The question of whether flipping or buying and holding real estate is the best strategy for investing in property doesn't have one correct answer. Instead, choosing one method over the other should be part of a clear strategic plan that considers your overall goals.
You should also take into consideration the opportunities presented by the existing market. Here is a look at what is involved in pursuing each strategy and how to decide which one might be right for you.
Why Invest in Real Estate?
That's a good question. Residential real estate ownership is gaining ever-increasing interest from retail investors for many of the following reasons:
- Real estate can provide more predictable returns than stocks and bonds.
- Real estate provides an inflation hedge because rental rates and investment cash flow usually rise by at least as much as the inflation rate.
- Real estate provides an excellent place for capital in times when you're unsure of the prospects for stocks and bonds.
- The equity created in a real estate investment provides an excellent base for financing other investment opportunities. Instead of borrowing to get the capital to invest (i.e., buying stocks on margin), investors can borrow against their equity to finance other projects.
- The tax-deductibility of mortgage interest makes borrowing against a home attractive.
- In addition to providing cash flow for owners, residential real estate can also be used for a home or other purposes.
Passive vs. Active Income
One key distinction between buying and holding and flipping properties is that the former can provide you with passive income, while the latter offers active income.
Passive income is money that is earned on investments that continues to make money without any material participation on your part. It could be from stocks and bonds or from owning rental property and receiving rental income each month, provided you hire a management company to do all the required tasks, such as finding tenants, collecting rent, and taking care of maintenance.
Active income is money that you earn in exchange for the work that you perform. That includes your salary from work, as well as the profits you make flipping houses. Flipping is considered active income, regardless of whether you are doing the physical labor of stripping floors. It is still a business that you engage in—finding a property to flip, purchasing it, obtaining insurance, overseeing contractors, managing the project, and more.
In this sense, flipping isn't just an investment strategy like buying and holding stocks or real estate. If you have a day job, keep in mind that your spare time will likely be taken up with all of the demands that flipping a property entails.
Two Ways to Flip Properties
Two major types of properties can be used in a buy/sell approach to real estate investing. The first is houses or apartments that can be purchased below current market value because they are in financial distress. The second is the fixer-upper, a property with structural, design, or condition issues that can be overcome to create value.
Investors who 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. On the other hand, those who prefer fixer-uppers will remodel or enhance a property so that it works better for homeowners or is more efficient for apartment tenants.
The buyer of a fixer-upper using this tactic relies on invested labor to increase values instead of just buying a property at a low cost to create high investment returns. Of course, it is possible to combine these two strategies when flipping properties, and many people do just that. However, consistently finding these opportunities can be challenging in the long run. For most people, flipping properties should be considered more of a tactical strategy than a long-term investment plan.