When deciding between fix-and-flip or holding a property as a rental, investors need to evaluate:
- Their financial position;
- The condition of the property;
- Local real estate market trends; and
- Their individual preferences.
Factor 1: Your Financial Situation Impacts the Decision
A big advantage of owning a rental property is that it may begin generating income right away. Of course, whether the property produces profits immediately or not will depend on your ability to find and retain tenants. If rent is set too high, the property could sit vacant for months, negatively impacting your bottom line. Investors should plan to have a sizable cash cushion available that can be used to cover mortgage payments and other costs during months when the property is not earning income.
Another benefit of renting versus flipping is that the income stream from the property tends to be predictable and also more stable over time. This is not the case with fix-and-flip properties, whose value can fluctuate with supply and demand. A downside of rental properties is that managing them can be time-consuming. The alternative, hiring a property manager, can be expensive.
An advantage of flipping over renting is that capital usually isn’t tied up in the property for as long. Most fix-and-flips sell within a few months, allowing capital to be redeployed quickly into new investments. Fix-and-flips often require large amounts of capital upfront, however, to cover costs for needed repairs, carrying costs and other upfront expenses. Investors who run out of cash mid-renovation may find themselves forced to sell at a loss. In addition fix-and-flips require closing costs to be paid twice. There are closing costs for both the purchase and sale of the property.
Factor 2: Evaluate the Condition of the Property
Buy-and-hold rental properties may deliver better returns in the long run if home values are rising in your area. If home prices are falling, fix-and-flips may produce better results since the investment is monetized more quickly. The National Association of Realtors provides good online sources for researching local real estate market trends.
The age of the property should be factored into the equation. Older properties generally have higher maintenance and upkeep costs, so fix-and-flip may be the more profitable option. The location of the property must also be considered. If the property is located hours away, managing a rental could involve frequent long commutes. Distance is less of an issue for fix-and-flip strategies since the property is usually re-sold within a few months.
The local real estate market should help guide your fix-and-flip or rent decision. If the local market is depressed, acquiring the property may be much easier than selling even after renovations are done. If there are more rental units than renters in your area, rents may drop to levels that barely cover mortgage and other property expenses.
Factor 3: Assess Regional Market Trends
A recent survey by Auction.com shows a national trend favoring buy-and-hold strategies over fix-and-flip tactics. The trend varies widely across regions, however. Investments in rental properties are most popular in the Midwest and South, whereas fix-and-flips are preferred in the Northeast. In the West, rentals are slightly more popular than fix-and-flips. In regions where home prices are high, fix-an-flips are prevalent whereas modestly priced markets tend to generate better long-term returns from rentals.
The trend nationwide shows the population of renters expanding faster than home buyers. According to the National Association of Realtors, four million new renter households have been created since 2010, while homeowner numbers have declined by one million. Experts attribute the increase in renter households to tighter lending standards since the recession, which keep some otherwise qualified individuals from obtaining mortgages and expectations of rising interest rates.
Roughly 29 percent of suburbanites living outside the nation’s eleven largest cities were renters in 2015, up from 23 percent in 2006, according to a report by New York University’s Furman Center and Capital One bank. The report examined rental trends in Atlanta, Boston, Chicago, Dallas, Houston, Los Angeles, Miami, New York, Philadelphia, San Francisco, Washington and their suburbs.
Regarding trends in fix-and-flips, RealtyTrac reported that flips accounted for 5.5 percent of all home sales during 2015. Average gross profits on flipped homes hit a ten-year high of $55,000 last year, but hold times for flipped properties also increased. During the second quarter of 2015, average hold times rose to 179 days, the longest since 2007, presenting liquidity challenges for some house flippers.
The regional market with the greatest number of flipped homes in 2015 was Miami, where flips accounted for 8.6 percent of overall home sales, States with the highest percentage of flipped houses included Nevada (8.8 percent of home sales); Florida (8.0 percent); Alabama (7.4 percent); Arizona (7.1 percent); and Tennessee (6.9 percent).
The good news for both house flippers and landlords were low vacancy rates in most markets. RealtyTrac’s most recent residential property vacancy analysis showed only 1.6 percent of residential properties vacant at the beginning of February 2016, which was down 9.3 percent from their vacancy analysis in late 2015. Unusually tight vacancy rates in many markets help both fix-and-flip strategists and buy-and-hold investors by putting upward pressure on rents and home prices.
Factor 4: Which Strategy Do You Prefer?
Ultimately, the choice to fix-and-flip a property or buy-and-hold a rental may come down to individual preference. Some investors thrive on the challenges and uncertainties of fix-and-flips while others find the uncertainty too stressful. Some individuals don’t mind managing tenants and properties, while others lack the patience to deal with day-to-day complaints. The bottom line is that the strategy you choose should be the one that you are most comfortable with.