In September of 2009, our owner purchased the very first of our now 1,050 owned rental properties. He chose something that was supposedly turnkey, because the complexity and cost of rehabbing seemed too much, and he still needed to learn the business. The property began generating income, and he began learning. A lot. Very quickly.
One early lesson: this first property wasn’t truly turnkey; it was lipstick on a pig. And the prior owner had bought if for an incredible bargain. Which got our owner thinking about the rehab game.
This was the inception of a career-long philosophy we still hold to today: at Epic, we’re not fans of the traditional house flip—but we are huge fans of what we call “flipping property to ourselves.” And it’s served us well.
There’s a lot to say on this topic, so we’re breaking this one into a 2-part series. In this first installment, we’ll look at
- Turnkey vs. rehab properties
- What it means to flip a house to yourself
- Why we believe in it
In the next post, we’ll dig into the financials.
Rehabs vs. Turnkey Properties
Let’s start with the decision to rehab in the first place. It’s true that this isn’t the simplest option—at least on the surface. But there are 2 big disadvantages to turnkey properties:
Price
This one’s pretty obvious. It’s far easier to come up with the lower purchase price you’ll need to buy a property that needs work. This can be a great advantage to investors who are just getting started, or to those who want to keep more capital freed up for more investments.
Competition
This one’s a bit less obvious: when you’re purchasing turnkey properties as investments, you’re entering a far more competitive buyers’ marketplace.
Why? Because most homeowners prefer to purchase and live in a property that’s in good condition, so when you target turnkey, you’re bidding against these homeowners as well as other investors. More competition, fewer opportunities.
Flip a House to Yourself? What Does that Mean?
If you can buy a relatively inexpensive property that needs work, then make great updates on it so it becomes an excellent property, it’s true that, in theory, you could then sell it for a higher price.
But if you retain that house and pull the equity out—what we call “flipping to yourself”—you gain 2 great benefits:
Profitability
You turned away from turnkey and bought the cheaper house that needed work. When you put the remodel in, you got to control the finishes and make it just how the market wants it.
So now, you have a higher quality property that’s worth more—and you’re not into it for as much money. In other words, you forced value into the property and boosted your price-to-rent ratio, because your updated house
- Is likely to rent for more
- Cost you less in the first place!
There’s also longer-term rental profit potential that, while difficult to quantify out of the gate, is absolutely real:
Your best path to long-term profits is to attract great tenants—and keep them. This freshly rehabbed property is likely to do just that, because it’s of high quality, updated to meet current market demands. And hopefully, you’re planning to invest in professional property management to help you screen those tenants well, then keep them happy so they stick around.
When you provide the nicest property in the market, at a fair market rent, with the most professional management, you greatly reduce your biggest expense: turnover.
Recycling Equity
This is a game-changer, and relatively few investors truly capitalize on it. While you’re collecting rent, you can also pull the equity out of your new-and-improved property to free up cash for more investments.
More on this in the 2nd installment in this series.
The Downside of Traditional House Flipping
Obviously, we’re buy-and-hold proponents, but we do have experience with traditional house flips. Occasionally, we’ll flip one of our investment properties and sell it—perhaps to keep contractors working, or to generate a quick influx of cash.
But we prefer to hold, in part because the downsides outweigh the upsides. Let’s look at 3 big drawbacks:
A Single Path to Profit
When you flip a home to sell, successfully forcing value into the property is your only path to profit. You better hope that rehab delivers value in the end, because there’s a day of reckoning coming: the day you sell, you either make money or lose money.
That’s a lot of pressure. You’ll feel it all the way through the process. And time is your enemy.
Taxes
Speaking of making or losing money, don’t forget to account for the fact that you might lose 30% – 40% of your profit when you sell. Not so if you “flip to yourself,” since pulling out equity through a refinance is tax free.
Sustainability of House Flipping
This might be the most overlooked downside:
Rehabbing a house is a lot of work! And if you want to sustain momentum with your investment portfolio, the day you sell that fix-and-flip house, you have to start all over again with a new property.
It’s far easier to maintain a buy-and-hold rental property than to continuously flip homes.
The Upside of Holding for Cashflow
Conversely, holding for cash flow leaves you with numerous avenues to making more money:
- Cash Flow: Net income received after expenses
- Appreciation potential: Either forced appreciation or, possibly, market appreciation over time
- Tax savings: With the depreciation on the property, your income is either tax-free or very reduced
- Principal pay-down: Perhaps best of all, if you put debt on the property, over time, your tenant effectively pays that principal. Even if that’s only $200 a month—and your cash flow is $200 a month—you’re basically doubling you return. We call this a “secret equity bank account.”
- Inflation-induced debt destruction: Borrowing money in today’s dollars and paying it off 5, 10, or even 30 years down the road—when the value of a dollar will be ½ or even less of today’s value—allows inflation to effectively reduce the cost of the property. (Note: At 3% inflation, the value of a dollar will be cut in half every 24 years.)
The Dollars and Cents of House Flipping to Yourself
In the next post, we’ll take a deep dive into how this works on the financial side. Stay tuned for that next month, and make sure you’re subscribed so you don’t miss it.
When House Flipping to Yourself Won’t Help You
One area of caution: when you’re rehabbing a property with a plan to rent it out, you need to be strategic about the rehab itself—investing in the right things, for the right reasons. Here are 2 great resources to help you determine what to focus on:
Investors who attract and keep excellent tenants make far better returns. And the secret to finding and keeping excellent tenants is 3 fold: offer a high quality property at a fair market rent, and provide top-of-the-line property management service.
Flipping to yourself won’t work if you don’t rehab smart or serve your tenants well with expert property management.
Don’t let your effort and investment go to waste. Schedule a call today to learn more about property management services.
Pass It On: House Flipping to Yourself & More
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