Thanks to HGTV and DIY Network, property flipping has gotten much more attention in recent years. From the outside looking in, it seems like a good way to make money fast – even if it takes a lot of work in a short amount of time.
On the flip side (pun intended!) owning investment property isn’t as flashy, but it looks like a passive way to make a lot of money.
So, how do you decide which option is right for you?
If you’re thinking of getting into the real estate game and trying to decide between these two routes, let’s take a look at the differences and common misconceptions.
What Are the Differences Between Flipping and Investing?
If you set out to flip a property, your goal is to buy something that is undervalued, fix it up, and sell it for a profit – preferably within a short period of time. You’re hoping to capture the appreciation of the property value.
However, when you invest in a property you plan to rent to tenants, your goal is to achieve a regular cash flow. You probably won’t get as much cash as quickly, but you will receive a steady supply every month.
Flipping a house is a job. Buying a rental property is an investment.
The Most Common Misconceptions About Flipping and Investing
One major misconception about real estate in general is that you will get rich quickly. Most people won’t. In fact, you might not even make much money for a few years.
Making money from real estate, whether by flipping or investing, is generally pretty slow and monotonous. You have to go through the same motions over and over again.
Real estate is a long-term game.
When you flip a property, if you don’t spend too much on upgrades and if the market doesn’t drop while you own it, you will likely make a good profit at the sale.
However, if you plan to continue on this path, much of the money you make will then roll over into the next purchase. So, you won’t necessarily walk away from the process pocketing a lot of cash.
Another misconception about investing in a rental property, especially when compared to flipping, is that you won’t make as much money. Again, you won’t make as much right away, but you will have a steady income coming in over time, which is not to be underestimated!
The Downsides of Flipping Properties
Something you should keep in mind regarding both of these options: Both scenarios require money up front. Oftentimes, if you are trying to secure financing, your lender will want to see that you have six months’ worth of expenses in reserve.
Generally speaking, flipping is the bigger risk. It’s easy to get upside-down if you aren’t disciplined in your approach, meaning you can wind up spending so much on renovations that you don’t make any money—or you lose money.
Also, you’ll need to try to time the market. If the market drops while you own the property, you may lose money when you try to sell it.
Don’t underestimate the cost of holding the property. If you finance the purchase, the longer you own it, the more interest you’ll pay. Your profit will need to outpace the cost of buying the property, the cost of renovations, and the cost of interest, as well as things like utilities, lawn care if applicable, HOA dues, and those sorts of things. Unloading the property in a timely manner may be more important than chasing the maximum profit.
You should have a good idea what kinds of renovations or fixes you want to pursue before you buy the property. You may run into unanticipated structural problems or other serious issues that go beyond cosmetic fixes.
The Downsides of Investing in Rental Properties
Owning a rental property is a longer-term commitment than flipping a house. You can flip one house, and if you don’t enjoy the experience, you can count it as a learning experience and move on. An investment property will require a longer time commitment to recoup your funds and make money.
The main downsides of an investment property are the hassles of being a landlord: finding good tenants, property management, and property maintenance.
(One upside to investing? When property values go down, rental rates typically stay about the same. And if they go down, they don’t drop as quickly. Rental rates are more likely to allow you to maintain a positive cash flow during a market downturn.)
The Tax Implications for Flipping and Investing
Before you make any moves into the real estate business, you should discuss these topics with your tax professional. The information in this article does not take the place of a consultation with your CPA.
Taxes generally favor investment property. When you flip a property and make a profit, that profit is taxed as capital gains. If you sell within one year, your profit will be taxed as ordinary income. If you own for more than a year, the tax rate will most likely be lower.
Income you receive from a rental property will most likely be taxed as passive income, which is taxed at a lower rate than capital gains.
How to Choose Between Flipping and Investing
Real estate, in general, is not a good business for people looking to make a quick buck with minimal effort. Both flipping and investing take work and discipline, and both strategies take some time to make a profit.
The two actions don’t have to be mutually exclusive. Sometimes an investor will flip a few houses to make money for a down payment on an investment property. Or someone who owns a few rental properties may pick up something to flip just to boost his bottom line one year.
Just try to think through the implications of each action and come up with a strategy that suits your personal goals. If investing is right for you, then LEAP Property Management can help you with all your rental property management needs.