Real Estate: Flip or Rent?
I would like to give you a brief
overview on the two major concepts of making money on investment property, and
why it is a perfect time to acquire and hold an investment property.
Fix & Flip
I am sure many of you have heard of
the term “fix & flip”. This is a good money making technique when the real
estate market is steady and the volatility is predictable. The concept is to
buy a property that is undervalued compared to the other homes in the area and
fix it up. The typical targeted repairs are items like new floors, carpet,
paint, window treatments, landscaping, kitchen & bathrooms cabinets, etc..
Ideally, these repairs take only 1–3 months, and then you list the property for
sale at a much higher price. The goal is to make enough to cover your repair
costs, the temporary mortgage payments, and walk away with $20K – $60K profit
on that property. The key to success is to have the right property and to turn
the property as quickly as possible.
Obviously, this doesn’t always work
as planned, and sometimes you lose money on the deal. Factors that contribute
to losing money on a Fix & Flip property are the repair costs being too
high, the repairs taking way too long, or the property not selling quickly. Sadly,
some Fix & Flippers got stuck with property over a year ago when the market
turned, and either took a loss selling it below cost or turned it into a rental
property. This is not the ideal strategy to own rental property, because most
of these people are still taking a monthly loss renting these properties today.
I feel that I am an authority on this topic, because I own one of these types
of properties myself.
Cash Flow
This is the concept used to identify property that will
make good rentals. The word “cash flow” refers to the amount of cash a rental
home generates and uses on a monthly basis. Cash flow can be used as an
indication of a rental home’s financial strength. When it comes to renting out
your investment property you would prefer it to have a positive cash flow, whereas you are making a
profit on a monthly basis. Due to the high price of housing in some Metro areas
it is more difficult to find homes with a positive cash flow, but it is not
impossible. Here are some of the factors we look at to determine a property’s
cash flow.
You should first calculate the monthly cost of the
property (sometimes called the nut). You need to
consider all costs associated with the property including the Mortgage Payment
(Principal, Interest, Taxes & Insurance), Property Management Fees, HOA
Dues, Pool Service, Home Warranty, Etc. This monthly cost will not only be
covered by your renters, but will also have to be covered by you during times
when the property is not rented. Also, take into account if you need immediate
repairs to the home to make it ready for renters.
Next, you have to calculate how much you can rent the home
for. I highly suggest using a seasoned property manager to
help you in this analysis. Not only can this person help you identify the right
rental rate, but can also help identify the current occupancy of rentals within
the area. That should give you an idea of how long it will take to rent your
property.
When you subtract the monthly cost
(nut) from your potential rent you will get that property’s monthly cash flow
number. Most people will gravitate towards properties with a positive cash flow
– but some people will also consider properties that simply “break even” with
the intent of selling them in a few years at an appreciated value.
Why is this a Good Time to Buy??
One of the biggest factors in finding
property with good cash flow will be in the price of the home. Being that the
mortgage payment on the property will constitute the largest portion of your
cost, you want to find rentable property at a low purchase price. This sounds
like common sense (Duh!), but a cheap list price doesn’t always mean it’s a
good deal.
Today’s housing market has a record number of short sales,
foreclosures, pre-foreclosures, distressed, and bank owned property!. This could
easily mark the low price point for home sales
for the next few years. When you see the following scenario you might think
that those properties are not really available. To that I can honestly
say,… have you really looked? Because, you only need
to find one property that works!
Example:
Here is a single family home
(3bd/2ba) in Boise near Boise State University. It is bank owned and they are
asking $150K (appraises at $205K) and they will pay all of your closing costs
with a full price offer. The property is basically move in ready and needs a
little paint. You pay 20% down ($30,000) & finance 80% ($120,000) on a 30
year fixed (4.75%).
The principal & interest payment is $778/mo + $50/mo
home owners ins. + $92/mo property taxes = total PITI = $920/month. You also
decide to have a property manager (a good idea) for $65/month, and you find no
other monthly costs. Your net cost is $985/mo.
Your realtor does their research, and informs you that
rent on a 3 bedroom within 2.5 miles of BSU should rent for $1,130/mo. And if
you get it listed before August 20th, you should be
able to rent in within 2 weeks.
$1,130 rent – ($985) cost = $145/
month in positive cash flow. This seems to be a pretty good scenario worth
exploring. Here are the positives:
§ You have the
potential to make $145/month cash flow.
§ You have a 30 year
fixed loan, so every month your principal balance goes down.
§ You have an great
source of Tax deductions at the end of the year
§ You have just
acquired a property with $55,000 of equity in it.
The above example is simply one basic
scenario out of thousands that exist. Investors can find the same scenario in
most college towns. There are going to be plenty of properties that have a
negative cash flow after thorough analysis. But, the key to finding the right
cash flow property begins in the act of building a team and looking for them.
Conclusion
Investment property is not
everybody’s cup of tea. However, if you have thought about it in the past,
today’s housing market provides great opportunities to buy properties that
“cash flow”. If you are waiting for the housing market to reduce inventory and
“tighten up” to buy an investment property – you are missing the boat.
There are many other concepts and
techniques that I did not touch on today that I will be happy to share with you
if you have interest
§ Buy investment
property as a primary residence (2% – 5% down)
§ Buy investment
property as a second home (5%-10% down)
§ Buy a multiplex (2
– 4 units)
§ 8 creative ways to
find your 20% down payment
§ Purchase an investment
property that needs rehab for 10% down
§ Buy a new home and
use your current home as a rental
