We’re inundated with “Flip This House” type TV shows which interject enough drama to keep our interest. “Hold This House” just doesn’t cut it for spell-binding television. So fix and flip has its advantages when it comes to reality TV but does it hold (pun intended) such advantages when it comes to reality itself?
I’ll admit bias. Our company, Stewardship Properties, built a relative fortune from buy and hold which would have never happened with a fix and flip strategy. With this bias in mind, let’s look at the relative merits of both.
The Benefits of FIX and FLIP
Cash Now: When you get good at fix and flip (and, like any endeavor, it takes work and experience to excel) you can make 10-30% of the properties’ original cost. Putting 10-30,000 or even more into your pocket two, three, or more times a year adds up to a pretty great income and all the time being your own boss. If you look at this as a game of getting the best ROI (return on cash investment dollars) flipping can produce a high ROI.
Limited Risk: As recent historical experience has reminded us, real estate does not always go up. Over time real estate follows inflation but if you are in a down cycle, flipping properties protects you from the downside.
Less Financing Pressure: If you can find a source of cash and you are successful at flipping, that cash can be “re-circulated” time and again without the need to look for further cash sources. This allows you to focus on finding and flipping for the highest returns.
No Property Management: There are no tenants, termites or toilets and thus no need to find competent property management (no small task) or to build a competent property management company yourself (no small task). Management, maintenance and tenant-landlord legal issues can eat up lots of time, energy and profits if not done well. Even when done well you can sometimes end up with high turnover costs and unpaid damage or rent. Again, consistent expert property management is no small feat, but the only way to reliably extract income from your rental assets.
Focus on Good Deals: Flippers know that margins can be thin and that any number of “soft costs” can eat into their profits. This often forces them to get the best deals possible. So they are always looking for motivated sellers, negotiating the best possible deal, keeping their hold times to a minimum in order to maximize their profits and move on to the next flip. The pressure is on from start to finish… and that’s a good thing.
Breadth of Market: There are higher-end homes and expensive locations (e.g. San Francisco or Honolulu) that will never pencil for a buy and hold strategy but conceivably you can flip any property in any location for a profit. Buy and hold investors who purchase such lower ROI properties may do so because they have plans for a large value add or because they believe the property/location has a significant upside in appreciation value. But normally higher end markets are not as conducive to a buy and hold strategy as they are to fix and flip.
The Benefits of BUY and HOLD
Holding properties has produced untold millionaires and billionaires. Real estate investment is flat out the average person’s best shot at creating serious wealth. If you flip you can make a profit, if you hold, you can make a fortune. As such holding real estate is the…
I-ncome: Residual income amounts to positive cash flow on automatic pilot, whether you put time into hustling for the next deal or lying somewhere on a beach. This is the goal of the buy and hold strategy, to provide you with a reliable stream of income that is not contingent on working. The challenge is to keep financing properties at 100% (or nearly 100%) and manage them so that the rental income exceeds the expenses. Obviously the more properties producing positive cash flow in your portfolio, the greater your monthly income becomes. There are many real estate buy/hold investors who would never have to work another day in their lives if they choose not to.
D-epreciation: One of the cons of flipping is that it produces taxable income at ordinary rates whereas holding can allow you to have an income via positive cash flow and yet show a tax loss from depreciation. When a property is sold, its depreciation must be recaptured and then incur capital gains tax (often at a lower rate than ordinary income). To avoid any such tax consequence, properties may be sold via a 1031 exchange or better, yet, kept for a lifetime of wealth creation and passed on to heirs who receive them as if they have not been depreciated at all (at zero tax basis). Federal inheritance tax law allows five million dollars (or five million from each spouse via a trust) to freely pass on to heirs. (State laws vary.)
Additionally, any time you refinance your properties, the capital you receive is a loan so those funds are not taxable at the time of receiving. Refinancing also can allow for a very high ROI or even an infinite ROI when all down payment funds are received back in the refinance. Refinance can, in effect, leverage the leverage!
E-quity Build-Up: Unless the mortgage is interest-only, each payment made on the loan cuts down the principal using rent to pay off the mortgage. Amortization tables are a thing of beauty to a buy and hold investor because each and every month they get closer to owning their property debt-free. And if they chose to refinance along the way, well, go back and read the previous paragraph! So, if you have a 120,000 property fully financed at 5.5% interested over 30 years you would have paid off 9,047 in 5 years and 20,951 in 10 years.
A-ppreciation: If you look back in history, the real estate market has appreciated at a rate similar to inflation which is calculated at 3.4% over the last 93 years and 2.5% over the last 10 years. (CLICK HERE.) If we see a 3% appreciation rate going forward, a 120,000 property will be worth 139,113 in five years and 161,270 in ten years. Below is a map that shows appreciation state-by-state since 1975. For more specifics on it, CLICK HERE.
Just taking equity build-up and appreciation on our hypothetical 120,000 property you have realized a gain of 28,160 in five years and 62,221 in ten years. Yes, the property required management over that period of time and you had to put in some capital improvements (like a new roof/water heater/exterior paint job/etc.) but you have also experienced a 6,222 per year gain over a ten year period of time as well.
L-everage: The reason that real estate is the only likely investment option that can make a person of average means wealthy is because of the last word in I-D-E-A-L: leverage. When you use only a small portion of your own funds: 25%, 15%, 5% or even less and you finance (use other people’s money) the remainder of your purchase/upgrade, you have put in a relatively small percentage of your own capital (0-25%) and yet realized 100% of the profits and benefits. Those benefits—
I-income from positive cash flow,
D-epreciation from tax benefits,
E-quity Build-Up from mortgage pay off,
A-ppreciation over time, combined with the
L-everage of using other people’s money
—will substantially multiply your return and, over time, MAKE YOU WEALTHY!
We are buy and hold investors because we’ve found the way to overcome the challenges and to realize the benefits… on a daily basis.
Question: Why would you EVER sell any property if
1) it cash flows,
2) you don’t need the money, and
3) it is well-managed?
Stewardship Funding has two objectives: CREATE WEALTH and OPPORTUNITIES.
To do this we look to form dynamic partnerships, combining our particular strengths and resources with local investors in order to address the challenges of a buy/hold strategy so we can realize its benefits… together.