The recent upheavals in the real estate market have many investors asking, “Is it better to buy and sell, or to buy and rent?” There is certainly no perfect real estate investment strategy for every real estate investor or for every property. However, we can make a very clear-cut case that buying and renting has many upsides. Before we explain why buying and renting is our answer to this question, let’s define some terms.
The term “buy and sell” for our story primarily means to buy a distressed property with the intent of selling it in a relatively short period of time. Perhaps after making some key renovations, or a full renovation to increase the value of the property. Some folks refer to this as “flipping houses or flipping real estate.” However, flipping and buying with an intent to sell can also be a bit different if the buy and hold real estate plan is to use cash as an investment that is not short term.
Now, let’s get back into our debate of buy and sell vs buy and rent.
Buy and Rent vs Buy and Sell
Buy and hold real estate investing is a strategy that works for many and has for centuries. A buy and hold real estate investment strategy is easy to understand, easy to begin, and hard to argue is not profitable if done correctly. If you step back and think about it, a rental business is also a buy and hold real estate investing strategy. The hold is simply indefinite.
Becoming a landlord may seem a bit scary to some, but rental income will always outpace real estate appreciation except in rare cases. Rent is the key part of a successful business managed on cash flow.
The way the “buy and sell” strategy can be profitable is due to the added equity of the investment property when the unit is fixed up. For it to work, the equity gain must be meaningful. That means the equity gain needs to be a double-digit percentage of the up-front cost. The most critical element is finding a way to do the needed repairs and updates at a lower cost than the equity that they add.
We’ve all seen the popular TV programs that illustrate the process. A couple buys a run-down home and then tours it with “their contractor.” The contractor makes a list of the required work and then creates a final tally. Once work begins, that tally is always a bit lower than what was actually needed, but the house lists and sells for a profit.
In the real world, house flippers have a lot of experience, know the codes, know the real estate market in which they are working very well, and they can pull off a profit. Perhaps most importantly, they give LOTS of work to contractors who in turn provide them with bottom-dollar prices.
There are headwinds for new investors. First up, renovation costs. Finding contractors in some areas is difficult. Finding ones that can do work at a cost lower than the equity added is a real magic trick. Of course, one can do the work themselves – to a degree. But if you already hold a license for contracting, an electrician’s license, and a plumbers license, you are one rare investor.
Flipping also comes with a tax penalty. State and local governments punish flippers with a short-term capital gains tax if they sell the house shortly after buying it. That tax dilutes already thin profits. Professional flippers use accountants to minimize the sting, but that too has a cost.
Flipping sounds great and makes good TV, but to do it profitably requires a long list of special skills. That’s why the buy and rent strategy is typically considered the better among the two, especially for beginner real estate investors.
A Few Things to Consider When It Comes to Buying Property and Renting It Out
It’s true that it is generally better for an investor to buy and rent out a property. However, there are some things you need to be aware of before you get started.
Passive Real Estate Investing vs. Rental Property Management
Passive real estate investing takes on many shapes and there is no single definition of what passive income is. For some investors, passive real estate investing means investing in a fund that others manage which holds real estate. This is one form of “buy and hold” investing. The managers do the buying and selling and you as a passive investor are able to share in some of the profits.
Buy and rent property investing in which you yourself are the company and you buy and then rent the properties is the other extreme – active real estate investing. And one that Mashvisor is built to assist you with. Here, you seek properties that will make good buy and hold rental properties. You do research using tools like those Mashvisor provides to analyze the return on investment that you can have from a property that you own long term and rent out.
With a buy and rent property business, you are in the thick of it. You will of course have a strong network of “partners” who assist you. You will work closely with realtors, financiers, and contractors. All of these people will profit from having your business and you will benefit from what they add. The key thing to note is that, even though you won’t be earning passive income, you are the leader of the enterprise and you make decisions at every level.
If you wish to earn passive income from the buy and rent strategy, you can always hire professional property managers. But keep in mind, there will still be some work on your part when it comes to finding and analyzing deals as well as overseeing the business and the work of all of your “partners”.
Cash Flow Investing – Fully-Owned Rental Units
There are many forms of rental property investing. A minority of investors start out with significant capital to invest in real estate. They may even own the rental properties that they rent outright. Meaning they have paid in full for the properties and have no outstanding mortgages. Although unusual, this method has a very high rate of return on investment. All of the rent after the utilities, repairs, and taxes are paid is profit. And there is more. The property holdings themselves will appreciate in almost all cases. With proper maintenance, the houses will consistently yield a healthy after-tax cash flow.
One big upside to this form of cash flow property investing is the ability to have a strong cash flow from a small number of units. One big downside is that since there is just a handful of units, one renter not paying his or her rent can cause the profitability to drop abruptly. With today’s political winds trending towards rent freezes and rental deferment, this investor could see some drop in cash flow, but with the units owned outright, there is little chance of bankruptcy or of losing the units.
Cash Flow Investing – Leveraged Holdings
There is a more common way that rental property investors allocate capital. Rather than pay off the rental units they purchase, the investors hold large mortgages on the properties. This allows the real estate investor to buy many more units with the same amount of capital. Perhaps as many as five or ten times the number of units.
This buy and rent model is the one most often associated with “cash flow real estate investing,” or “cash flow properties.” The general idea is that the investor borrows as much money as practical so that the investment capital is leveraged to allow many more units.
Although the cash flow is of course lower due to the cost of the mortgage payment and the interest on the mortgage, cash flow investing works. Using real estate investment tools like the ones Mashvisor has developed, an investor can easily determine the cash flow from a given property with a modest capital outlay (or a downpayment on the property).
Note that this investor will be increasing equity with each month’s mortgage payment and with the rising tide of the value of properties as they increase over time. So, every rental property investor is also a potential “buy and sell” investor. It’s just that selling is indefinitely delayed. The investor still reaps an increase in equity. In many cases, the investor pulls that added equity out and then either renovates the property to add even more equity or uses the money to purchase yet another rental unit.
Selling Rental Units Is a Form of Buy and Sell and Also Buy and Hold
There is no single answer to the question of whether buying and selling or the buy and rent strategy works “best.” Both have their merits. Most importantly, an investor can do both. Even a beginner real estate investor knows that his or her company does not have to do just one thing or the other. As a rental property investor, I have done exactly that. When the market conditions turned up sharply at one point, I sold a unit I had help for about five years.
I sold the cash-flowing rental unit because I had an excess of equity in the property and I felt that the particular unit had a risk of a sharply falling value in the coming years. The unit’s value was up over 50% since I bought and I felt the value ahead would not continue to rise so rapidly and may even decline. By selling it, I not only earned a profit on the sale and freed-up my capital, but I also avoided all of the short-term capital gains tax penalties that come with short-term flipping.
Whether you opt to buy and sell or buy and rent, Mashvisor has the rental property analysis tool and other real estate investment tools you need to locate and analyze properties. Why not get started with Mashvisor today?