Do You Know the Best Strategy for Investing in Residential Real Estate?
The debate rages on amongst real estate investors…On one side of the argument, you’ll hear about quick profits made seemingly overnight. This is from properties that were bought below market value, had quick repairs, and were sold immediately thereafter with handsome markups.
On the other side of the argument, you’ll hear about sizable monthly cash flow checks that come in every month from happy tenants. This comes from properties purchased in solid neighborhoods that seem to appreciate at incredibly high rates.
What’s the right answer for real estate investing?
There are ups and downs to both strategies and ultimately it comes down to choosing the best method that will help YOU achieve your overall financial goals. To help you make the best decision about which method to use, we’ll provide a detailed breakdown of both strategies.
Due to the large amount of popularity glamorized through real estate investing seminars, dozens of T.V. shows, and celebrity endorsements, the “fix and flip” strategy is becoming more common for investors who are looking to turn a quick profit.
How It Works
The way the fix and flip strategy works is that investors look for properties that are undervalued in neighborhoods that are stable and/or growing. Ideal properties are those that will require a minimum investment in repairs and rehab, and can be sold shortly after renovation.
While you can be a one-person investor who takes care of everything from start to finish, there is a lot of work involved in this style of real estate investing. Most investors typically have several parties they work with, including local real estate agents, a team of construction workers and contractors, and they have some type of financial support and/or backing.
Funding for this type of real estate strategy can present some challenges, if you don’t already have a large sum of cash to work with. Because of the shortened timeline to get a return on the investment, most fix and flip investors avoid traditional loans. This means they either pay for the properties in full with cash, work with a team of private investors whom the profit is shared once the property is sold, or seek alternative funding methods. While there are hard money lenders, portfolio lenders, and other potential options for getting access to capital, these solutions can be costly or come with contingencies regarding when the property needs to be sold or how much money needs to be used as a down payment from the investors.
Part of the profit comes through picking houses in which a little bit of work can go a long way. Improving key areas of the house like bathrooms and kitchens have the potential to dramatically increase the value of the home. Other cosmetic changes also take place, which include replacing carpet, paint, upgrading flooring, and fixing things like HVAC systems. Remember that because you are looking to recoup the costs on your investment quickly, all the capital that is put into transforming the property will be coming out of your bottom line when the house is sold.
Your goal for making renovations in a fix-and-flip is to hopefully increase the value of the home, which potentially leads to a higher sale price. By increasing the sale price, you have a higher chance to recoup what was spent on the renovations and gain additional profits.
After the house has been purchased and the renovations are completed, it is time to sell your investment. Most investors partner with a real estate agent to help ensure the fast sale of their property, but this does add an additional cost of his or her commission. Working with a real estate agent is typically easier than choosing a “for sale by owner” option, which can often take longer.
What You Should Know Before You Invest
As with any investment, there is certainly risk involved in successfully getting enough return on your investment. Part of this comes from knowing which neighborhoods present the right balance of risk-versus-reward, as well as successfully crafting an exit strategy. If the markets take a shift when you are ready to sell or the local economy suffers from a downturn, you could be forced to hold onto your property longer than you anticipated or have to sell at a lower price than projected. Both of which hurt your bottom-line, and because of this risk, fix and flip sales are on a downward trend. According to a recent article on RealtyTrac, only 4.5% of overall home sales in Q2 of 2015 were fix and flip; down from the 8% peak in 2006.
If you carefully budget out your renovations and/or choose the right funding strategy it is possible to turn a quick profit on your investment. While this method takes a great deal of research, planning, and sweat equity, it isn’t for everyone. The potential risk of not hitting an exit in time as well as not being able to make enough profit to compensate for all the work can be a huge deterrent for investors who would use this style of real estate investing to fund retirement or pay for their kids’ college fund in the future.
Much like the “buy and hold” strategy that Charlie Munger and Warren Buffet successfully use for stock market investing, you can take that same methodology and apply it to real estate. Instead of looking for a quick profit found on a sale shortly after purchase, the profits are made over the long haul through cash flow and appreciation on your real estate investments.
How It Works
Investors looking to buy and hold should choose properties in neighborhoods that are stable, poised for growth, and will attract renters. While there are numerous factors to look at, most investors examine the local statistics for employment, median income, average rent prices, crime rates, and proximity to good schools.
While this option isn’t nearly as labor intensive as the buy-and-sell strategy, you’ll still need to work with a real estate agent, possibly a general contractor (for potential rehab), a property management company, and bank or mortgage lender for funding.
After you’ve found quality investment properties, you need to choose the right funding strategy so that you can achieve the ROI that is inline with your financial goals. Most investors who are far from retirement can take advantage of leverage by using other people’s money to fund their investment and maximize gains. This means you put down a down payment of about 20-30% and the bank picks up the remainder. You set up the terms according to your investment goals, but they are typically 15 or 30 year loans. If you invest in the right neighborhoods, the loan and expenses are paid for by the cash flow that is generated through rents.
Alternatively, some investors simply like to pay for their income properties with cash. Paying in full with cash can maximize cash flow almost immediately, provide an added advantage in price negotiations, and provide you with an asset that has zero debt and less risk, as you do not have a mortgage to pay in the event that the rental is vacant.
Rental homes purchased for the buy-and-hold strategy typically require some minor renovations. This won’t be nearly as expensive or time consuming as the fix and flip strategy as these homes are usually in better condition, and the renovations are designed to enhance the overall rentability of the home.
That being said, the renovations will contribute to increasing the overall value of the property and making sure you are maximizing your cash flow through rent. Rehabs on these properties are typically quick, because the sooner tenants occupy the property, the sooner it will start generating cash flow.
While there is more pressure to get a quick return on investment with the fix and flip strategy, there are multiple ways you can generate profits through the buy and hold method. Profits can be generated through the monthly rents that are collected, and if you opted to use leverage, this will help you pay down your mortgage, and cover expenses. Although cash flow can happen relatively quickly, the big lump sum of profit that comes with fix and flips won’t be seen until the future.
Properties chosen in the right markets will also see profits gained through appreciation. The longer time frame takes the pressure off of trying to quickly recoup your ROI, and instead you are creating a vehicle that could continue to grow in cash flow and value well into the future.
What You Should Know Before You Invest
As with any investment vehicle, there is certainly risk involved in buying and holding real estate, but you can mitigate much of that risk by investing in the right neighborhoods and having plenty of time to grow your asset.
Researching neighborhoods and working with the right team (real estate agents, property managers, etc.) can help you easily achieve your financial goals through real estate investing. Best of all, you can use this strategy to help you fund retirement or as a way to grow your capital to pay for your children’s college in the future.
Pick the Right Strategy for Your Investment Goals
Which strategy is best for investing in real estate? Ultimately, it comes down to choosing the option that is right for your investing goals. For investors that prefer to take on a bigger risk in exchange for a chance at a more immediate reward, the fix and flip method might be the right option.
For other investors who are focused on an investing solution with lower risk combined with a stable reward, the buy-and-hold strategy is likely the right choice for you. In terms of broad market trends, the current real estate market is primed for growth with select markets around the country showing strong projections for buy-and-hold investors.
How To Implement Successful Real Estate Investing Strategies
While there are multiple ways to invest in real estate, partnering with a company that will take care of all the hard work and help you see success in your real estate investing strategy is ideal. HomeUnion® has created a one-of-a-kind solution that will help investors like you easily, find, acquire, and manage single family rentals in proven cash-flow markets across the country.
Learn more about how you can easily create a portfolio of real estate assets that are inline with your buy and hold strategy by scheduling a consultation with one of our Solutions Managers.
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