Do You Own Your Business or Does It Own You: Flip or Buy & Hold?

[Jared Garfield]

As an experienced real estate investor, having already owned dozens of properties and a real estate brokerage, I found instant wisdom in Robert Kiyosaki's "Rich Dad, Poor Dad."  I read the book and thought, "This guy has nailed it, pulling together such great wisdom and explaining complex topics in such a motivational way!"  When a head-hunter later asked me to come and provide some training for the coaching staff and to help train investors on buying income producing portfolios for the "Rich Dad's Coaching" program I thought this would be a great way to network with other like minded people who had been very successful in real estate.  One of the things that stood out to me that Robert taught was, "Work on your business, not in your business!"

(In another blog I may assess what I thought of the coaching industry)

If your main goal as a real estate investor is passive income, and having assets that put money in your pocket, then you have one clear path to real estate wealth.  BUY AND HOLD CASH FLOWING PROPERTIES THAT SOMEONE ELSE PAYS OFF FOR YOU!  Sure, you can fix and flip properties to owner occupants, but let's compare and contrast Flipping for Profits with Buy & Hold.  Let's also see which allows you to work on your business verses in your business.

Flipping

This is much like raising cattle for slaughter, a great deal of effort goes into feeding, medical care, housing the cow.  In the end the cow is sent to slaughter and the rancher gets a nice pay day that is higher than what he had in the cow.  Once the transaction is completed the cow no longer provides value to the rancher, and a new cow must be found and raised to start the process over.  The commodities market dictates the price of the meet, corn or wheat prices may fluctuate and make the beef prices go up or down and the rancher could make more or less depending upon these things, dietary trends and more!

The Problems:

• Flipping relies upon market condition, there is a great deal of speculation, market cycles based upon macroeconomic trends and timing can have huge effects upon the success or failure of the strategy. 
• A great deal of know how is required to make sure that the property is bought enough below value to be able to produce a profit after renovation costs, real estate commissions, closing costs, financing costs, and holding costs.  
• The flipper must know trends in interior design and have some marketing acumen.  Buying in the right neighborhoods where there is in-migration, new shopping, and great schools is very important.  Miss one of these and the flip could backfire.  
• There can be a lot of hands on management of construction crews, and one must be very careful to make sure the job finishes on time, on budget and with the right scope.
• Depending upon how many deals the flipper does, they may become a dealer, and pay much higher taxes than if they invested in real estate for passive gain.  Flipping for large profits may, for people who have a regular job, place them in a higher tax bracket than they were in before.  
• There is steep competition from contractors that due to changed market conditions can no longer build spec homes and need work.  They along with realtors who aren't selling as much as they used to provide steep competition.  Worse yet, hedge funds with billions of dollars are willing to pay more because they don't have to sell for a steep profit, they can hold the asset for a much lower return.

The Benefits:

• It's a way to make a much higher return. Instead of making 8-12% ROI/Cap Rates per year on deals that you pay cash on, flippers can make much higher returns in only three to six months!
• Flipping is a great way to increase the down payments one has for funding buy and hold deals, so often this is a great place to grow down payment funds!  
• If one is trying to do real estate full time, flipping five to ten homes per year may make full time real estate investing possible for those who want to quit their jobs.
• There is a satisfaction in making a neighborhood better, the before and after, the jobs provided.

Buy & Hold:

Buying and holding real estate is more like having a dairy farm.  You buy the cows, take care of them and spend a little time with them and they continue to produce for you day in and day out.  It's a commodity that people need every day and runs out, and there are many outlets, milk can be sold, it can be turned into cheese, cottage cheese, or Philadelphia cream cheese.  When the cow produces less milk, it can still be sold for meat, and leather because after all the years of production, it's still the dairyman's asset.

The Problems:

• If you don't have deep pockets and can only buy one property that cash flows $400 per month, it will be very difficult to quit your job on $4,800 per year.
• In expensive markets it's very difficult to find high cash flow assets so an investor may have to go out of state and spend a lot of time learning markets and building teams they can trust.
• If properties are not purchased at a low enough price, without deferred maintenance, in low property tax, low insurance areas, or where the economy is stable, or where population is declining significantly, it's possible that an asset might not cash flow down the road.
• Property management must be very good, because poor management may mean uncollected rents, high maintenance fees and cash flow less than expected.

The Benefits:

• Buy & Hold Cash Flow Properties are passive instead of active income assets.  With good selection and management they pay income every month that you don't have to work for.  With flipping you pretty much have to be very involved, unless you give up significant profit to a partner who runs the process.
• This is an asset that the tenant buys for you, so they are essentially buying you the house. 
• As inflation goes up, so do rents and it becomes easier to pay off the mortgage with cheaper dollars, it's a hedge against inflation.  As interest rates go up the value of your mortgage at a lower rate means your cash flow will likely go up too.
• When done correctly, cost segregation can provide significant income shelter from taxation for many investors.  Property taxes, building, personal property and land improvements may all provide tax savings.
• As the property appreciates the value of the home goes up.
• The property may be refinanced to pull out equity without paying taxes on the money and also increasing the tax savings.  It may also be 1031 exchanged, indefinitely deferring the payment of taxes.  This process allows the investor to purchase many more assets and reap the above benefits on each new asset.
• If bought in the right neighborhood, the home may still appreciate and sell for an even greater profit than what can occur during a short time table required by a flip.
• The income increases over time, and as the tax benefits or the condition of the properties systems age or deteriorate, the property can be exchanged to reset tax advantages and move to newer properties with newer systems.
• The passive income can eventually exceed the money required to live, allowing the investor to exit the rat race and live fully off of passive income, while building a huge nest egg from equity and principal pay down.
• Your financial statement looks better and better to the banker as time goes on.
• Properties can sometimes be purchased with little or no money down.
• A property that might net a $25,000 profit on a flip might net $20,000 after taxes.  The same property might net $400 per month or $4,800 per year in cash flow.  If it is lease optioned it might yield $500 per month or $6,000 per year, meaning that in a little over 3 to 5 years the same profit will have been made, but the asset that is kept may yield a much higher than $20,000 net in five  years!
• If the market takes a sharp down turn, a property that yields a 20% cash on cash return will still provide positive cash flow and produce income even if rents must be dropped.  In a down turn the property is still being paid off by the tenant, and if it was bought right, it still might not be under water.  
• With a good property management, buy and hold investing can be nearly hands off, especially if the property is purchased turn key from a reputable source who buys at steep discounts and can renovate cheaper than you can.  Ask for the complete rehab scope, make sure that the cash flow is at least $300 per month and a minimum of 15% cash on cash return, that it appraises or at least is being sold pretty close to appraisal.  Try to buy in a market that is going up or likely recovering from a downward cycle.

As assets put money in your pocket, principle is paid down, tax liabilities are lessened, leveraged returns allow you to make appreciation on the banks money as well as your own, and someone else buys you houses.  Cash flow produces a monthly income, and refinancing or 1031 exchanging allows you to pick up more assets that are newer properties, in better condition that increase your cash flow!  This can allow you to work on your business and not in it, and I believe it offers the long term wealth that flipping does not!  Flipping sure is a great way to generate down payments for buy and hold though!