Most Americans would agree that buying property is a sound investment. Many of us dream about our very own weekend country house sitting on several acres, or perhaps a top floor downtown condo with stunning views of the city. In fact, home ownership in America is almost 65%. However, investing in property is a whole different ball game, and the game is played using competing rules. Will it be a long or short… requiring risk or caution, a quick play or an exercise in patience? This is all to answer the question of whether to flip a property… or buy and hold. To use a Wall Street analogy, think of flipping as day trading and holding properties as a long position. Some people hold a stock for a short time, hoping that the stock price will immediately increase and they can cash in quickly. With flipping, you buy it, fix it up and sell it as quickly as possible. The profits (or losses) can happen within weeks. Even if you make a profit, the capital gains tax is substantial. On the other hand, holding a stock for a long period of time is the exact opposite. You are in it for the long run and expect to see a steady return over the years. In some cases, perhaps there will even be a quarterly dividend. The stock may go up and down, but ultimately you are hoping that your initial investment appreciates over time. The same is true in purchasing rental or vacation property. Investors using this strategy tend to have an eye on their more distant future. We talked previously about certain criteria that should be considered before purchasing an investment property. Below, we will discuss some of the expectations that come with flipping and holding investment properties.
This is simple, right? Find a place, fix it up and sell it for a profit. And here in the Research Triangle, it’s likely that residential properties will go up in value, but it’s not that simple. Here are several things you must consider:
- Understand the game. Buy at the lowest possible price, and sell at the highest price. Many investors try to locate neighborhoods on the rise or distressed properties seeking to take advantage of a short sale or foreclosures. Finding those special properties is key.
- Set a budget and expectations. This might be the most important step. Flipping a property is a fast-paced game. The moment you buy the property, you start losing cash. It is important to have a complete understanding of house renovations, yard work, structural issues, electrical, plumbing, flooring, roofing, construction permits, insurance, licenses etc. From the time you own an investment property, you are a business owner and should understand the labor and costs required to complete every project. Costs can get away from you very quickly when you are fixing up a place. Do not leave yourself at the mercy of contractors. Remember, you are paying closing costs, contractors, property fees, capital gain taxes and local municipalities, depending on necessary local permits.
- Expect the unexpected. In your budget you also need to account for the fact that renovations may not be completed on your anticipated time schedule. In fact, they rarely are. Also, the property may not sell right away. Therefore, it is important to plan ahead for these contingencies. The 20% down payment is not the only cash you are going to need up front. There is risk involved, and you should be in a financial position to manage those risks.
- Vet your contractors. If you are not handy with a wrench and plunger, then you are going to have to hire several contractors to do the work for you. You should vet them properly and understand the scope of the work that needs to be done (see No. 2). Check their reviews, get recommendations and set a timeline. Remember, every day the property is not sold means a day you are losing profits.
- Anticipate the sale. You do not have to wait until all the renovations are complete to begin marketing the property. In fact, it may be wise to begin the selling process at least two months prior to completion of the renovations.
The show Flip or Flop provides some insight into the business of flipping houses. Here, the objective is to buy a house, remodel it to breathtaking standards and flip it. The series shows various types of renovations and what the profits are from the houses that are flipped. The records show that some properties were unsold, some sold for a loss and most were profitable (over $200,000 in some cases). But one thing becomes clear – this is their business and not intended to be a long-term investment. The cash comes (and goes) fast and furious. Unless you have a background in home construction, architecture or design, trying to renovate and flip a house is an arduous (though not impossible) task.
A long-term investment property requires a different analysis. These are usually business, residential or vacation rentals. One thing is clear; no matter what, investing in rental properties will require some direct oversight by the investor. How much oversight will determine how much of a job or career you will make of your rental properties. Rental properties will be able to supplement (and eventually replace) your income as part of a long-term portfolio investment strategy. If you are going to be in it for the long run, the goal should be to purchase one, then another and another. Here is a rundown of some things you will need to consider when purchasing investment property:
- Hiring a property manager. This may be one of the most important decisions. Having someone to manage your rental property in the long run will free up your time for other potential investments… or just some personal time.
- The tax advantage. Rental property income is considered investment income. It is taxed at a lower rate than capital gains from flipping a house. Also, there are several tax exemptions that apply to rental properties.
- Understanding the rental or vacation market in the desired area. Neighborhoods change. Not so long ago, the real estate market crashed… and billions of dollars in property value was wiped out overnight. While rental and vacation properties are “hold” positions, there may come a time to sell. Constantly researching what is happening in the neighborhood and city is prudent. Don’t get caught watching the paint dry.
- Understanding landlord/tenant laws. There are many laws that regulate the relationship between renters and landlords… and these laws differ from city to city. You will eventually need to hire an attorney, but understanding the basic landlord/tenant laws in your area is a must.
- Vacation rentals… Beware the Airbnb effect. Right now, there is a legal battle going on in several cities and states around the country about short-term house rentals. Airbnb is at the forefront in trying to get some of these laws changed in its favor, while hotels are seeking to push back. Before you purchase that beautiful beach property as a three-season rental, someone should conduct some research into the laws and proposed regulations for short-term rentals in that area.
Rental properties should be considered a long-term investment strategy, while flipping houses is more of a career choice. Either way, there are opportunities to reap profits in both ventures.