Why Flipping Houses is Stupid
I don’t believe that house flippers and real estate investors are anywhere close to being the same animal. They have very different reasons for buying property, and their methods and desired outcomes require much different means of planning to execute. Lots of people have made lots of money flipping houses, and I’m not faulting anyone for doing so. If you have a nose for it and you make money doing it, more power to you. But when I look at the alternatives to flipping houses, it makes me want to slap my hand over my eyes and bow my head in shame. It makes very little sense, as I see it, not to invest for the long term, and I’ll tell you the reasons why.
If you’ve ever watched a show on television about flipping houses, I’m sure you may have said to yourself at some point, “I could do that. I could make lots of money at it, too.” That’s because it’s tempting to trust yourself – to believe that you have the eye for finding diamonds in the rough and the mental prowess to pull it off time and time again. The idea of making tens of thousands of dollars in a short time appeals to lots of people. It has a similar appeal to playing Blackjack in Vegas or day trading the stock market – it’s exciting, in a sense. It’s the thrill of winning, and it’s easy to let yourself daydream about winning big. But in all those situations, you have to put a lot at stake. More, if you ask me, than the winning is worth. You are gambling, putting a large number of resources on the line for what will only be a significant gain if you get really lucky.
There is one fundamental reason why this approach to handling your money is foolhardy: because a wise person looks not only at his or her potential for gains, but also at what he or she stands to lose. Whether you’re gambling with short-term stock trades, a game of cards, or a house, you’re forced to put lots on the line and cross your fingers. I can think of much better ways to live my life than that.
Let’s say you pay $100,000 for a fixer-upper, putting down 20% ($20k). In the current market, the house is worth about $150,000. You spend another $20,000 fixing it up and sell it at market value, for a net gain of $30,000. Not too bad for a few months’ work. If you have a background in construction and/or your three best friends are a plumber, a painter and an electrician, you’re in an even better spot. But if the market goes down or you run into any snags during the process, you’re stuck – financially crippled because you can’t unload your investment and take profits. You’ve effectively sunk $40,000 into an investment that is returning nothing.
Now imagine you’re the buyer of the same house after it has been fixed up and sold to you at $150,000 – market value. You take the same $40,000 the flipper spent on a down payment and repairs, and put the whole chunk toward your down payment instead. Then you rent out the house for $1,500 per month. The flipper would’ve made $30,000 right away, assuming the value of the house stayed the same over the course of a few months. That would’ve been it; assuming he was successful at fixing and reselling it, the payout from that investment would’ve ended at that point.
Now, if you rent the house instead, you’d make $36,000 over the first two years. Much of this is likely going toward your mortgage and upkeep, but you have still nearly doubled your money, earning a 50% return per year. But here’s the difference, as I stated above – even if the value of the house goes down, you will still make back the difference on the mortgage ($110,000) in rent payments after just 6 years.
Granted, you will always need to factor in things such as repairs, maintenance, cleaning, property taxes, insurance, etc. But the point is, you have now created a stream of passive income – hopefully one among multiple streams income that will pay you somewhere in the neighborhood of $1,500 every month for the rest of your life. Even though you have all those additional costs associated with owning the property, you are paying for the vast majority of them with someone else’s money. That is the key concept I want to teach you through this website – that by providing a product or service that someone is willing to pay for (in this case, a nice place to live) you are able to make money work for you in more efficient ways. I don’t know about you, but almost without exception I’d rather spend other peoples’ money than mine.
The work involved in scheduling repairs, interviewing tenants, and paying your taxes is minimal compared to the hours you’d spend on most other money-making activities. And if maintaining rental property seems like it would be too much for you, there are management companies you can pay a small percentage of your rental income to take care of all the “dirty work” for you. By the time the mortgage is paid off, that recurring income becomes almost a purely profit-yielding venture.
Sure, I could go out and buy one really big, nice house – and spend the next 30 years trying to pay it off. Or, I could do what I’m doing now and be in the process of buying my third smaller home. Now instead of working for “the man” for the next forty years, I will essentially be living rent-free because my tenants are footing the vast majority of my mortgage bills. When three properties are paid off in less than 20 years (I use my regular income from my job to pay my mortgages down faster with extra principle) I will not only have a paid-off house, but a source of recurring income until the day I die. It’s quite a long-term strategy, but it’s one I’m willing to work for.
The bottom line is that your style of generating income has to be synced to who you are as a person; it has to feel good to do things your way. Peace of mind speaks volumes above what anyone else tells you you should do. But don’t throw wisdom out the door and remain completely within the confines of your own gut instincts, either – doing so can lead you to make one poor decision after another. If flipping looks more attractive than landlording, do what you feel will work for you. I’m simply telling you that from my perspective, the reduced risk and greater potential for long-term return on investment makes renting a far more attractive option for me.