Should you fix and flip, or buy and hold?
Real estate investing
- Fixing and flipping can generate quick profits.
- Evaluating properties and repair costs for a quick sale is an acquired skill.
- Long-term real estate investment is a proven source of wealth accumulation.
- Rentals require systematic management and tenant-relations policies.
A basic decision to make if you are entering the real estate investment business is determining just what type of investor you want to be. Will you be a fix-and-flipper, who buys, upgrades and sells properties regularly and seeks a quick profit? Or, will you be a buy-and-hold owner, who invests in property for the long term and relies on steady rental income, as well as the promise of years-long property appreciation?
Although it's not new, a fix-and-flip strategy is now the trendier approach, made popular by reality TV shows and online real estate gurus. A buy-and-hold approach is the less flashy path that has, for centuries, allowed investors to generate a good income and accumulate wealth.
One is not necessarily better than the other. Each has advantages and disadvantages related to both starting out in the business and maintaining solid investments.
Pros of fix and flip
1. It can generate a quick profit. When it goes right — that is, when you find a property in a promising location that needs mostly cosmetic, rather than structural, repairs — fixing and flipping produces a profit with a relatively small investment and without tying up capital for a long period of time.
2. It's less risky. In terms of worries about the overall real estate market, there is more shelter from the storms compared with longer-term plays.Fix-and-flip investors who do their research know what their property is worth, and what price it will likely bring after improvements, so there is a reasonable degree of predictability. Property flippers work fast, and are generally less susceptible to long-term market fluctuations.
3. It's simpler. Sure, there is the hassle of making the repairs that quickly improve the value of a property, but there are not the constant management headaches that come with being a buy-and-hold landlord. Most significantly, you do not have to find tenants, make judgments about their financial condition, and deal with the consequences if they don't pay the rent.
Cons of fix and flip
1. It's an acquired skill. Successful fix-and-flippers can expertly compare the value of existing properties, estimate the selling price of fixed-up houses, and anticipate the extent and costs of necessary property repairs. A mistake anywhere in the process, or the inability to navigate the inevitable unexpected problems, can reduce or wipe out profits.
2. It's expensive. Buying and selling real estate requires access to money.Every transaction potentially involves fees — from real estate agents, banks, lawyers, title companies and others involved in the sale and closing processes. Also, interest rates are generally higher for short-term fix-and-flip loans, compared with traditional long-term mortgages, and any delays in repairing or reselling a property can become quite costly.
3. It has tax consequences. The fix-and-flip approach to property investment leaves you open to more tax liabilities and fewer tax breaks than does long-term real estate investing. It can be complicated, and individuals should get specific tax advice, but in many cases the IRS considers revenue generated from fix-and-flip transactions a form of active income that is taxed at a higher rate than long-term real estate investments, and taxes typically cannot be deferred by rolling funds into another investment property.
Pros of buy and hold
1. It creates long-term value. Investing in real estate for the long term is a proven strategy for accumulating substantial wealth. Buy-and-hold investors can ignore short-term market fluctuations and take advantage of tax breaks, with the confidence that, historically, real estate rebounds after severe market declines and outperforms many other investments.
2. It's steady income. With some allowances for periodic vacancies and missed payments, landlords can generally depend on rent payments and on a reliable stream of prospective new tenants. If the mortgage-related costs work out initially, investors can be fairly confident that their property will only become more profitable over time, as a result of rising rents.
3. It can require less capital than fix-and-flip investing. Long-term investors do not have to estimate the cost of extensive property repairs, nor pay contractors to make the fixes. Also, although maintenance costs are a concern for any landlord, a long-term investor can often delay unessential repairs, such as cosmetic upgrades, that could make or break a deal for fix-and-flippers.
Cons of buy and hold
1. It's a management project. Although rents are often referred to as "passive income," there's nothing passive about responding to maintenance emergencies and conducting regularly scheduled repairs. Landlords sometimes hire management companies to handle those details, but that's often too expensive to make sense for small-scale investors.
2. It requires good tenants. This is a separate management issue itself. It's time-consuming to advertise for tenants and check their credit, and even the most conscientious landlords know that good tenants are hard to find. Long-term investors need to be aware of legal issues arising from landlord-tenant relations, especially laws that regulate evictions and collection of unpaid rent.
3. It's not a get-rich-quick business. Unlike fix-and-flippers, long-term investors are not embracing the promise of a quick remodel to improve the value of their property. Instead, they're relying on the overall real estate market to produce the returns. Real estate usually appreciates considerably, but over a time frame measured in years, or even decades, rather than weeks or months.
So, it's not a matter of one technique being superior to another. Taking into account the advantages and disadvantages, the decision on whether to fix and flip or buy and hold usually comes down to a matter of investment-risk philosophy, financial resources, repair and maintenance skills, and simple personal preference.