New investors often wonder whether to focus on flipping properties or to concentrate on rentals. Here’s my take on the pros and cons of both.
Flipping properties is an excellent way to rapidly begin making money with real estate investing. Flipping is a general term that can mean a variety of things. It can mean buying, rehabbing, and retailing a property to a homeowner. It can mean wholesaling a property to another investor. It can mean assigning a contract; sandwich lease options, etc. Basically, “flipping” means buying a property at a discount and then reselling it in a relatively short time for a profit.
The advantage of flipping is that a person can start quickly and literally turn this into a full time occupation almost overnight. By flipping only one or two properties a month, many people could replace the income from their JOB.
The disadvantages of flipping are two-fold. First, profits from flipping are treated as ordinary income. This means that you’ll pay both state and federal income tax which can literally eat up nearly half of your profit!!! Also, flipping is a lot like a job - if you stop working, the money stops! So, with flipping you must constantly be finding new deals - if the deals stop for any reason, you’re out of business.
Operating a rental business is self-explanatory. You buy properties and rent them out for a positive cash flow (profit).
The primary advantage of rental properties is that (in theory, at least) this is passive income. Once you’ve got the business going, you make money 24/7 without actually working. You can take a trip around the world and the money still comes in. The reality is somewhat different in that someone has to manage the rentals or at least manage the manager. Therefore, the management does require some degree of work to keep the business going.
With rentals, you make money at least 5 ways:
- You pick up equity when you buy - if you buy at a discount.
- You get the cash each month from the rents (assuming that you have a positive cash flow. This is money that you can live on.
- The tenants pay down the mortgages on your property, thereby always increasing your equity in the property you own.
- You get the appreciation of the property over time, which is historically 3% to 5% per year.
- Finally, you get the tax advantages of owning rentals. There are many deductions and you’re receiving passive income.
The BIG disadvantage of owning rental properties is PEOPLE! Dealing with tenants can be an absolute NIGHTMARE - enough so that many landlords get quickly burned out and sell their rental properties. This subject could be a book in itself, but the negatives associated with tenants should not be underestimated.
Another disadvantage of owning rentals is that it takes longer to become a full time landlord than to become a full time flipper. For most people, it will take years to build a large enough portfolio to support their family.
Sooooo, to flip or rent - THAT IS THE QUESTION!