Flip or Rent??

Question

Hello, my wife and I are first time investors. We recently purchased a single family detached home with a tax value of 120K. We bought the property as a short sale for $60K. We are currently undecided on whether we should flip this property and sell it for double the investment, or simply rent it out for the long term gain of $1000 per month. We estimate the cost of the flip to be aprox. $5K for cosmetic fixes.

Any advice would be greatly appreciated, thanks!

Michael Evans · Answer

If your goal is financial independence (having enough income generating assets that produce enough cash flow each year so that you can afford to live the way you want without having to work), then must first accumulate the income producing assets.  There are only types of investments, regardless of asset class (stocks, bonds, real estate, business, etc.): appreciation (buy low and sell high) or cash flow (buy and hold).  My system is to use appreciation investments to grow my cash to the point where I can then use the cash to purchase my income producing assets.  Here's the equation:

Income Producing Assets = Annual Expense Budget / ROI

If $100,000 per year will be enough for to afford to live the way I want to live without having to work, and my risk tolerance for my income producing assets says I can live with a 10% annual ROI, then the amount of Income Producing Assets I need is the following:

Income Producing Assets = $100,000 / 10% = $1,000,000

So now I have to come up with an Asset Accumulation Plan (AAP) to generate $1,000,000 so I can then convert the cash into income producing assets.  Your APP is based on the three following things:

1. How much money can you commit to invest every single year, without fail?

2. How many years do you commit to invest that money?

3. What annual ROI are you comfortable with generating for the number of years?  This ROI is higher than you income producing assets ROI.

There is an Excel formula you can use to change two of the three variables to see how your AAP plan will work.  In the example above, where you need to generate $1,000,000, the variables are related as such:

1.  If you commit to invest $10,000 per year for 20 years, you need an annual ROI of 13.71%.

2. If you commit to for 20 years to achieve an ROI of 15%, you will need to invest $8,488 per year.

3. If you commit to invest $10,000 per year and achieve an ROI of 15%, you will need to commit to 18.90 years.

4.  If you change the ROI to 25% and keep the years at 20 years, you only need to invest $2,333 per year.

The main point here is to have a goal and then develop a plan.  I would suggest that focus on appreciation investments that generate at least 25% cash on cash ROI and an annual ROI of at least 25%.  Feel free to contact me if you (or anyone) has additional questions.

God Bless You!

Brett Russell · Answer

@Jason Bridges , welcome to BP and congrats on getting started.

I think most people would say you should start with the end in mind and know what your planned (and backup) exit strategy is for a property before purchasing.  Obviously too late for that on this one.  This is a personal decision... flippers will tell you to flip it, landlords will tell you to hold it.  What is your plan for your investing?  What do you want/need out of this property?

Also, I would recommend spending a bit more time reading this site because I think your projections may be a bit too rosy for either exit strategy as you may not be considering all costs, but once you figure out realistic projections, you need to decide what you want.

Daniel Moore · Answer

That is a very common question and always falls back into what is your goals and current financial abilities. For some people taking the quick forced appreciation and rolling those gains into more forced appreciation until there are pockets of cash that can be set to the side for long term cash flow (as well as many other benefits like amortization, irs depreciation, economic appreciation, inflation etc). For many just starting out that don't have large amounts of capital like to do wholesales/rehabs to create the capital necessary to buy the cash flow, and often once you get the cash flow the capital gains are always great to maintain the cash flow.

I always look at a property deal by deal and look at what the COC returns would be, and what is the best use of my resources. Can i spend 60k today and receive 1000k a month in cash flow, or could I take a 40k capital gain and use that infusion to purchase 1500k a month in cash flow with minimal leverage?

Thomas Kempton · Answer

My wife and I discuss this with the purchase of every property.  Buy to sell or to hold? And that answer usually derives itself from the financials. We do not wish to hold higher end properties.  This is because we do not yet have enough capital for a high end property (1300-1500/mo) to sit vacant for a few months. We would rather sell It at a deep discount and build capital than a vulnerable portfolio.

Jeremy Roll · Answer

So how did you make out on this deal? Did you sell or find a renter?

Matt B. · Answer

@Jason Bridges

Update?

Michael Bailey · Answer

Hi Jason,

I wanted to know what you ended up doing. I hope everything worked out for you.

Daniel Moore · Answer

@Jason Bridges

Amortization - the tenant paying down your principal balance monthly for you "equity growth"

Depreciation - you can use an IRS depreciation schedule to write of the "loss" of the assets value against your gains. This is also called Phantom loss because it didn't truly occur.

Appreciation - the typical rise in value of the home over time - avg 4%

inflation - re is a great hedge against inflation, especially leveraged re. buy a house for 100k, and inflation goes wild, the house cost goes with it, therefore hedging the inflation. Leveraged purchases are even better becasue you can hedge more than just "your dollar". The bank loaned ya good money, and if inflation takes a run, you still only owe the bank what was loaned, but you are essentially returning a  bad dollar.

Jonathan Godes · Answer

No problem Jason - it is always good to have a fallback strategy (or three). Don't forget about a hybrid between the two... a lease option.  I would say that if you could spend $60k and make a $30k profit... well, you don't get too many deals that would have a 50% return. Good luck and if you run into the Avett Brothers (I think Concord is their hometown) try to get one of them to buy the sucker off of you:)

Jason Bridges · Answer

@Jonathan Godes @Kyle Kelley I appreciate your feedback, and the more research I've done, I'm actually leaning in that direction as well.  Initially the plan was to buy and hold, but we see the potential in the property and would love to flip it and turn the profit into 2 or 3 more buy and hold properties.  That would be the best case scenario!  If I'm not able to make at least a $40K profit, then renting would be my fall back plan.  Thanks again, its great to get different opinions on this.

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