Flipping houses and purchasing rental properties are both good ways to get started in the world of real estate. They’re lucrative opportunities that offer an alternative source of income to the daily grind. But which one is best for those just getting started?
Ultimately, the right answer for you depends on several factors. The two biggest are your goals and how much money you’re willing to risk. To decide which method is best for your situation, you can compare flipping homes and investing in rentals based on four different categories.
Rentals have a much lower risk than flips because you will have money coming in every month from your tenants. This money can be used to pay the mortgage you took out to pay for the property while also giving you a decent flow of cash. It’s a truly passive form of income that can last for several years.
Generally, rental owners will purchase properties that are in good condition. Beyond basic cosmetic upgrades, there are no major changes you have to make or unforeseen expenses that could affect your return.
With flips, you don’t have tenants to provide a monthly flow of cash. On top of that, you might have to make monthly payments to your investors. The good news is that you usually only hold onto flips for a short period and use the final profits to pay your investor and the monthly costs.
The issue with flips, however, is that there are greater financial risks involved. Typically, you’re buying distressed properties that require a lot more work to ensure a positive return on your investment. With distressed properties come more unknowns. You could run into major problems like foundation issues, asbestos, and more, which could ultimately cut into your budget and profit margins.
With both rentals and flips, you can minimize your risks by employing the help of a contractor and inspector who could find those problems before you invest.
With higher risks comes the potential for higher returns. Flips are a great example of that. You can purchase properties that offer a modest 20 percent return on your investment when you sell. If a flip takes four to six months to complete, you could end up completing up to three flips a year. This provides an average of a 50 percent annual return on a year’s investment.
Rental properties, on the other hand, provide a much lower annual return. You can easily find a rental at a 12 percent return. However, that’s for a single property with an all-cash purchase. When you factor in mortgage payments and expenses, that figure can drop significantly.
When it comes to the money required to invest, there’s a huge difference between flips and rentals. Rentals will usually require your own cash or credit. Meanwhile, it’s possible to complete flips with none of your own money invested in the project.
Investors are willing to fund flipping projects because they know that doing so will result in a relatively high return in a short amount of time. However, they don’t want to spend time managing the project themselves. That’s where you come in. Investors will share a percentage of the profits because it’s an easy investment that they don’t have to be involved in.
With rentals, investors can easily purchase properties themselves, hire a property manager, and keep all of the profits. There’s no need for a middle man, so it doesn’t make financial sense to invest in your project.
Let’s say that you purchase a rental property with a mortgage and 10 percent cash down. After mortgage payments, maintenance costs, property management fees, and backup vacancy savings, you’re looking at a 20 percent return on that initial investment per year.
In the grand scheme of things, this isn’t much. It’s certainly not enough to quit the rat race. You can invest in multiple properties, but this takes time and is better suited for building a retirement plan.
Now, consider the investment you make by flipping homes with an investor. Using none of your own money, you can pay for a property in full, spend 30 percent of the home’s value in renovations, and sell it for much more than the sale price. You’ll end up with a significant chunk of profit. Even after paying upfront fees, interest, and splitting the profit with your investor, you’ll still end up with far more money than you would with a rental property. Plus, it’s all pure profit from zero money down.
Rental properties require less of your own time. For the most part, the steps required to start generating income from a rental involve other people working for you. For example, a real estate agent will find suitable properties, your contractor will take care of necessary repairs, and your property manager will get tenants. At most, you can expect to spend 10 hours of your own active time in the month or two it takes to start generating income.
Flipping properties is much more involved. Depending on how you approach the project, it could turn into a full-time job. Taking the time to learn about the process, networking with investors, and finding the perfect property to flip takes time. You may end up working upwards of 80 hours during some weeks.
However, when you do things right, you can earn thousands of dollars in profit a few times a year. Not only that, but those hours worked will be done without any of your own money invested.
The better choice for you depends entirely on how much you are willing to risk. Overall, renting is a safer bet. You can start generating income quickly with very little time invested. However, the potential returns are lower and you need to put up more money or credit upfront. While flips are the riskier of the two options, you can start flipping with zero money down and reap the rewards of significantly higher returns.
Chris Graeve would love to hear your thoughts, and whether you decided to go with flips or rentals, or both in your real estate investment strategies.