Flipping Houses vs Rental Property - The Best Way to Invest in Real Estate
You can make money in any area of real estate.
But, it's hard to be good at everything. So, in order to be successful, you should focus on one thing and become exceptionally good at it.
So, the question really is, should you flip houses or rent them out?
That really depends... Keep reading and I'll explain.
Should I Flip Houses or Rent them Instead?
In this article, we've moved beyond the question of IF we should invest in real estate. Stocks can't compare to real estate, so of course we are going to buy property. So, the more important question is "what is the best way to invest in real estate?"
I've done flips and I own plenty of rentals (see my newest rental property). Over the years I have become biased toward one area and believe it's far better. But, I recognize the importance of both areas of real estate... So it really comes down to your goals.
In order to know what's better to invest in, you need to understand your goals better.
Passive Income vs Active Income
To understand if you should flip or rent houses, you need to understand the difference between passive income and active income.
Passive Income is earned without much effort. Regardless of where you are or what you're doing, the checks keep coming.
Active Income requires day to day involvement (work) in order to generate the money.
Eventually, we will all retire and in order to do that, you need passive income. A lot of passive income usually requires a lot of money invested, so you can use active income to grow your passive "nest-egg."
So, I would ask you to answer the following questions
- Do you have enough money to retire now?
- If not, do you want to stay in your career field or switch fields (to real estate)?
Hang on to those questions, we'll come back to them.
Flipping is not Investing
Alright, a thousand people are up in arms that I would even dare to say that. "Real estate investor" has become a catch phrase for all flippers. Stock market day trading is not investing so why would the real estate equivalent be considered investing?
Don't get me wrong, you can earn a ton of money from it...but notice how I phrased that sentence - You can earn a ton of money.
Let's quickly compare that to the definition of speculation.
Speculation is the practice of engaging in risky financial transactions in an attempt to profit from fluctuations in the market value of a tradable good such as a financial instrument, rather than attempting to profit from the underlying financial attributes embodied in the instrument such as capital gains, interest, or dividends.
So, yes you put money and time into real estate with the expectation of obtaining profit, but a day trader puts their money into a stock and expects to get profit. People put their money in all kinds of things and expect to get a profit.
The reality is, you need to also put time and effort into making a plan, overseeing the project, and ensuring your vision can be achieved within the budget in order to earn money when it sells. A lot of these aspects are active income and would be considered work, not investing.
What is house flipping - flipping is a combination of speculation and working (project management).
You can make a ton of money flipping
Just to be clear, I'm not saying you shouldn't flip. I'm just saying you should understand that it's a business and not an investment.
You can earn a ton of money with flipping, There are people making millions doing it.
Owning Rental Property is Investing; Flipping is Speculating
Flipping is a combination of speculation and project management.
Buy and hold rental property is an investment based up underlying expectations of long term capital gains, and dividends (rent income).
It's really important to have this distinction because it will help us figure out what we want to do with our money and time. Like I said before, you can make money in just about any area of real estate, you just need to decide which area, and how much time to spend.
House Flipping vs Renting
Let's get back to those questions. I'll just go out on a limb and say, if you answered "yes" to question #1 then just take your extra cash and invest in some passive multi-family properties or other rental property. Unless you're looking to start a second career.
Keep your job and invest in real estate
If you want to keep your day-job (I don't know why you would want that), you still can be involved in real estate. Since you are already working full time, you will want real estate to be part-time which still leads you back to the same question - flip part time or invest in rental property.
If you have a job already, I personally would lean toward rental property. It's easier and takes much less time to manage compared to flips. You can also use your income to get more properties where as it's harder to get loans without a job. It will earn you less at first, but once you start accumulating property you will be fine.
Quitting your job and becoming a real estate investor
So you don't have enough money to retire now (question #1) and you hate your job and want to work for yourself or start your own business (question #2).
Should you flip or buy rental property.
The answer is simple - both!
You will need the flipping income to replace your salary. You will want the rental property to provide for your retirement.
I recommend learning about preparing financially to invest in real estate before you quit your day job (you may need that income to get your first rental or two).
The Pros and Cons of Flipping
Quick breakdown of the good and bad about flipping:
A Lot of Cash - Quick
Flipping can put a lot of money into your pocket and put it there fast. The better you are at flipping, the more money you put in your pocket....obviously, right?
Well, I mean it from a mathematical point of view. If you can earn even $5,000 or $10,000 per flip, but can turn them over very fast, you can make a huge ROI.
Just for round numbers, if you earn $10k per flip and you take one year to do it, you earn $10k. If you increase the velocity of your flips, you can earn more per year even if you earn less per flip.
Let's say you hire out some sub-contractors and now you are only earning $6k per flip, but now you can get it done in 2 months. That's 6 flipped houses per year, or $36k profit.
No Long Term Headaches
Some properties are maintenance nightmares. They are old or just designed in a way that will cause it to always need excessive maintenance.
Other properties are in neighborhoods that just attract the wrong type of tenant - the one that causes problems, doesn't pay rent, or robs banks (yea, I had one of those once).
Unless you are hardcore, you may not want to take these headaches on. It may be easier to sell the house for quick cash rather than take on these long term problems.
You Have a Lot of Spare Time to Manage Projects
If you have a lot of spare time and don't want to sit around, flipping is a great way to earn money, work in real estate, and take up your time. Realistically you could manage a few flips at the same time before you even need to hire an assistant or project manager.
Opportunity Cost of Flipping
This is an economic term for - "what you give up in order to gain something else." Basically, by taking on a job flipping, you give up the opportunity to work full time in another career.
You can make money flipping, but you need to consider if it will pay you more or less than your current career. Also, since flipping creates active income, as soon as you stop working at it, your income will dry up. Flipping is still a job.
Taxes on Flipping Income
Taxes are complicated so this cannot be construed as tax advice (consult with your accountant), but taxes on flipping income is generally taxed like self employed income - and the self employed pay the highest income taxes of anyone (up to 43%). I won't get into the details of it, but you basically need to pay an additional 15% tax on top of all your normal taxes.
Rental Property is a Long Term Play
We have already discussed how flipping can earn a lot of money in a short amount of time. The other side to this coin is that rentals tend to earn less, but they earn it consistently over many years.
Since you plan to keep the property for a long time, you will want to spend more time investigating the property before you purchase it, as you need to check both tenants and the physical property itself. Things you could brush under the rug for a flip will need to be addressed for your rental.
Rental Property is Passive Income
If you break your neck tomorrow and can never work again, this money never stops coming in. You may not earn so much as a flip, but it's permanent income.
Naysayers may say that all properties will require some effort, which is true. But, you don't have to deal with any problems or tenants if you don't want. It's simple to hire a property manager and it's not even a big deal if you work the numbers in before you purchase.
Investment Property Has Tax Incentives and Flipping Does Not
Rental property is taxed as investment income and you also have a number of write-offs to help offset your taxes.
Investment income is usually taxed at 15% (or 20% if you make a ton of money). Compare this to the 25-43% on flipping income, and you are saving a ton!
Also, you can write off a lot of additional expenses with investment income. The biggest benefit is writing off depreciation, which can save you thousands each year in taxes.
Answer: Should I Rent Houses or Flip Them?
I've gone over the pros and cons of each. I believe that you can retire in 5 or 6 years if you focus on rental property, but flipping may be a necessary evil for you depending on your individual situation. So, a hybrid approach may be best for some people.
Buying rental property quickly sucks up your spare cash. Without cash, it becomes very difficult to buy more rentals.
Flipping is Your Business and Rentals are Your Investments
Treat flipping as a business and do not lose focus on the fact that flipping is a job. It requires constant attention, time, workers and employees, and effort but it can produce a lot of income.
If you constantly put all your money back into your job, you'll find some day that you have a lot of cash but no passive income.
Use Flips to Generate Cash for renting property
Take your extra money and put it toward your investments to build up your passive income streams.
As you get more passive income, you can spend less time working. Eventually, you will be completely financially independent and you won't need to work, though of course you can still continue to flip if you enjoy it!