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Flipping homes and holding them for a long term are two dramatically different approaches to making money in real estate. Some investors specialize only in one particular area. Others like to employ both strategies: selling off some properties and keeping others in their portfolio. I like comparing flippers and long-term investors to hares and turtles – without passing judgment on hares. Both animals are evolutionary winners and thrive because of their different survival skills. Similar to them, short-term investors (aka flippers) work, think, and build their wealth in different ways from those who are planning to hold onto their properties for years to come. So how different is flipping homes vs holding them? Most importantly, what is the best way to leverage each strategy to make money in real estate?
Rentals Build Long-Term Wealth and Generate Passive Income
The Merriam-Webster dictionary defines an investment as “the commitment of funds to minimize risk and safeguard capital while earning a return.” Becoming a landlord fits the definition to a “T.” The long-term outlook minimizes your risk by protecting you from real estate market fluctuations. At the same time, your monthly rents provide you with a return or “dividend.”
While being a landlord has its own challenges, long-term investing is considered passive income. Once the mortgage on your property is paid off, a well-managed property should generate stable income for years to come without everyday involvement from its owner. This is why building your real estate investment portfolio is an ideal retirement diversification strategy. While you are still physically and mentally capable of managing your properties, you can enjoy the regular income they generate. Once you become too old to manage them effectively, you can easily convert them to cash by selling them.
The challenge with having rental properties is that it might take years to pay the loans secured against them. Meanwhile, you will make mortgage payments, pay taxes, insurance, and HOA fees, and cover maintenance and vacancies. Sure, the monthly rent payments will cover the bulk of these expenses. Sure, your net worth will be increasing – at least on paper. Still, the property’s income will be marginal at best until all the liens are paid off and the property is free and clear, which might take fifteen to thirty years. This is a long time, and it would require financial resources, discipline, and determination to keep the course. Are you ready for it?
Flipping Homes Generates Immediate Income Streams
Flipping homes is different. Home flipping refers to the real estate investment strategy of purchasing a property, making improvements (usually renovations or repairs), and then selling it quickly for a profit. The idea is to “flip” the property—buy it, fix it, and sell it—within a relatively short period, often within a few months to a year.
Some analysts out there like to think about flipping homes as speculation. I strongly disagree with such a view. Speculation is commonly defined as the practice of committing capital to risky financial transactions in an attempt to profit from short-term fluctuations in the market value. Yes, fix-and-flip transactions are short-term in their nature, but they are NOT relying on short-term market fluctuations. In fact, as a hard money lender, we steer borrowers against hoping for market appreciation when analyzing their transaction’s profitability.
What generates the profit in fix-and-flip transactions is its “fix” part. It turns a property that is so neglected it is frequently ineligible for traditional financing into a modern home ready for new occupants. Yes, you need capital to purchase a property, but capital alone is not enough. Every investor actively invests their labor by physically working on the property or managing the crew. It’s that labor that creates value for future buyers and the community. This labor, together with the capital invested in the transactions, generates profit for the investor.
As opposed to a buy-and-hold strategy, the income earned via a fix-and-flip project is more active. In many cases, it’s more similar to earning money by working a regular job than by passively investing your capital. As such, flipping homes is not a strategy that will support you in retirement (unless you are buying in the name of your self-administered IRA using non-recourse loans).
Use a Combination of Fix-and-Flip and Fix-and-Hold to Make Money and Build Wealth
When deciding whether to hold or flip the property, consider rentals as an investment that one day will support your retirement. Unless you are mortgage-free, it won’t generate little immediate income. In twenty to thirty years, however, you will have a free and clear asset that makes you money on a monthly basis.
In contrast, think about flipping homes as your active business to generate income right now. One portion of this income supports your lifestyle. Use another portion to reinvest and fuel your renovation business so you can fund more expensive projects or invest in more properties simultaneously.
Unless your money is infinite, sooner or later, you run out of funds to finance new acquisitions for your rental portfolio. This is why our mosy active borrowers do more flips than buy-and-holds. They need to generate money to keep growing and expanding their business and then need these funds now. The most disciplined and successful set a few properties aside to keep in their real estate portfolio and flip the rest of them.
New Funding Resources is a private mortgage lender that helps Maryland real estate investors make money by buying and rehabbing investment properties. For more information on deciding whether you should flip homes or choose a buy-and-hold strategy, please read our next blog article.
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