Both residential real estate investment strategies have advantages and disadvantages. Choosing one approach over the other should be part of a deliberate plan reflecting your overall financial goals.
In addition to your personal financial goals, you should also consider what opportunities may be available based on the current market.
Passive vs. Active Income
When you consider which real estate investment strategy is the best fit for you, it’s helpful to understand the difference between passive and active income. Owning rental property provides you passive income; you receive money regularly with no active participation on your part. On the other hand, flipping property generates active income. While it’s certainly possible to make a great deal of money flipping houses, you have to earn it.
Theoretically, flipping properties could be considered a safer investment strategy than the stock market. Real estate is much more predictable than the stock market, and flipping aims to keep your resources at risk for the shortest possible time. The faster you can flip the house, the more return on investment (ROI) potential. The average house flip takes six months, though it can often take longer for first-timers.
Another benefit to flipping houses is that you can move on as soon as the property is sold, hopefully having made a nice profit. You don’t have to worry about locating tenants, collecting rent, or coordinating maintenance of the property.
There are two types of properties used in the flipping approach to residential real estate investing:
The first type is properties in financial distress so that an investor can purchase them below market value. Investors must know how to identify homeowners having difficulty sustaining their properties or those with overleveraged properties and at risk of default.
The second type is the fixer-upper, a property with structural, design, or condition problems that can be addressed to create and increase value. Fixer-upper investors will remodel or enhance a property and must rely on invested labor to increase values.
It’s possible to combine the two strategies; however, opportunities to do so can be rare, so doing so should not be counted on as a long-term investment strategy.
Flipping houses can present funding issues that you don’t face with long-term investments. The expenses involved in flipping can often be miscalculated and lead to cash flow problems. Also, because transaction costs can be high on both the buy and sell sides, they can greatly diminish profits. Finally, the fast turnaround essential to flipping can cause significant swings in your income that ultimately increase your tax bill. Be sure to consult a tax professional about the tax implications of this approach to real estate investing.
Renting an investment property can generate significant returns, particularly if the real estate is held for several years. You won’t get the large lump sum of cash that flipping should provide, but instead, you’ll collect income in smaller, more consistent amounts as long as you choose to own and rent out the property.
In the long run, there exists a limited amount of land. Therefore, the value of land should always rebound, regardless of decreasing prices. The longer you hold your rental property you increase your chances that you’ll benefit from inflation. You’d benefit even more if you were lucky enough to be able to purchase the property during a buyer’s market and sell it during a seller’s market.
Notably, investment property has tax incentives, and you will recall, flipping does not. Rental property owners can write off the cost of a property manager, repairs and maintenance, and more. But the most significant advantage is writing off your asset’s depreciation, which can potentially save you thousands of dollars a year on your taxes.
As with any type of investment, there is some degree of risk. When investing in rental property, you should expect and plan for periods of extended vacancy. You never know what might cause such a situation, so it’s always best to prepare for the worst. Also, there is potential for your investment to turn into an active income situation. Not everyone possesses the skills or has the resources required to manage a property, and doing so can be stressful and time-consuming. To increase the likelihood of ongoing cash flow from your investment, hire a reputable professional property management company.
Choosing a Strategy
The decision between the two strategies discussed rests on your particular financial situation and goals. It may help to consider whether the funds you plan to invest in real estate are a permanent investment or just a chance to make a quick buck in a hot real estate market. You should also possess the skill or budget to handle the management responsibilities that come with either type of investment. It’s also possible to receive both strategies’ benefits by flipping houses and using the profits to invest in rental property.
The Bottom Line
Many people have created great wealth by flipping houses and renting them out, and you can too with a reliable team on your side. If you’d like more information and resources about real estate investing, don’t hesitate to reach out.