Which investment strategy is better, renting or flipping houses? It’s a common question of many real estate investors and the simple answer is, it depends. I’m going to look at all the angles of this question so that you can come to your own conclusions based on your personal situation. You can consider your short and long term goals and decide which is better for you. As always, this is real world truth, incorporating details that you won’t hear anywhere else.
4 Advantages to Renting Single Family Homes
- It involves less work. It’s like making money while you sleep.
- As the tenant makes payments, a portion of that payment is going toward the principal and is paying down the mortgage.
- In theory, the value of the property will appreciate over time. That means you make more money over the long haul and you’re building wealth. In contrast, when you flip a house, once you sell the house, you can never make money off that house again.
- Tax advantage. Thanks to depreciation, you pay less in federal and state income taxes than you do with flipping houses.
The Numbers on Renting Houses
Often people miscalculate the cashflow of renting a single-family home. They forget to include these factors:
- The mortgage payment
- Higher insurance than if it was your own home
- Hiring a property manager; you can’t have less work if you’re the manager
When you consider all these factors, I argue that the average single-family home makes about $200 a month positive cashflow.
The Numbers on Flipping Houses
The statistics on the profit of a typical house flip are around $70,000, but those numbers are totally inflated. Those stats call a house flip all homes owned less than twelve months, and include what the person paid for the house and what the house sold for.
However, that doesn’t include any of the expenses of an actual house flip. The average net for our apprentices nationally is approximately $28,000. That includes the properties we fix up and the ones that we wholesale and resell immediately without ever touching the house. We net a lot more in some areas and less in other areas, but $28,000 is the average profit nationally for a flip.
How many months will it take you to get to $28,000 renting a single-family home? 140 months or almost twelve years. That’s a long time. Would you rather have $28,000 now or $200 a month for the next 12 years?
Renting vs Flipping Houses
You may be thinking that when you consider appreciation, the increase in property value could make a lot more money in the long term. This is a valid point. Robert Shiller, who is the leading authority on housing values in America over the last 40 years, developed the Case Shiller Index. He argues that over the past 120 years single family homes appreciate with inflation, meaning they don’t appreciate above the inflation rate. It’s approximately 2% to 3% annually, but remember, that’s averaged over 120 years.
For example, if you bought a house in 2007 during the real estate crash, it may have taken you 10 years just to get back to it’s value in 2007. If you bought a house in 2012, you bought it at the perfect time in American history and you’ve had an amazing seven years.
That said, how do you benefit from a rental property that appreciates? It’s just on paper, right?
For sure, having it on paper is better than not having it all. However, the only way to capture that appreciation is to refinance, negating the idea of paying down the mortgage. You are also banking on the rent rates increasing with the higher cost of insurance and taxes, and if you refinance, the higher cost of your mortgage. So, when I say renting single-family homes has a positive cash flow of $200 a month, it is not set in stone. It could go up, but it could also go down.
Taxes and insurance are increasing, particularly near coastal areas. If you try to capture any of the value that has increased in the property, it could cause your cashflow to go down. Therefore, I maintain that even with reducing the average profit of a house flip, it will take years compared to getting the money right up front as a flip. Keep in mind, there are exceptions to this rule.
There is a tax advantage in renting that you must consider. However, even if you had to pay 25% in state or federal tax on the $28,000 from a house flip, you would still make $21,000. It would take you 104 months or eight to nine years to reach that amount renting single-family homes.
4 Disadvantages of Renting Single Family Homes:
- High vacancy. When the property is vacant no one is helping pay the mortgage and expenses. With a vacation rental, you have many different guests, so you’re spreading the risk across 40- 50 guest a year. Also, with a multifamily rental when one unit is vacant you can still rely on other renters to cover costs.
- Low cashflow.
- Lack of efficiency. If you own several single-family home rentals, even if they are in the same town, they’re going to be in different areas.That means separate roofs, separate yards, separate everything.
- High maintenance costs. Lack of efficiency means higher maintenance costs. Whereas in a multifamily these costs are consolidated.
An Important Lesson About Renting Single Family Homes
When I was first getting started in real estate investing, I met a guy who had owned over a hundred single family homes. He was in the process of selling each one as it went vacant. He would fix it up and put it on the market. I was confused because at that time I was stuck in that conventional wisdom. I asked him, “Isn’t the goal to own a bunch of properties that other people are paying off while you earn money while you sleep?” He laughed and said, “You mean single family homes? You think that’s money while you sleep?”
He gave me some advice. He said, “Take a trip to the eviction court and meet some of the landlords of single family homes that are there and ask them if it’s money while they sleep.” It was a good lesson.
Renting High ROI Properties vs Single Family Homes
Just to be clear, I love rental property and own millions of dollars in rental property. I just don’t like turning single family homes into rentals in most cases.
I have a video called 3 Ways to Turn a House Into a Cash Flowing Machine, which tells you how you can supercharge rentals as vacation rentals, turn it into a rent-to-own, or in some areas you can make it into student housing. You can turn a single-family home into a money making machine, but with the traditional long term tenant rental, often the math just doesn’t add up. Therefore, you’re better off flipping.
Invest in High ROI Properties
What do you do with this flip money? You make as much flip money as you can and then go buy high ROI rental property. This includes:
- vacation rentals
- multifamily duplex
- commercial real estate, which is five or plus units
These are property types where the cashflow is much better. Why? Because these properties are investment properties, whereas a single-family home is best used as someone’s primary residence.
Get the Best of Both Worlds
The problem with single family homes is they were not designed to be investment properties. That is why the most profitable way to monetize it in almost all cases is to flip the property to a buyer. Now, there are some exceptions to that rule, but here’s the formula I have used to becoming extremely wealthy in real estate.
Formula: Flip houses to generate cashflow then buy high ROI rental property
I’m aware that when you flip, you are going to get hit with more taxes. That’s okay because there’s a lot more cash and when you take that money and buy a high ROI rental property you get the benefits of the taxed advantage income.
You get the benefits of making money while you sleep, but you do it in the most efficient way possible. You’re not using single family houses as your high ROI, unless you’re doing vacation rentals. Instead what you’re doing is taking flip money and turning it into high octane rental income, getting the best of both worlds.