Real estate investments generally fall somewhere along a spectrum of risk and effort. On one end, you have house flippers, who take on a high level of risk and put forth a lot of effort as they buy, renovate, and flip. On the other end of the spectrum are the people using the buy-and-hold strategy; it’s a pretty safe bet to buy a property and rent it out long-term, and it doesn’t take a lot of effort, comparatively, to get that passive cash flow coming in.
So which strategy is better? We’re going to look at each in more detail, and examine their pros and cons. And it turns out, there’s a pretty clear winner here— as well as a third, hybrid path that we don’t hear much about.
We all know what house flipping entails; you buy a property, renovate it, and sell it at a profit. Cheap loans, waves of gentrification, and dozens of flipping-themed reality TV shows have made house flipping into one of the most popular investment paths in America. But is it overrated? Let’s look at some of the pros and cons.
Flipping houses can be complicated, but it can also be highly profitable. The pros reflect that.
The latest data from 2019 showed that the average profit from a house flip was a little over $62,000. Consider that a fix-and-flip takes somewhere in the neighborhood of three to six months. On the low end, you’re talking about $120,000 a year; on the high end, potentially a quarter-million dollars a year. Now consider that once you forge relationships with trustworthy contractors and iron out a smooth process, you could potentially scale up to doing multiple fix-and-flips simultaneously.
A Beginning, a Middle, and an End
Investing in real estate is usually a long-term play, and while the market usually trends steadily upwards (minus those occasional hiccups), holding onto a property over the long term means being exposed to factors like potential market downturns or changes in the neighborhood. You can get stuck holding a property in a neighborhood that’s become less desirable over time.
In a flip, you’re in and out in a handful of months.
One thing that the television shows don’t mention is that house flipping can be very risky, and very expensive. The cons reflect these facts.
Flipping Is a Big Gamble
The term “flipping” can obscure the fact that you’re buying, owning, and then, eventually, reselling a home. All that time you own the home, you’re at a pretty high level of risk. If the market dips, you could find yourself the owner of one (or more) properties that are now worth less than what you paid for them. Flippers can make a lot of money when the market’s on a hot streak, and then lose it all when it declines.
It’s Also Expensive
While you own the property, you have to pay carrying costs. That includes financing, insurance, utilities, and more, and it can all add up pretty quickly. Then there are transaction costs, on both the purchase and the sale. Real estate commission fees, title fees, outstanding liens, repairs, and other costs can quickly add up and cut into your profits.
On top of that, rehab costs are notorious for mushrooming out of control. If the renovation costs twice as much as you budgeted for, you may end up only breaking even, or maybe even losing money.
You’ll also have to pay taxes. When you sell a property for more than you paid for it, you have to pay taxes on the profit. If you owned it for more than a year, you have to pay capital gains, which is capped at 20%. But the majority of house flippers will have owned the property for much less than a year, which means the profits will be taxed as regular income, and at a much higher rate than capital gains.
While the buy-and-hold strategy doesn’t offer quite the explosive profit potential that the fix-and-flip does, it does have a major edge in long-term stability and ease. Let’s review the main pros and cons.
Remember when we said house flipping is lucrative but risky? Renting out long-term holdings is just the opposite; comfortably profitable and safe.
Renting out your investment properties means you’ll have cash coming in every month like clockwork. House flipping is essentially a gamble, while being a landlord is much more like a legitimate business. Steady income also makes it much easier to plan your financial future and to devote yourself full-time to your investment.
The longer you own a property, the more it increases in value. A flipped property appreciates in value because you put money into it; experts call that “forced appreciation,” and if you miscalculate your costs, it’s easy to end up losing money. But if you buy-and-hold? That property tends to gain value just by existing. Appreciation is an unstoppable force, and it’ll make you rich without you lifting a finger.
Buying-and-holding is safe and stable, but it’s not necessarily easy. These are two of the main drawbacks of being a long-term property owner.
It’s High Effort
Managing tenants and properties, overseeing maintenance, and collecting rents is extremely time-consuming. You have to be part accountant, part handyman, part lawyer, and part therapist. Many landlords end up hiring professional property management services, which are very effective but generally charge a percentage of the rents collected.
Your rental properties will only bring in rent if they’re filled by tenants, and if unexpected vacancies stretch into multiple months, your bottom line can take a beating. Even if you carefully study the local vacancy rates and the rental market before you invest, you can still end up struggling to fill your rental units.
Alternative Real Estate Investment Strategies
Many seasoned investors have begun to use the BRRRR strategy, which is essentially a mix of the fix-and-flip and the buy-and-hold— with a unique twist.
BRRRR stands for “buy, rehabilitate, rent, refinance, and repeat.” It works like this; the investor buys a distressed or undervalued property, renovates it to quickly build equity, rents it out to establish a solid cash flow, and then does a cash-out refinance and uses that money to acquire a second investment property.
The advantages to this strategy are clear. It offers nearly as much profit potential as flipping, but hedges risk by including a period of solid rental cash flow. On the back end, the cash-out refinance helps investors expand their portfolio at unprecedented speed, by converting their equity to hard cash they can use to acquire their next investment.
Are there risks to this strategy? Sure. Banks generally require a seasoning period before they’ll allow a cash-out refinance, during which time you’ll be exposed to the same risk as any other property owner. And since refinances are based on appraisals, a low appraisal could present a serious obstacle.
Still, if everything goes right, the BRRR strategy is second only to the buy-and-hold for safety, cash flow, and scale. Does that mean you shouldn’t try to flip houses? Not at all; if you have a high appetite for risk and existing relationships with a contractor, it can be a great way to make some money. You might find it more profitable to sell off the property if the market is extremely seller-friendly, but the benefit of this strategy is you aren’t forced into a corner – you have options based on whatever the market holds.
For most investors, flipping isn’t a long term investment strategy, simply because on a long enough timeline, the risk becomes inevitable. Renting, on the other hand, is one of the safest and most consistent money-making strategies out there. For those looking to build long term wealth rather than creating a job of fixing and flipping, some version of buy and hold is the way to go.
WOW! Great content Ben. This is very knowledgeable post, especially for those who are new to the real estate industry. Straight-forward contents and you really tackle the important parts that would differentiate buying, renting, and fix and flip a property. Way to go!
I agree, Ben wrote brilliantly on the subject. Thanks for that great feedback. Because you’ve shown interest, you might enjoy this other article from our blog: Understanding Turnkey Property Investing