Buy to Flip or Buy to Hold?
It’s not uncommon for residential real estate investors to begin dabbling in real estate by flipping homes before pursuing a buy-to-hold strategy.
Flipping a home may bring in more money over a shorter time period than a buy-to-hold strategy and it requires a smaller out-of-pocket financial investment.
The true goal of a real estate investor, however, is to hold an asset that appreciates in value and pays the investor back along the way. A house flipper is more of a dealer: buying at a discount, improving an asset and selling it at what the market will bear.
In this post, we’ll take a look at what it takes to be successful at buy to flip and buy to hold to decide which strategy is best for you.
THE SUCCESSFUL FLIPPER
Flipping, first and foremost, requires a good lead source for home purchases. That often means finding a wholesaler in your market who is willing to sell distressed properties at a discount to market prices. Some flippers also attend public auctions to bid on REOs, but that option is becoming less viable as foreclosures decline nationally. Still others deal with distressed homeowners directly.
Networking at real estate investment clubs, where investors may have properties to sell, is one place to begin building leads. Some investors also advertise via direct mail or other means to find properties to flip.
Flippers will need a good rehab skill set or they could quickly find themselves in a financial hole. They should understand the ins and outs of hiring a good contractor and what questions to ask. There are inherent risks in buying distressed or discounted property, as there may be unforeseen issues that aren’t discovered until the rehab begins.
That’s why buying deep must be the goal to ensure a solid return. This type of real estate deal is generally financed by hard money lenders — financing that comes at a significant cost with interest rates usually in the double digits — so flippers will want to get their properties rehabbed and sell quickly to keep financing costs down.
BUY AND HOLD
Sometimes a home bought with plans to flip won’t bring in the projected return. This could happen when the flipper pays too much for the property up front, when renovation costs exceed the rehab budget, or if the housing market softens.
When a situation like that occurs, the investor may decide it makes sense to convert the asset into a rental home.
Such a situation often is a good segue into a buy-to-hold strategy, which allows an investor to create value from rental cash flow. At the same time rental cash flow is coming in, a buy-to-hold investor has an appreciating asset. Say a home is purchased for $100,000 and it appreciates at just 3% per year. That means your $100,000 home in 10 years is worth about $134,000. During this time, the investor is paying down principal and receiving a depreciating tax shelter as well.
WHICH STRATEGY IS BEST?
Now let’s examine whether you should flip or buy-to-hold. The answer often depends on where you are located and what is happening with home prices in your particular metro market. The interest rate environment may also play a role.
As home price appreciation slows, as it is expected to do this year, the volume of flipping usually declines. That is because the profit that flippers can expect to gain on the flip is likely to decline.
Rising home prices can translate into significant short-term gains for flippers. If you live in a region where job growth is exploding, such as the northern Dallas suburbs — then this might be a good strategy to pursue. However, on the downside, a hot housing market also means it might be difficult to buy deep.
A buy-to-hold strategy makes more sense in markets where the housing market is soft, as the investor is in it for the long term and willing to wait things out. It also makes good sense when investors cannot find homes at deep discounts.
These regions often allow the RE investor to still charge a competitive rental rate that will bring in healthy returns, even without buying much below market prices.
Asset-based lending, the type of lending done at B2R Finance, allows an investor to finance their properties based on cash flows from the rentals. The buy-to-hold strategy usually also allows the investor to put less money into the rehab to get it to rental grade as opposed to selling grade.
Both strategies, buy to flip and buy to rent, provide tax benefits.
For more information on asset-based lending and how you can leverage equity in your current rental properties to unlock equity and free-up cash to buy more rentals, contact John Cantleberry at firstname.lastname@example.org.
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