Is it smarter to buy-and-flip or buy-and-hold? The answer depends upon an investor’s financial goals, appetite for risk, access to capital, time constraints and other factors. In general, buy-and-flip is preferred by investors who seek immediate financial gains and actively managed projects. Those who desire steady income and a passive approach are more likely to choose a buy-and-hold strategy. With buy-and-hold, investors build monthly income versus a one-time payout from buy-and-flip.
Market conditions sometimes dictate which strategy should be utilized. Buy-and-flip is generally most successful in real estate markets characterized by buyer demand and a plentiful supply of aging homes in need of facelifts. Foreclosures and REOs often present affordable purchase opportunities. In markets where housing inventories are scarce and most properties are already in mint condition, there are fewer opportunities for upgrades that can drive fix-and-flip profits.
Either strategy requires time and effort. Flippers must constantly be on the lookout for that next property. In addition to finding properties, flippers must continually deal with lenders, realtors and contractors. The day-to-day responsibilities for landlords include finding tenants, collecting rents and maintaining properties.
Major pros and cons of the buy-and-flip approach are discussed below:
Buy-and-Flip: Pros and Cons
Pro: Potential for High ROI. Buy-and-flip strategies involve purchasing a property at a discounted price, making upgrades and re-selling the property at market price. A flipper who is skilled at figuring out what buyers want and keeping renovation projects on-track and within budget can often generate 50-60% returns on investment.
Pro: Quick turnaround for capital: Another appeal of buy-and-flip is short hold times. Most flips are completed within a few months and profits are realized immediately when the property is sold. Investor capital is not tied up for extended periods of time. A downside of the buy-and-flip approach, however, is that large amounts of money may be required upfront. Investors pay closing costs, commissions, inspection and permitting fees, interest on loans and labor and material costs.
Pro: Less risk exposure: Since a buy-and-flip investor doesn’t hold an asset for long, exposure to market risks such as rising interest rates or downturns in the local real estate market are minimal.
Con: Many outsiders involved. The typical buy-and-flip investor relies on a hard money lender, private investor or business partner to provide financing. These lending professionals have their own interests to safeguard, which may not always align 100% with those of the borrower.
Con: Unplanned repairs. It’s not unusual to encounter unforeseen problems during a renovation that require additional repair work and extra expense. Big problems can quickly blow through a budget and eliminate any chance of making a profit. Although unexpected problems are also encountered with buy-and-hold strategies, risks are spread over a longer period of time. As a result, cost overruns are more easily absorbed and the damage to profits is more controllable.
There are also several pros and cons associated with buy-and-hold strategies:
Buy-and-Hold: Pros and Cons
Pro: Predictable income. A major appeal of buy-and-hold is the ability to generate monthly income. Owning multiple properties that are all producing rental income can quickly build a solid income stream. While an income stream can also be generated from buy-and-flip, a nearly continuous flow of deals would be required.
Pro: Increased potential for capital gains. Buy-and-hold typically offers greater opportunities for capital appreciation than buy-and-flip. In most circumstances, a well-maintained property will continue to appreciate in value, potentially yielding sizable gains when the property is sold after several years. Owning a property long-term also means that the investor is less affected by the whims of the market. Buy-and-flip investors sometimes must sell properties regardless of market conditions whereas buy-and- hold investors can wait for the optimal moment to sell.
Pro: More flexibility on purchase price. Buy-and-hold strategies may be successful even if the property is not acquired at a distressed price. If monthly rental income covers expenses, the investor has the luxury of allowing equity to build over time.
Pro: Better access to financing. Financing is generally easier to obtain for rental properties than for flips. One reason for this is that FHA loans are usually not available for buy-and-flip properties. A requirement for FHA financing is that the borrower has owned the property for at least 90 days.
Con: Cash drain from vacancies. A major downside of buy-and-hold is properties that aren’t generating income while the property owner remains on the hook for monthly maintenance costs, utilities, mortgage payments and other expenses. A property that stands vacant for several months can create a significant drain on investor resources.
Con: Dealing with tenants. Finding good tenants takes time, patience and initiative. Keeping good tenants requires constant property maintenance and quick responses to tenant complaints. Collecting back rent and/or evicting problem tenants can be both difficult and unpleasant.
All other things being equal, tax issues may sometimes make one strategy more attractive than the other. The tax implications of the two approaches are very different. Buy-and-hold investors pay taxes on rental income and capital gains taxes when properties are sold. Most rental properties are held for several years. As a result, profits on the property sale are treated as a long-term capital gain and taxed at a 15-20% rate. Buy-and-flip investors also pay capital gains taxes on property sales. However, because most flip properties are held for only a few months, profits on the sale are considered a short-term capital gain, which is taxed at the same rate as ordinary income. For some investors, this tax rate can be higher than 35%. Buy-and-flip investors who do many transactions may also run the risk of being classified as dealers by the IRS. In addition to dealer profits being taxed at the higher ordinary income, dealers may be required to pay a self-employment tax. In 2017, the self-employment tax rate maxes out at 15.3% and is paid on the first $127,200 of self-employment income (up from $118,500 for 2016).