If you're interested in getting into real estate investing, you might be considering house flipping.
You're probably familiar with this widely publicized strategy for making money in real estate. It involves purchasing a home and quickly selling it for more than you paid for it -- often after making some minor upgrades.
While flipping homes might seem like a quick way to make a buck, it could actually end up being a big waste of time -- or worse, a source of lost funds. Here's why.
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House flipping has some serious downsides
There are some big disadvantages to flipping homes that can make it very difficult to make this real estate investing strategy work. Here are just a few reasons you might want to steer clear:
- You'll need a lot of money to flip houses: You need to spend money up front to purchase the home, to buy materials and pay laborers to fix up the property, and to pay carrying costs such as property taxes and insurance. That's especially tough with current labor and materials shortages. It can be difficult and expensive to get loans for house flipping, and you risk incurring huge ongoing expenditures if you can't sell the property as quickly as anticipated.
- There's a huge risk of loss: In order to make a profit flipping houses, you'll need to get the property you're selling at a good price and be able to sell it for enough to cover all your costs plus have money left over. If there's a downturn in the real estate market before you can unload the home, you could be out thousands of dollars or stuck with the property for years while waiting for the market to recover.
- There are big opportunity costs: Your money will be tied up in the house while you do any necessary repairs and wait to find a buyer. That cash can't do other things for you during this time. You'll also need to spend time managing repairs -- or even making them yourself if you hope to benefit from sweat equity. That's time you can't spend doing other work that could earn you money.
- You could incur high tax bills: If you sell the home before owning it for at least a year, you could face short-term capital gains taxes on profits. This means you'd pay taxes at your ordinary income tax rate, rather than the more favorable long-term capital gains rate.
For all of these reasons, it can be hard to make a profit with house flipping, and the process can be much more stressful than other methods of real estate investing. It simply may not be worth it.
What should you do instead?
Have the downsides of house flipping convinced you that buying and reselling houses isn't worth the time and effort? The good news is, there are plenty of alternatives to consider, including:
- Purchasing rental properties: While this strategy requires a hands-on commitment (or money to pay a great property manager), you won't have to rely on the short-term trends in the housing market going your way. You will theoretically be able to earn returns both as tenants pay rent and as your property appreciates in value. And you'll have access to some generous tax write-offs. But you will need a lot of capital to get started with this approach as well.
- Investing in REITs: This is a simple, hands-off approach that involves buying into publicly traded trusts that own and manage commercial properties. REITs are a much more liquid investment, and you can expect to receive high dividend payments that provide steady income if you select the right REIT.
- Real estate ETFs or mutual funds: This is also an easy way to invest in real estate. There are many mutual funds and ETFs that are designed to give you exposure to the real estate market. This investment is usually very liquid compared with actually owning properties, and you may not need much money to get started. It's also not difficult to research funds to find one with reasonable fees and a consistent track record.
All of these approaches are very different from flipping houses. They may be better options unless you happen to be lucky with timing the real estate market and handy enough to manage your own repairs and upgrades at a low cost. You should seriously consider them before deciding what real estate investing approach is right for you.
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