There are two camps into which residential real estate investors fall. The first camp buys houses, fixes or upgrades them, and then sells them for a profit. This is known as flipping. The second camp take the opposite approach. They buy houses and hold onto them, hoping to sell them in the future and make a profit from the appreciation. As a side note, many homebuyers fall into this latter camp; they live in their homes, but are inclined to sell if the price is right. So, which path is better: flipping or buying to hold?
Below, we’ll explore this issue in more detail. We’ll first explain the main reasons to consider investing in residential properties. We’ll then describe the two paths you can choose, and the pros and cons of each.
Reasons To Invest In Residential Properties
The recent debacle in both residential and commercial real estate markets has caused many would-be investors to sit by the proverbial sidelines. Because prices have declined so sharply over the last few years, however, there are more investment opportunities than ever. One of the most common reasons people have traditionally invested in homes is because they offer a hedge against inflation along with the prospect of appreciation. This continues to be true today.
Another reason to invest is a lack of certainty in the stock and bond markets. Essentially, the value of a home follows a more predictable trajectory than securities.
Lastly, the equity that grows in your real estate investment portfolio can be tapped to finance other projects. This allows you to leverage your portfolio’s value while retaining ownership of the underlying properties.
Advantages And Drawbacks Of Flipping
The first advantage to buying homes for sale with the intention of flipping them is that doing so yields an immediate profit (hopefully). This means your investment capital is released for other projects rather than remaining tied up within the property.
Another advantage is that the real estate market is largely inefficient compared with the stock market. The price of a given security can fluctuate throughout the day while home values rarely do so. For this reason, many investors consider the real estate market to pose less risk.
On the other hand, the transaction costs associated with buying and selling homes are high. Flipping them can only be done profitably if there has been a sufficient rise in their value. Also, there may be tax implications involved with the sale of a residential property. Flipping can trigger a tax event, making the transaction even most costly.
Advantages And Drawbacks Of Buying And Holding
Most residential real estate investors who have done well in the market have done so based largely on buying homes for sale and holding them. Over time, the aggregate value of their properties rises, often leading to great wealth. This is one of the reasons many people stick to a “buy and hold” strategy.
There are a few drawbacks to such an investment strategy. First, capital is tied up in the properties, making it unavailable (aside from equity loans) to invest in competing projects.
Second, the risk of holding a house increases with time since its value is more likely to fluctuate. Because home values typically rise, there’s rarely reason for concern over the long run. But the most recent market crash has provided a jarring reminder that rising values are not guaranteed, especially over short timeframes.
Third, many investors in the residential real estate market buy homes for sale and rent them to others. The rent provides cash flow. While this can be an advantage, the responsibilities of finding and interviewing tenants, collecting rents (often late), and managing properties are enormous. Most investors lack the necessary expertise or patience.
To recap, there are distinct pros and cons inherent to each real estate investment strategy. Choosing between them depends largely on your access to capital and your tolerance for risk.
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