The Pros of Flipping Houses
If you’ve looked into flipping houses, you’ve probably watched plenty of TV shows that are about the subject, such as “Flip or Flop” or “Desert Flippers”. While shows like these make flipping look somewhat easy even with the drama thrown in, reality can be much better… or much worse. Flipping has its advantages, but look out – it has its heavy risks, as well.
Make A Lot of Money Fast
There’s no doubt about it, you can make a lot of money flipping a house in a short period of time… if you know what you’re doing. When you flip a house, you want to get in the house, get it renovated to your satisfaction, and get it sold as fast as possible. Depending on how much you have to spend on the home and the renovation, you could end up with $10k in profit or $100k+ in profit.
The Investment Is Short-Term
When you flip, you’re wanting to get rid of the property at a profit quickly. You don’t want to sit on it for 6 or 8 months, because the mortgage payments will eat away at your profits much faster than you think they will.
There Are Two Ways To Flip
You can flip a property either by purchasing it below market value and selling it at a profit without renovating it at all or you can flip one by purchasing it at market price and making the renovations necessary to make it worth more and either renting or flipping it. Either way you choose, there are still many profitable benefits to investing in property no matter the methodology.
The first method requires that you find a property that is in financial distress, such as a foreclosure, and selling it.
The second is fairly self-explanatory: purchase the property, make improvements, and the profit comes from the improvements.
Flipping a property in financial distress may cost less than messing with a fixer upper, but the fixer upper could be more lucrative if the renovations are done correctly and in a timely fashion.
The Cons of Flipping Houses
Flipping houses has its downsides, too. Anything from unexpected expenses to downturns in the local real estate market to tax issues and even the weather can really put a damper on your profits. Financing a flip may be a bit harder than usual if you have no record flipping properties.
Traditional banks may be a bit hesitant to finance your investment when purchasing to flip even if you have strong credit if you haven’t contracted major home improvement projects or flips before.
You Can Lose Money Fast And In Multiple Ways
If you’ve watched house flipping shows on TV very much, one of the big things they run into is unexpected expenses that they couldn’t have foreseen. There can be quite a few hidden problems with a house that can explode the budget on a moment’s notice.
Some of the most common things we’ve seen on flipping TV shows that can break your budget are household-wide electrical or plumbing issues, foundation problems, rotting floor joists, mold in the bathrooms or kitchen, and complete HVAC system renovations.
Without a thorough inspection of the house before you buy it, you’re walking into something that could have a lot more problems than you think. Sometimes even a good inspector doesn’t catch everything.
You can also lose money simply by not being able to sell the house quickly enough. When you don’t sell fast enough, you have the cost of the mortgage every month, taxes, insurance, mowing the grass (if applicable), and other types of property maintenance.
The city may also raise the property taxes on the home after you’ve renovated it.
The Market Dictates How Much You Make
Before you go flipping in a community, you need to research the local market for real estate and find out what’s selling and for what prices. The last thing you want to do is dump your money into a type of property that just isn’t selling well in that area, such as a 5 bedroom house in an area where only 1 to 3 bedrooms are selling consistently. It’s the same thing with the design of a house. You don’t want to renovate a home and make it look modern when traditional style is what’s selling in that area.
Dealing With Taxes
When you buy and flip a house, you may be treated two different ways when the tax man comes ’round. The sale will trigger one of two taxes: ordinary income or capital gains taxes.
Ordinary income tax is the income tax that is applied to normal income that is generated through running your business or doing your job. Most house flippers will be classified as “dealers” by the IRS and will be subject to ordinary income tax, which can be anywhere from 10% to 37% and self-employment tax of 15.3% will have to be paid in addition to that income tax.
Capital gains tax is the lower of the two types of taxes and even capital gains tax is split into 2 categories: short term and long term. Long term capital gains taxes are typically between 0 and 20% and since you don’t have to pay the self-employment tax on the income from the property as well, you’re saving a lot of money. But, you have to hold onto the property for over a year to get that treatment.
Transaction Costs Are High Buying & Selling
Closing costs are something to consider when buying to flip. These are things such as property insurance, title insurance, title company fees, transfer taxes, and such. You can get a list of what is included in the closing costs from your real estate agent.
But, these costs are often at least 5% of your property’s total purchase price. On a $100,000 home, that’s $5000. It’s no small amount of money and it counts against your profits.
The Pros of Renting Property
If you’re not interested in the stress involved in flipping a house, maybe renting a house out would be something better for you. Here are some benefits of renting property.
Regular Cash Flow
One of the first pros to renting is the monthly cash flow that comes from the rent being paid. There should be enough made on the rent every month to pay the mortgage, pay expenses, and still make a profit.
Multiple Tax Deductions and Lack of Capital Gains Tax
There are quite a few tax deductions that you can take advantage of when you rent. Loan interest on the mortgage is deductible, as is interest on purchases made to improve or maintain the property if it was done with a credit card or other unsecured loan.
Property taxes are also deductible, as are occupancy taxes, local rental licensing fees, and sales taxes on items related to the property. For a complete rundown of what is tax deductible in your area, consult a CPA.
Less Risky In An Economic Downturn
Any losses experienced during an economic downturn will be dwarfed by the losses experienced by those who invest in the stock market.
Over the time that you own the property, its value will likely go up. This is called “appreciation”.
As an example, let’s say that you finance a property for $200,000 and you pay $40,000 down. If your property appreciates in value by 5% per year, in 10 years the home should be worth around $310,000. You’ve taken your initial money investment of $40,000 and turned it into $110,000.
Cons of Renting Property
The cons of renting property are few, but collectively they can add up to a lot of cost and risk.
Long-Term Investment Requiring Maintenance
As mentioned above, the cost of maintenance is tax deductible. But, that means there’s maintenance to be done in the first place, so you have to prepare for it. Property maintenance is going to happen; there’s no getting around it. The property must be maintained to a livable condition for any tenants that you have and any issues should be repaired as quickly as possible to reduce the potential for extreme costs later. Neglecting small repairs can turn into big expenses later, especially if you’re dealing with something that spreads like water intrusion and mold.
Tenants Can Be Great… Or Not
You can’t guarantee that a tenant is going to pay their rent on time or even at all. Even great tenants who have rented from you for years can suddenly fall off the wagon and have a hard time paying for an unpredictable amount of time. You never know. There will be times when you be out several months of rent due to a tenant just bailing out of the property without even telling you they’re moving out.
It Will Be Empty More Than You Think
As an addendum to the section above, there will be times when you don’t have a tenant in the property at all. Sometimes you can predict this, as when a tenant lets you know in advance that they’ll be moving out for one reason or another. Other times, you can end up with a situation where you need to force a tenant out of the property to be able to make repairs, such as if a tree falls on the house or some other significant damage occurs that makes the property unlivable.