An investor asks at a networking event. This is one of the most common questions real estate investors grapple with. Obviously, this question is extremely specific to an individual and a transaction and is a challenging one to answer. This is not a question that can be answered by anyone but you but here are some variables to consider on your quest for the right decision.
If you have a long-term focus, renting will almost always produce a better result.
Reasons To Rent/Hold The Property
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Income without liquidating the asset
The idea of financial freedom is having more passive income than you do monthly expenses. That is true freedom. You will never get there unless you keep cash flowing assets. Rental properties, when done right, will produce monthly cash flow that will increase over time.
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Tax benefits
There are a lot of tax benefits of rentals over flipping. When you flip a property, you will pay ordinary income taxes which can be as high as 37% at the federal level. When you have rentals, you will pay investment interest which could be taxed at a lower rate or could be offset by losses. I suggest you check with your CPA to get more details. You will also be able to take depreciation expense which is one of the primary tax advantages of rental property. The IRS considers a useful life of property and then allows you to take a portion of the asset as a deduction in equal portions throughout that useful life. For example, residential real estate can be depreciated over 27.5 years so you can deduct the value of the asset by 27.5 and take that amount as a tax deduction every year. This is a huge benefit because it is not money out of your pocket but still reduces your tax liability. This is a specialized area of tax law and there are multiple ways to accelerate or slow the depreciation rate so be sure you work with a great real estate CPA to maximize this benefit for your situation. You cannot take this deduction with fix and flips.
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Multiple areas for growth
With a fix and flip you rehab the house, sell the house, and then you are done. That sounds more like a high paying job than an investment. With a rental you have multiple streams of returns to help accelerate your long-term growth. This is broken down in four categories. Obviously, you receive the cash flow and the tax benefits that we have discussed. You will also benefit from the tenant paying off your mortgage for you. Each month you make a payment on your loan, a portion is applied to the loan balances which is a huge benefit over time. Finally, what is likely the largest benefit of rentals is the appreciation over the years. Over time the house is expected to go up in value and if you do decide to sell, you will get a windfall of proceeds at a lower tax rate. These four ways you benefit from your investment is what separates rentals from any other investment in my opinion.
With all this said. It is not as easy as just deciding to keep an asset. Rental properties take effort and money to hold. Most likely you will have some cash tied up in your rentals and you need to set aside reserves to handle vacancies and maintenance issues. You will also need to figure out how to finance them with good long-term debt which means you need to be in a financial position (income, assets, credit score, etc.) to qualify for loans. Even if you do qualify for loans, most lenders will limit the number of properties you can finance so eventually qualifying for more loans gets more complicated and challenging.
Deciding To Flip Or Keep An Asset? Consider These Questions:
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Do you need the money that a flip would produce?
We all gotta eat! If you are flipping for the income because you need the income, then flipping might be the better option. It takes a lot of rentals to replace income but just a few flips can generate a significant amount of cash. If you are flipping for income, you could consider keeping a few of your flips as rentals so you can accomplish the income that you need now and set yourself up for the future. If you do it this way, you can likely use the depreciation tax benefits from your rentals to offset income from your flips.
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Will the rental produce enough cash flow to keep you safe?
There will be ups, downs and vacancies. I would want there to be sufficient cash flow so that you will still end the year with a positive return even if you hit a road bump along the way. Or if you have a turnover with significant damage, how many years of cash flow will it take to pay for that? Obviously what is acceptable is different for everyone but this is a great question to ask to reduce risk.
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Is there specific criteria you can create that will make the decision for you?
I know a lot of fix and flippers that only buy properties they are ok with holding long term. They do this so that they can convert to a rental at any time. Others will keep any property that has a rent ratio that hits a target, or a return, or positive cash flow. There are a number of ways that you can look at this but if you can establish a set criteria of when you keep and when you don’t, it takes this agonizing question, out of the question. We learn in business to create a decision tree or decision frameworks wherever possible. This eliminates stress, improves efficiency, and allows others to step in and help in our absence. This is a great habit in any business and real estate investing is no exception.
Make Sure To Set Aside Income For Future Investments
Regardless of if you keep or flip properties it is important to set aside income to invest for the future. Obviously, keeping a rental will do this but if you don’t want to deal with rental properties, it might make sense to convert some earned income, through flipping or something else, into cash flow. You can do this with traditional investments like stocks or bonds, or nontraditional investments like passive real estate investments or partnerships, private lending, or mortgage pools like what Pine Financial offers.
The last thing you want is to have successful fix and flips turn into nothing for your future! Maybe a goal for 2024 is to turn every flip you do into some kind of sustainable income that will last forever.