In order to outline the implications of the flip or hold decision, one must understand the issues inherent to each of the transaction strategies. The question of whether to buy and flip or buy and hold is better real estate investment strategy does not have one correct answer. Rather, the decision to choose one strategy over another should be part of an explicit strategy that takes the investor’s overall investment goals, as well as the opportunities in the existing market, into account. This article will discuss each investment strategy’s advantages and disadvantages and to find out which strategy will edge out the others in the market in which you invest.
Why Invest in Real Estate?
Real estate ownership is gaining ever-increasing interest from retail investors for many of the following reasons:
- Real estate provides more predictable returns than stocks and bonds.
- Real estate provides an inflation hedge because rental rates and investment cash flows usually rise by at least as much as the inflation rate.
- Real estate provides an excellent place for capital in times when investors are unsure of prospects in the stock and bond markets.
- The equity created in a real estate investment provides an excellent base for financing other investment opportunities.
The Influence of Market Factors
Real estate is a unique asset class in that compared to stocks and bonds, it is a relatively inefficient market and is characterized by low transaction volume and market data that is not very transparent, lacking and not up to-date.
Some investors focus on flipping—that is, turning properties over quickly, rather than keeping them long term. In some cases, holding property generates more long-term wealth for you than flipping. Therefore, you may consider flipping some properties and holding others. On the other hand, you may consider using the flipping strategy awhile, and then begin holding properties later. The big question is, “When should you hold versus when should you flip?” By knowing the 18-year property cycle will enable you to time the market and make the hold or flip decisions easily.
The Pros and Cons of Flipping
The most apparent advantage of flipping is that you can cash out immediately and to have capital tied up for the least amount of time possible. For many people, the ability to realize gains right away is highly appealing.
Also, unlike the stock market, which can change in the middle of a day, real estate markets are more easily predicted and have a longer timeframe that compensate investors for flipping properties. In this sense, flipping properties could be considered a less risky investment strategy because it is intended to keep capital at risk for a minimal amount of time and because it lacks the management and leasing risks inherent in holding real estate.
For most investors, flipping properties should be considered more of a tactical strategy than a long-term investment strategy. Because transaction costs are very high on both the buy and sell side, they can significantly affect profits.
There are two major types of properties that can be used to flip compared to real estate investing. The first is homes or apartments that can be purchased from motivated sellers and have below current market value. The second is the buy and renovate to create value. Investors that focus on distressed properties do so by identifying homeowners who can no longer manage or sustain their properties or by finding properties that are overleveraged and are at risk of going into default.
Those who prefer fix it/remodelling by enhancing the value of the property so that it works better for prospective buyers or is more efficient for apartment tenants. Using this tactic, the buyer of a fixer is relying on investing capital to increase values as opposed to just buying property for a low basis in order to create high investment returns.
However, flipping properties can create tax and cost issues that one doesn’t face with long-term investments. Flipping usually leads to swings in income that can create cash flow and tax management issues. Also, finding these opportunities can be difficult over the long term, making this strategy better suited for those wishing to take advantage of shorter-term opportunities in the real estate market.
The Pros and Cons of Holding
It is a well-known fact that buying and holding real estate is a recipe for amassing great wealth. Most wealthy entrepreneurs in the world accumulated their wealth through land ownership. Even after periods of decreasing land prices, land values have almost always rebounded in the long run because there is a limited supply of land.
Property holders can generate true wealth over the long term. Historically, property values appreciate at a rate greater than the rate of inflation. If you buy in the right time and in the right area, your annual appreciation may reach double digits.
You can use properties with equity as collateral. You can provide rental income for your retirement years, and you can pass property down to the next generation. Once your rental properties are free from encumbrance, you have passive income from rents paid that gives you an income even when you’re not working.
Equity investors have to have the skills to analyze a particular market, a particular company and management’s ability to execute its business strategies. A long-term real estate investor needs the same skills but has the added responsibility of creating and executing those business strategies for his or her properties. Many investors, especially first-time rental property owners, are ill-prepared or ill-equipped to deal with the responsibilities that come with managing rental property. The process of finding quality tenants and servicing their needs, along with ensuring the maintenance and upkeep of the property, can be a stressful and time-intensive undertaking, but successful property management is necessary for ensuring ongoing cash flows from one’s investment.
The risks inherent in long-term real estate ownership are great, but if mitigated, the investor is well compensated for assuming them. Most of these risks, which include the transactional risks of purchasing and selling properties, risks to the well-being of the property and the risks of finding and maintaining tenants are considered unsystematic risks, or investment risks that can be diversified away if an appropriate number of investments are purchased in a well-crafted portfolio.
The problem for most investors is that real estate is so capital-intensive that the amount needed to purchase enough property to diversify away these risks is outside of their abilities.
Choosing a Strategy – What’s Right for You?
The important question isn’t whether flipping is better or worse than holding, but which strategy is right for you. To discover the answer for yourself, ask these questions:
Do I need additional cash now or in the future?
An investor must decide whether the capital allocation is a permanent or a transient one and whether it is a core part of an overall investment strategy or a means to enhance returns.
Am I in a high-income tax bracket that would be adversely affected by more income now?
Does my local real estate market present opportunities to acquire bargains, yet still command high rents that would cover my expenses if I need to hold on to the properties?
One also needs to determine what risk and return is appropriate for this portion of their investment portfolios and whether the investor has the appropriate tolerance and skill to take on the management responsibilities that go along with either type of investment.
Do I have other income or savings that I could tap into in case my rental properties become vacant or need major repairs?
If the capital is not available to purchase a diversified portfolio, a prospective investor must be prepared to take on unsystematic risk including individual property risks and potential lack of demand for the property, whether by homeowners or renters.
Is the local real estate market rising or falling at this time?
By knowing where you are in the 18-year property cycle you will find the answer easily. Find out more by clicking here.
Does bringing in income now or later fit into my short-term and long-term financial goals?
Choosing the two strategies in question depends on one’s particular financial situation and investment goals, the long-term holding strategy is generally more appropriate for those using real estate as a core portion of their overall investment portfolios; flipping properties is more appropriate when real estate is used as an adjunct or a return-enhancement tactic.
Investors wishing to amass wealth and to derive income from their real estate investments should consider holding real estate for the long term, using the equity built into the portfolio to finance other investment opportunities, with the potential of eventually selling the properties in an up market.
Flipping properties is a tactic that is best suited for periods when prospects in the stock and bond markets are low, or for investors wishing to realize short-term capital gains for as long as the present market will allow.
Most investors start out flipping houses, and then gradually work into managing rental houses or becoming involved in larger, more complex real estate projects. Some people don’t have the temperament to deal with tenants and the headaches that come with rental properties. Some look for side income by flipping. Others want to quit their jobs and make flipping houses their full-time business.
Be sure to consider all options, including a combination of flipping and holding properties. Review your financial goals on a regular basis and adjust your real estate strategies to support these goals.