Flipping vs renting: which one is a better choice for your investment property?
The gross profit on a typical flip rose to $67,000 in 2021. When done right, flipping can generate quite the returns.
But renting out a property can be just as lucrative – if not more so. 36 percent of households in the US are renters, so you have plenty of opportunities should you choose to rent out your property.
Numerous factors come into play when you’re deciding to flip or rent. Below we’ll explain how you can make the right choice between flipping and renting to maximize your returns.
Location is one of the top factors – if not the top factor – when it comes to buying a home. Nothing will determine the value of your home more than where it is located.
Not only will you want to think about the location within the city, but you’ll also want to consider the neighborhood, noise level on the street, and the school district.
Homes located next to stores, schools, and public transportation will increase the property’s value. Highways and airports, both of which are noisy, may decrease value.
With this information in mind, you’ll want to think about the location of the house in the context of the local demographic. Comparing the house to the people who may live in it will help you determine whether to flip or rent the property.
For instance, say you want to buy a home in an up-and-coming city known for its young residents and new families. Should you buy or rent the property?
Maybe the property is near a great transportation system, but not near the best school district in the area. In this case, you may want to consider renting out the property. Young adults will appreciate the proximity to transportation methods, but they won’t care about the school district.
And speaking of transpiration, what are the transportation methods for the area? Do most people own cars, or do they rely on public transportation to get around? If you want to flip a house in an area where most people have cars, your property will need parking options.
You’ll also want to consider the physical characteristics of the home. You want it to be unique enough that it attracts buyers’ attention, but you also want it to have comparable features to other homes in the area.
For example, say all the homes in the area are at least 2,000 square feet with three bedrooms. Does your home have similar characteristics?
Even choices like landscaping and curb appeal can matter for choosing to rent or flip a home. Curb appeal can add up to 7% to a home’s value.
If you purchase a house that needs a major exterior upgrade, it may be worth it to invest in the changes and then flip the house. Otherwise, it could take months to earn back what you paid in fixes with rental income.
One of the most valuable physical characteristics is the size of the lot. Generally, people will prefer larger than average lots in the neighborhood. A home with a smaller lot will likely sell for less.
When deciding whether you want to flip or rent a home, consider the size of the lot.
Even if you invest in upgrading the home, you can’t change the size of the lot without buying adjoining property. Homebuyers may be turned off by the lot size, but renters aren’t as likely to care.
Another part of your decision will involve looking at the current state of the house. Today’s homebuyers want move-in-ready homes. Is your property move-in ready?
If the answer is yes, you may not gain much from flipping the house. Homes that are already move-in-ready will be subject to the market more than they will change in prices from cosmetic changes.
It’s a good idea to purchase a move-in-ready home when the buying market is relatively low. That way, you can rent out the home and then sell it when the market gets hotter years down the line.
But if the answer is no, you have to consider a few more options when determining whether to rent or sell a home.
What are the problems with the home? Are they more structural or cosmetic?
Structural problems will require fixing no matter what. It’s rare that someone will want to buy your flipped property if you don’t make it livable. And rental standards require your property to be livable before renting it out.
Say that your home has some structural issues but is fairly acceptable cosmetically. In this situation, you would likely want to rent it out. You can recoup what you spent on the structural issues through the rental income, then decide your next move.
Homes with major structural cosmetic issues will require the most work. But they can generate the largest returns should you choose to flip them.
These homes give you significant leeway in your purchase offer. You can buy the house for a steal, redo the entire thing, then make a serious profit.
Bedrooms & Bathrooms
The number of bedrooms and bathrooms can help you decide what you should do with the house. You’ll also want to think about the number of bedrooms and bathrooms in the context of the entire home’s size.
If you’re selling a 2,000 square-foot house with five bedrooms and only two bathrooms, it’s unlikely that a family of 6 people would live comfortably with so few bathrooms.
But say that you choose to rent out the bedrooms individually for short-term stays. Guests will have shared bathrooms and common spaces, but their own rooms. People who stay at the property for a week or two will be less likely to mind sharing bathrooms.
Let’s take another example. Maybe you find another house with 4 bedrooms and 4 bathrooms, including a master bath and two bathrooms next to two bedrooms.
The structure of a home like this is more friendly for flipping. It’s much more comfortable for a family who is looking for a home to envision themselves here.
How can you determine if you should flip or rent out a home? Look at the numbers.
Below we’ll consider the expenses that go into preparing your house for rent and then renting it out. Then we’ll compare it to the costs spent on remodeling a house to flip it.
Renting a Property
To determine if it’s worth renting out a house, you’ll want to calculate the capitalization rate. Lenders find this rate to determine the risk involved in funding a property purchase given the choice of flipping it or renting it out.
Here’s the formula for the Cap Rate:
Net Operating Income (NOI) x purchase price = capitalizations rate
The lower the capitalization rate, the lower the risk. Now let’s consider an example using this formula.
Below we’ll consider a house that has a purchase price of $200,000. Let’s see what happens next.
Based on the formula above, we need to find the NOI of the property and multiply it by $200,000 to find the capitalization rate.
You find NOI by taking the projected gross income from rent on the property then subtracting the costs of that property.
The true NOI reveals your earnings after you take into account vacancies, maintenance, taxes, and insurance.
For instance, say you earn $2,000 in rental income a month for your property. This equals $24,000 a year.
But after maintenance, taxes, and accounting for a vacancy, your NOI is $20000 a year.
To find the capitalization rate, we multiply:
$20,000 x $200,000 = 10% capitalization rate. Although a bit high, 10% is a reasonable cap rate for your investment property.
Flipping a Property
We can’t use a cap rate for flipping a home because they don’t accurately represent what the cash flow will look like. There won’t be a stream of income over time. Instead, there will only be income once when the property is sold.
Many financial estimations for flipping a house will be speculative. You will know how much you pay for the house and what the closing costs will look like.
Besides that, it’s difficult to predict what you can spend. You will rarely complete a project without unexpected expenses.
The same goes for time. You can estimate that a project will take six months and budget accordingly. But delays could make the project take twice as long, and you’ll have to pay for it.
On the flip side, you may find that you don’t have to make as many changes as you originally thought. You may be able to get the house on the market in just a few weeks.
This doesn’t mean that you shouldn’t do your research when determining the costs of flipping a house. You can still find ways to control your budget and do your best to keep your costs in check.
Just prepare for the fact that you will encounter the unexpected. If you’re equipped to handle the unknown, you’re ready to flip a property.
Depending on whether you choose to flip or rent a home, your tax rates will be different.
When a property sells for more than it was purchased for, it faces a capital gains tax. The tax varies based on the time you held the investment.
When you gain from flipping houses, you’ll be taxed with ordinary income. This is usually a higher tax rate than you would face with rental income.
Holding a rental property makes you subject to long-term capital gains rates, which are lower. They can be 0%.
In addition, owning real estate properties provides certain tax advantages. First, rental property owners can deduct expenses from operating and maintaining the property.
Property taxes and mortgage interest can be deducted, to name a few. They can also record depreciation, which deducts a portion of the property’s value. This will help offset costs.
Lastly, you’ll want to consider your time frame. What are you looking to accomplish?
When you choose to rent out properties, you’re facing long-term management and property upkeep. This means you’ll need to be responsible for your property for a long time.
You could also find someone else to take care of the property, which will be an additional cost.
There are high standards for rental properties, so you’ll need to ensure your house is up to code long after you make the initial renovations. You’ll also be subject to inspections by the city to ensure your home is up to standards.
Before you choose to buy a property to rent out, you’ll want to understand everything that goes into maintaining it. You’ll also have to decide on the expectations you set for your guests.
For instance, will you let smokers stay on your property? What about students?
When you choose to flip a property, the time frame will be much shorter. You’ll have to be prepared to work fast and make major decisions quickly.
From the moment you buy the property to flip, the goal is to complete changes as fast as you can. The more time you spend on remodeling it, the more expensive your costs are.
If you want to flip a property, you need to be prepared to dedicate a significant amount of your time and energy in short stretches.
Flipping vs. Renting Houses
There’s no universal answer for deciding whether to flip or rent an investment property. Flipping your property can provide short-term returns and the thrill of beating the market. Renting a property could offer you long-term financial security and connections.
But regardless of what you choose, buying a home is a large investment. You’ll want a team of lenders who care about your success and will help you along the way.
At Lend Simpli, our private investors will help you fund your dream property.
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