but there is no way around their owner occupant restrictions. It is against the law to pretend to be an owner occupant when you will not be occupying the property.

How to buy HUD homes below market value

HUD homes are properties that had FHA insured mortgages, were foreclosed on and went back to the government. The properties go back to the government, because the government guarantees FHA mortgages. HUD homes have a unique online bidding system located at HUDHOMESTORE.COM. All bids have to be entered by a licensed agent and are sealed, meaning no other buyers can see what the other buyers are bidding.

Buying HUD homes can be frustrating for investors because HUD has a very strict owner occupant bid period that varies on different types of properties. HUD does an appraisal on each home before it is listed, and the list price is based on that appraisal. The appraiser also decides if the home can qualify for FHA financing. If the home will qualify for FHA, HUD uses the term “FHA insurable,” and if the home does not qualify they use the term “uninsurable.” For insurable homes, HUD does not let investors bid for the first 15 days, for uninsured homes investors cannot bid for the first 5 days. If you are interested in a HUD home, make sure you are using a Realtor that knows the system inside and out. There are also many costs associated with HUD homes that are not associated with regular or REO sales. HUD will not pay for title insurance, and it is the buyers responsibility to pay for all utilities when doing an inspection. Please check out my investors guide to purchasing HUD Homes to get more detailed information on the process.

Even with all these restrictions, HUD homes can provide great deals for investors. I cannot buy a HUD home because I am a HUD listing broker. I have helped many investors buy HUD homes at well below market value.

How to buy short sales below market value

Short sales are another great source for investors. Short sales are owned by a private seller, but the seller owes the bank more than they are trying to sell the home for. In order to sell the home, the bank has to agree to take less money than they are owed. Historically, short sales could take up to 6 months or even a year to close because lenders were so slow to make a decision. In the last couple of years, banks have gotten much quicker at making decisions and some short sales are approved in two weeks or less. Many times on short sales, the first party to make an offer will get the home. You have to be very quick to act when a great short sale deal comes on the market. Remember, even if you get your offer accepted by the seller, there is no guarantee the bank will approve the offer. It is wise to wait to perform an inspection or start the loan process, until you have written approval of your offer from the sellers’ lien holders. I bought rental property number 7 as a short sale.

How to buy fair market sales below market value

Fair market sales are homes owned by a private seller who has enough equity in the home to sell it without having to involve the bank in the decision making. It is harder to find great deals on fair market sales because the seller is usually not in a huge rush to sell their home below market value. There are some cases where you can find a great deal on a fair market sale.

I have purchased properties from estates that were great deals. Many times, estates have issues or creditors that need to be paid quickly, and they just want to get rid of the home. I have also purchased homes that the seller had recently bought as a foreclosure. The home needed a lot of work, and they never had the money to complete the repairs, but the market appreciated enough that they could sell the home.

Another situation that an investor can buy below market value is an investor owned home. The investor owned home is usually rented, and although it may be perfect for a first time home buyer, the first time home buyer can’t wait three months for the tenants to move out. The only choice for the investor is to sell the home to another investor for a discount.

How to buy off-market properties below market value

Many investors buy properties that are never listed on MLS or marketed in any way. These are called off-market properties, because they are not for sale. It takes money and time to be able to purchase these types of investment properties. Investors will send out direct mail, postcards or advertise with signs that let people know they buy houses. I am sure you have heard of “We buy Ugly Houses.” They use billboards, newspaper ads and their giant trucks to advertise to potential sellers. I have bought numerous houses that were not listed on the MLS.

Making an offer on below market value properties

When I make on offer on a property that is listed in MLS, I want to submit the offer as quickly as possible. I am a Realtor, so I have a huge advantage because I can check new listings multiple times a day. As soon as I see a possibility, I will make an appointment ASAP to see the home, and if it meets my criteria I will make an offer that same day. If I see a great deal, it can take me less than 2 hours to see a property on MLS, look at the property and make an offer. This doesn’t always get me the deal, but it gives me a better chance of getting the home under contract, before other offers are received. If you are not an agent you need to make sure you have a great agent who can act quickly for you.

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 fix and flip about ten houses a year and use much of that income to buy rental properties. When I flip houses, I have much less strict criteria for properties. I am not searching for 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% of the final selling price. Most of the flips I buy do not have the rental potential to create the cash flow I need.

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