Which investment strategy is better, flipping or renting houses? It's a common question in the minds of so many real estate investors. While a simple way to respond would be to say, "it depends." What you're about to discover are all angles of this question so that you can develop your own conclusion, based on your personal situation and your short as well as long term goals, what is better for you. And as always, this is the real world truth of the matter, incorporating many details that you typically won't hear anywhere else.
Which is the better investment strategy, flipping or renting houses? Conventional wisdom would suggest that renting houses is the clear winner.
4 Advantages to Renting Houses
- Taxed advantaged income: Thanks to depreciation, you pay less in federal and state income taxes than you do with flipping houses.
- Mortgage paydown: As the tenant makes payments, slowly but surely a portion of that payment, if you have a mortgage, is going toward the principal and it's paying down that mortgage.
- Appreciation: In theory, the value of the property will go up over time. What that means is more money over the long haul. It also means that you're building wealth. The problem with flipping a house is once you sell the house, you can never make money off that house again.
- It involves less work: It's almost like making money while you sleep.
How do you feel about this argument? Is this where you land? You don't come to me to get regurgitated conventional wisdom that you can hear anywhere else. You come to me because you want to learn about real world truth, wisdom that someone could only learn if they'd been in the field a very long time and done thousands of deals. So, that's what you are going to get here.
The Numbers on House Flipping
The statistics that are out there say that a typical house flip is around $70,000, but that's complete bull. Those stats are including what the person paid for the house, what the house sold for, and that it was owned less than 12 months. They call that a house flip. However, that doesn't include any of the expenses of a house flip. The average for our apprentices nationally is about $28,000. That's the net, and that includes the ones that we fix up and the ones that we wholesale, and we resell immediately without ever touching the house. We make a lot more in certain areas and less in other areas, but $28,000 is the average profit nationally for a flip.
The Numbers on Renting Houses
So often there are mistakes that people make when they look at what the cashflow of a single-family home is. They don’t consider these factors:
- the mortgage payment
- the insurance is higher than it normally would if you lived there
- hiring management; because long term you can't have less work if you're the manager
When you include all those things, I argue that the average single-family home makes about $200 a month positive cashflow. How many months will it take for you to get to $28,000? 140 months or almost twelve years. That's a long time. Would you rather have $28,000 now or $200 a month for the next 140 months?
Flipping vs Renting Houses
There is the tax advantage of renting you must consider. However, even if you had to pay 25% in state or federal tax on the $28,000, you would end up with $21,000. It would take you 104 months or eight to nine years to reach that amount.
You may be thinking that the property can go up in value and could make a lot more money when you look at the appreciation long term. Love your point. Robert Shiller, who is the foremost authority on housing values in America over the last 40 years, developed the Case Shiller Index. His argument is that over the past 120 years single family homes, if they appreciate at all, appreciate with inflation. This means they don't appreciate above the inflation rate. It’s somewhere in the range of 2% to 3% annually, however that's over 120 years.
For example, if you bought a house in 2007, it may have taken you 10 years just to get right back to what the value was back in 2007. If you bought a house in 2012 you bought it literally the perfect time in American history and you've had an amazing run the last seven years. That said, if you own a rental property and it appreciates, how do you benefit from that? It's just on paper, right?
Certainly, having it on paper is better than not having it. But the only way to capture that appreciation is to refinance, which completely kills the concept of the mortgage paydown. You are also hoping that the rates of rent are going up to keep up with the higher cost of insurance, the higher cost of taxes, and if you refinance, the higher cost of your mortgage. So, when I say $200 a month, this could go up, but it could also go down.
Taxes and insurance are going up rapidly, especially if you're near a coastal area with all the flooding that's gone on. Then if you try to capture any of the value that has increased the property, you could run into a problem where your cashflow goes down. Therefore, I go back to the argument that even if we reduce the average profit of a house flip, you're still talking about years of your life compared to getting the money right up front as a flip. Granted, there are exceptions to this rule.
Renting High ROI Properties vs Single Family Homes
Just to be clear, I love rental property. I own millions of dollars of rental property. What we're talking about are houses. I just don't like turning single family homes into rentals in most cases. I do have a video called 3 Ways to Turn a House Into a Cash Flowing Machine, which tells you how you can supercharge rentals as vacation rentals, turning it into a rent-to-own, and in some areas if you can make it into student housing. You can turn a single-family home into a money making machine, but with the traditional long term tenant rental, often the math just doesn't shake out. Therefore, you're better off flipping.
Invest in High ROI Properties
What do you do with this flip money? Make as much flip money as you can and then go buy high ROI rental property. I do a lot of vacation rentals, but that could also be multifamily duplex, triplex, quads. You can even go to commercial real estate, which is five or plus units. There are different property types where cashflow is so much better. Why? It's because a single-family home is best used as someone's home to live in as a primary residence. Meanwhile, duplex, triplex, quad, any other multifamily of any size, that's investment property.
I have an apprentice right now in Pennsylvania that's paying $20,000 for a duplex and he can rent either side for $700 a month. That's an investment property. Let's say with minor repairs he's in the deal completely at $25,000. He's paying cash for it and he's bringing in gross rental income of $1400 a month. The benefit of two sides is, if one is not paying, the other side is still paying.
Problems with Renting Single Family Homes:
- Very low cashflow.
- High vacancy: Unlike multifamily, where if one unit is not paying or they have moved out, you have others that can help pay the bills. Or if it's a vacation rental, you have so many different guests, you're spreading the risk across what could be 30 to 50 or more guests in a year.
- Lack of efficiency: If you have several single-family home rentals, they're going to be in different areas, even if they're in the same town. That means separate roofs, separate yards, separate everything.
- High Maintenance: Lack of efficiency means higher maintenance costs. Whereas if these things were combined, for example in a multifamily, you'd have the same roof potentially and one yard, as opposed to three.
An Important Lesson About Renting Single Family Homes
When I was first getting started in real estate investing, I ran into a guy who had owned over a hundred single family homes and he was in the process of selling each one. As they went vacant, he would have it fixed up and then he'd put it on the market and sell it. I was so puzzled because at that time I was stuck in that conventional wisdom. I was thinking, "Isn't that the goal? Isn't that the goal to own a whole bunch of properties that other people are making payments to you and you get to earn money while you sleep?" I asked him that and he started laughing. He said, "You mean single family homes? You think that's money while you sleep?" He thought it was funny.
He said, "You know Phil, you’re brand new. I've got a little lesson for you. Take a trip to the eviction court, spend a day there, meet with some of the landlords of single family homes that are at eviction court and ask them if it's money while they sleep." It was a good lesson.
Get the Best of Both Worlds
The problem is single family homes were not designed to be investment properties per se as it relates to long term rentals. Their highest and their best use is as a primary residence for someone else. That is why the best way to monetize it in almost all cases is to flip the property to an end user, to a buyer. Now again, there are some caveats to that rule, but here's the formula to becoming extremely wealthy in real estate. How I've done it, and how many of my apprentices have done it, is this.
Formula: Flip houses to generate cashflow then buy high ROI rental property
I understand when you flip, it’s going to get hit with more taxes. That's okay because the cash is so much greater. When you take that money and buy a high ROI rental property you get the benefits of the taxed advantage income. You get the benefits of making money while you sleep, but you do it in the most efficient way possible. You're not using single family houses as your high ROI, unless you're doing some vacation rentals or some of those caveats. Instead what you're doing is taking flip money and turning it into high octane rental income and so you're getting the best of both worlds.