Flip or rental?

Question

I have a paid off rental house and no mortgage on my modest bungalow. I recently bought a property from the VA for 52k, intending to use it as a rental for passive income. However, my son who has flipped two houses successfully asked if I wanted to flip it instead with him for more cash flow. I used a LOC on my primary residence to buy this house and have $20k in savings. Most of the work involved in this house is strictly cosmetic to the tune of $5-$7k.  He wants me to hire him out as general contractor and he will pay for all rehab costs. He can get it completed in a month.  Then we would split the profit after selling it. My question? Hold it for a year and then sell or immediately rent and sell down the road or use as a rental?  My experienced real estate agent/investor said we could sell for 80-85k, county website estimates value at $94k. Houses in that area quickly rent for $700-$800 month.  How do I determine the best avenue to take? I want to continue down this new journey of real estate investing a little more aggressively than I have been thus far. Thanks in advance for your wisdom!

Mike H. · Answer

@David Roberts

Again, it depends on your investing goals and your current situation.

Is their goal to create a chunk of cash or to create a chunk of passive income.If their goal is to simply create a chunk of cash, then flipping is the answer. Buy and hold is not going to generate chunks of cash fast.

If their goal is create passive income, then the next question becomes - do they have the cash reserves to grow a portfolio at the pace they're looking for. If not, then flipping is the answer.

But if they have the cash reserves and if they're trying to generate a chunk of cash flow for the long term, then I wouldn't care if I could make 30k in 5 months. What I've found is that if a house is a good deal to flip, its an even better deal as a buy and hold.

For someone like me that uses hard money to take down deals, I'd really have to have a huge margin in order to flip a house. Because quite honestly, if a deal is a good candidate for a flip, its an even better candidate for a buy and hold.

And my goal is strictly to build up a bunch of cash flowing properties that have a reasonable expectation for decent appreciation as well. And what I've found is that the numbers simply don't make sense to me to flip a home.

Ultimately, if I find a really good deal, I might be able to make about 15 to 20k profit. Then you have to pay taxes on that as well. Now if you're lucky and only do one flip a year - or maybe two tops - you can get away with paying just earned income taxes (30%).  If not, you're adding the self employment taxes and paying 40%.

So on a 15k to 20k profit, you're looking at anywhere from 9k to 14k actual cash in your pocket.OR I can take the 200 to 250/mo net income from that house plus the appreciation plus the principal paydown and pocket that for the next 20 to 30 years.

And what does that rental income look like in 10 years? Its going to be higher than 200 to 250/mo. Rents go up.  Mortgage payments stay the same (if fixed) or go down (if loan is renewed and based off the new principal).

So your net profits should increase over time as well.

But that 9k to 14k is a one time fee that I don't see you turning into much over a 20 year period.

Versus holding on to a 90k for 20 or 25 years. Not only will you get all that rental income over the years but you'll end up with a paid off house that will probably be worth 160 to 180k in that time and that you'll eventually own free and clear.

But again, its about where you're at in your investing. If you don't want to deal with tenants, then flip. If you need cash for your reserves, then flip. If you just want to do this as a way to give yourself a nice bonus every now and then, then flip.

But if you have a decent amount in reserve and if your goal is to build up your passive income, then NEVER SELL!

David Roberts · Answer

What if he could.net 12-15k off of the deal flipping it?  So basically make 5-6 years worth of cash flow in 5 months time.  Would you suggest that he flip it instead?

It is a good problem to have.  Make more money now or make money over time.

Im just wonderin.

Mike H. · Answer

Thats always the million dollar question. Should I flip or rent.

The key question I go back to is what are your goals with your investing?Is your goal to build up more income? Or simply to use REI to supplement your income.

On this particular deal though, that all may not matter though.

If you bought it for 52k and it needs 5 to 7k, then you're going to be all in at 60k.

If it will sell for 80k, there's not much room there for any real profit - even less so if you're going to split it.  Remember, just because the house is assessed for 90k, that doesn't have any bearing on how much you sell it for.....

At being all in at 60k on a house that rents for 900/mo, I'm guessing your net income to be rouighly around 150 to 200/mo maybe? Thats about 2k a year. And, after depreciation, that number will likely be tax free.

To me, I'd rather make 2k a year in rental profits, plus some appreciation (assuming there is any as that is a seemingly lower end neighborhood), plus principal paydown every year then flip the house and make 4 or 5k in a one time bump.  After paying taxes on that 4 or 5k, you're looking at a 2,500 to 3k total net profit anyway.

Why not pocket the 2k every year on it?

So in this instance, based on some rough guestimates on the numbers, I would definitely think it would be better to keep as buy and hold.