In Part 1 of this series, I shared why an agent should consider becoming an investor and the most important aspect of being an investor – having the right deals. What comes next? Strategy. To be a successful investor, you need to know the right strategy for every deal you participate in. To start, let us ask the most popular question: What is better? Rental or Flip?
The Eternal Question: Rental or Flip?
When it comes to investing, you have two main options: Rentals & Flips. Every deal you have seen will usually fall into one of these two categories. Most new investors often ask, ‘What should I buy: Rental or Flip?’ Well, it depends on the investor, and their goals are. Most investors tend to be actively involved in both: Flips AND Rentals.
HGTV Shows Are a Lie!
Throughout my career, I have met hundreds of investor wannabes who have been inspired by Flipping shows on HGTV. They usually start by looking for flips because they believe that its easy money. After all, the guy on TV makes it look so easy: Drive a sledgehammer through the wall, fix the roof, and finally walk away with $50,000 for his troubles! I hate to break it to you, but flips in the real world rarely happen the way it is shown on TV.
Flips aren’t about the rehab as much as they are about the acquisition. If you buy them correctly, rehabbing them is the easiest part. It’s the buying and selling that’s hardest. Flipping properties is a risky business. It takes a great deal of knowledge and experience to pull off a flip. If real estate investing was like going to college: flipping properties would be like your senior year – the last step in your journey.
Boring is Best
To continue our previous analogy of comparing real estate investing with college, being a freshman is like buying a turnkey long term rental. It doesn’t feel exciting. There’s no drama or excitement. It’s dull, boring even. That’s exactly what new investors need when they’re starting. Something predictable that’s performing before they purchased it. The easiest way to find a performing rental is to find one on the MLS that is being managed by a professional management company with a tenant who has occupied the property for a long time. You can usually buy a property like this with conventional financing with 25% down and financing the remaining 75% over 30 years. Though the cash flow on a property like this is unlikely to be 10%+ like I mentioned in my previous article, it’s a great place to begin your journey.
What’s the Real Difference Between a Flip & a Rental
The biggest difference between a rental and a flip has got to do with taxes. With a rental, you get passive income in the form of rent, gain cash flow in the short term and slow capital appreciation in the long run. Rental income is usually taxed at a lower rate than income from flips. With a flip, you’re looking at the forced appreciation of the property that can be realized only when you sell the property. Typically, this triggers a capital gain, and the IRS usually treats flipping as an active income.
One of my mentors once told me this: If you want to know what the best strategy is, follow the taxman. Look at the actions he rewards vs. what actions he punishes and follow his advice. The reward/punishment is in the form of a tax break or a tax penalty. If you follow this strategy, you will emerge with a golden strategy: buy a property, fix it, rent it out, and if you wanted to sell it, you’d usually wait for a year before doing so. I can’t tell you how many millionaires have followed this same strategy and have come out on top.
Investor Hybrid Strategies – Best of Both Worlds
Once you become a seasoned investor, you will want to explore hybrid strategies – ones that combine the best of flips and rentals. Here are two of the best hybrid options you will find: BRRRR & Lease options.
BRRRR stands for Buy-Rehab-Rent-Refinance-Repeat. With this strategy, you’re looking to buy a distressed home and buy it up to 75 cents on the dollar, rehab it, rent it to a long term tenant, refinance it to pull out most of your initial capital, and then repeat the process. BRRRR gives you the best of both worlds: it allows you to do multiple deals like flips because you get most of your capital back within a few months. It also provides for passive income through the long term rental, and you get a tax break from the IRS for keeping the property as a long term rental.
Lease Option or is sometimes called ‘Rent-to-own.’ Is usually a two-year strategy where you acquire a turn-key asset up to 85 cents on the dollar and sell it to a tenant-buyer at 105 cents on the dollar. A tenant-buyer is someone who pays approximately 5% of the purchase price as a downpayment and rents the property for up to 2 years before he can purchase it. With this strategy, you get the tax benefit of having kept it for more than one year. The IRS allows you to do a 1031 exchange with the capital gains through the process.
Be a Risk-Taker but Not a Gambler
There’s a fine line between being a risk-taker and being a gambler. As an investor, you are going to walk on that line every day. I have met people who are so afraid of risk that when they run the numbers, they’re too conservative. They never find a deal because the price they offer is so low that no seller will ever accept it. I have also met people who love risk when they run the numbers, they’re overly optimistic. They end up overpaying for a property. You will be shocked to discover that 90% of investors are in this category. They usually end up doing only one deal in their careers because they got burnt on their first deal and exited the game.
As a ‘Real Investor,’ you need to take calculated risks, have a buffer for when things go wrong (because Mr. Murphy loves real estate investors!), and be like the 10% of investors who do several deals throughout their career.
Stay tuned for the next part in this series on ‘Finding (or having) the money.’
ABOUT THE AUTHOR
Jorge Vazquez is a broker and founder of Graystone Investment Group headquartered in Tampa, Florida. He has been in the business for over 20 years and has participated in more than 2000 transactions. Graystone is one of the first companies in Florida with all divisions under one umbrella: Wholesaling, Brokerage, Private Lending, Rehabbing, and Property Management. You can find Jorge at homes4income.com or Graystoneig.com and connect with him to either join his brokerage, invest, or just to learn more about real estate.