The main reason we do business is to make profits either in the short or long run. So, it is important to know if a strategy will be rewarding. Selecting between the two strategies depends on the type of profit you want to make.
Profitability of Flipping House
Flipping is an investment strategy where the investor acquires the property under market value, repairs, and sells it in a short time. This investment type can put a lot of money in your pocket provided you are good at it. If you want a quick return on investment (ROI), you should consider fix-and-flip. In fix and flip, you are required to follow the 70-percent rule. The rule states that the cost of the property and the total repair amount should be below 70-percent of the building’s After Repair Value (ARV.
In order for you to make a profit using the fix and flip strategy, it is important to buy an undervalued property, like a foreclosed or distressed property. For example, if you buy and repair a foreclosed property using the 70-percent rule,by selling the property at the market value you will make a 30-percent profit on the investment.
Profitability of Rental Properties
Rental or buy-and-hold is when the investor buys a property, repairs it (if required), and rents it out. It is considered the safest type of investment in real estate. The investors have a steady source of income as you wait for the property’s market price to appreciate. In real estate, especially for rental investment strategy, the term of financing (mortgage or cash payment) can affect the Return on Investment (ROI).
What Is ROI?
Return on Investment (ROI) is a performance measure, used to evaluate the efficiency of an investment or compare the efficiency of a number of different investments. ROI measures the amount of return on an investment, relative to the investment’s cost.
How to Calculate ROI?
To calculate ROI, the benefit (or return) of an investment is divided by the cost of the investment. The result is expressed as a percentage or a ratio.
The return on investment formula:
ROI = (Gain from Investment – Cost of Investment) / Cost of Investment
How Mortgage is Leveraging Your Investment
Leverage Finance Definition
Leverage is the use of various financial instruments or borrowed capital to purchase a property and to increase the potential ROI.
Let’s consider a general real estate rule that requires the borrower to provide a down payment of 20-percent when investing with a mortgage. The borrower did not need to provide the full purchase price of the property before making a full profit.
This means that when you flip or rent out the property, you only pay back the borrowed amount i.e. the 20-percent down payment plus the ROI, which will increase because of how you have managed your investment. You not only save money, but you also make more in the process.
Property management is another factor to consider when starting out your real estate investment. Although both flipping and rental require attention, managing property for both strategies can differ based on location and other factors.
Fix and Flip Strategy
In flipping, all you are required to do is buy, fix, and sell. You don’t tie up your investment for long. You also don’t have to worry about tenants damaging your property, collecting monthly rent or working with management companies. Flipping does not require management and supervision like rentals. It is a better investment strategy for people with little or no time.
Property Management for Rentals
Rental strategy consumes time because you have to worry about many things like property management, repairs, bills payment, and so on. Apart from being time-consuming, it’s a venture that requires a level of professionalism that only a few know. Therefore, to be successful in the endeavor, you should contact a property management company for assistance.
Note: If you want to work with a property management company, know that you are required to pay 8- to 12-percent of the property’s monthly rental value.
Taxed on Fix and Flip
Flipping income tax payment is similar to the self-employed income tax, which means the percentage of tax on income is similar. According to a Huffington Post article, self-employed individuals are considered the highest taxpayers in the United States. You have to decide and be ready to pay taxes up to 43% of your income before moving forward.
Unlike flipping, buy-and-hold are similar to investment property. It means you are not required to pay a large percentage of your income as tax. Also, there are situations where you don’t have to pay tax. If you don’t want to pay more tax on your income, you can consider choosing the rental investment strategy.
Paying taxes is complicated so working with an accountant is the only way to be sure of your decision on task payment.
What To Do With Your Investment Property
With the above factors, we see that making decisions depends on many factors like availability, investment goals and financial situation. For individuals who want a consistent stream of income and long-term investment holding, the rental strategy is a good choice. For those who are contemplating on making real estate a source of income, the flipping strategy should be their preference.
Should I Rent or Flip A House
You should be able to identify that rental investment is the best choice for you if:
- You want a slow but steady Return On Investment
- You want to pay less tax
- You have more time to invest
While Flipping is a better alternative if:
- You want quick and more ROI
- You have less time
- You want to avoid the stress of managing a property
In conclusion, depending on the strategy you choose, you should evaluate your goals and compare the pros and cons mentioned above, and, through this, make an informed decision which benefits you now and in the future.