Flipping vs. renting is always a tough decision. Both are viable ways to earn income as a real estate investor and have their own advantages and disadvantages. So which is a better way to invest -- flipping or buying rentals?
Let's take a look at the differences between the investment strategies as well as the pros and cons of each to help you determine which may be a better investment for you.
Flipping houses vs. buying rentals -- the big difference
The biggest difference between flipping housings and buying rentals is that flipping requires active management, while rentals earn you passive income from monthly rent.
You don't have to do all the work yourself to flip a house, but it requires active management, oversight, and participation. Flipping houses is more like running a business than being an investor. Your income is limited to the number of flips you do. You only make money when you find, fund, and flip a house. This is typically paid as a one-time lump sum.
When you buy a rental property, you do the work once and receive monthly cash flow in the form of rent checks every month. Rental income is ongoing and doesn't stop until the property becomes vacant or you sell it.
The pros of flipping houses
Flipping houses has significant advantages. The primary benefits are that you can make lots of money at one time and it's a short-term investment.
You can make large amounts of money quickly
Flipping properties can produce a large income in a short amount of time. Most flips can be completed in three to six months and produce tens of thousands of dollars in profit if done properly. The faster your money is returned to you, the higher the return on investment and the more deals you can complete.
If you complete five flips per year making $20,000 per flip, you could earn $100,000. Making the same amount of money with rental real estate would be extremely difficult in the same amount of time.
It's a short-term investment
While you still have your fair share of management dealing with contractors and real estate agents, flipping a house is a short-term investment. In just a few months, the project is completed and you can move onto to the next venture -- hopefully with some money in your pocket. You don't have to deal with long-term management of the property, like collecting rent checks and dealing with tenants (or evictions).
The cons of flipping houses
Of course, there are downsides to flipping houses, too. The main disadvantages include paying more taxes than you would on rentals, having your success dictated by the market's whims, and unexpected expenses cutting into your profits.
When a property is sold for more than it was purchased for, it's subject to capital gains tax. The capital gains tax rate varies based on the time the investment was held.
Flipping houses is typically taxed as a short-term capital gain because they're held for a year or less. Short-term gains taxes can be anywhere from 10% to 37%. This means flippers often pay the highest income tax.
Rental properties, as long as they're held for more than a year, are taxed at long-term capital gains rates, which can be 0%, 15%, or 20%.
At the mercy of the market
Investments that rely on appreciation aren't investments -- they're speculations. Flipping houses assumes the improvements will increase the property value enough to make a profit. And that relies on current or improving market conditions.
In a growing or expanding market, this is possible. But, if the real estate markets crash, the assumed value can dramatically decrease, putting house flippers in a risky position.
Unexpected expenses and repairs can hurt your bottom line
It's especially important for new investors to prepare for unexpected expenses and repairs in their first few flips. Contractors can leave without completing their work, do a poor job, or take longer than expected. Expensive unexpected repairs could arise as the project is underway.
This can cause higher-than-expected costs, which hurts your final return.
While you can make a lot of money flipping, you can lose a lot of money, too. I know plenty of flippers who have done well in this business and plenty who have lost their shirts.
The pros of investing in rental properties
Buying rental properties has some big benefits -- namely, that you get to take advantage of high cash flow, tax benefits, property appreciation, and recession-resistance.
One of the largest benefits of buying rental property is cash flow. Rentals are typically a long-term investment that can provide substantial passive income to the owner over time. Cash flow, especially creating passive income, is a significant contributor to building wealth and financial independence.
You can slowly grow your rental portfolio until you have enough passive income to exceed your monthly or annual expenses. Residential rentals are one of the more common forms of income property, but there are other types, like commercial real estate.
Owning real estate, especially rental properties, presents several tax advantages. Rental property owners can deduct expenses relating to the operation and maintenance of the property, including property management fees, property taxes, mortgage interest, and other expenses. They can also depreciate the property over the duration of ownership.
Depreciation deducts a portion of the property’s value over time to account for wear and tear. There are other tax benefits available, depending on the number of rentals you own, but in most cases owning a rental property offers favorable tax advantages.
Appreciation is an increase in a property's value over time. While not always the case, most properties increase in value the longer they're held. Since rentals are typically held as a long-term investment, this lets the owner collect cash flow, gain tax benefits, and potentially cash in on an increase in the property's value over time.
Less risk in a recession
Cash-flowing assets are more likely to sustain themselves during an economic downturn because the investor isn't relying on the value of the home to support the investment. The cash flow supports the property.
The cons of investing in rental properties
Of course, rentals have some downsides, too. Specifically, you have to deal with long-term property management and upkeep and you may find yourself with high vacancy rates.
Long-term management and property upkeep
Being a landlord isn't for everyone. There's a lot of work that goes into maintaining a successful rental property. Finding quality tenants can be tough, things break or need to be replaced, and tenants could stop paying.
You can hire a property management team that handles the active management for you, but their services can cut into your profits and not all third-party management companies are considered equal. Before buying a rental property, make sure you understand what goes into running a rental property and determine if you're willing to commit time and effort to becoming a landlord.
Higher than expected vacancy rates
Rental vacancy is a natural part of owning rental real estate. It's the time in which a property goes unrented and can range from a few days to a few months. Most landlords strive to keep their vacancy rates as low as possible, but sometimes the property can remain vacant longer than expected because of economic conditions, low demand, or asking too much for rent.
Not accounting for vacancy or not having an accurate vacancy rate in your rental analysis can lead to a much lower return on investment.
Flipping houses vs. buying rentals -- which is better for you?
There's no blanket answer to which is the better investment strategy. It's based on your investment goals. If your goal is to earn income quickly, flipping houses may be a better option for you. If your goal is to build your cash flow to earn passive income, buying rentals may be a better option.
Assess how much time you can dedicate to your investing business. While both investment strategies require dedication, effort, and time, rentals often require less time, especially if you use a third-party property management company.
Also, keep in mind the amount of capital you have to invest. If you're short on funds and don't have enough money for a downpayment on a rental property, you could flip a house or two to help you earn enough money to buy a rental. It's a common strategy in real estate investing to flip two or three houses and then buy a rental property. This lets you participate in the benefits of both flipping and renting while building a diverse portfolio.
Don't forget to think about your personality and preferences, too. Do you have what it takes to be a good landlord? Or would you be better suited for flipping because, for example, you have a strong eye for design? Weigh the pros and cons of each investment strategy and choose the method of investing that best aligns with you and your financial goals.