Although the housing market looks like it\u2019s already recovered from the pandemic-induced downturn of last spring, don\u2019t make the mistake of thinking we\u2019re back to normal. With millions of potential evictions looming, a potential mass migration from cities to the suburbs, and historically low inventory coupled with sky-high demand, it\u2019s safe to say the market\u2019s in the midst of a radical reshaping.<\/p>\n
So how is all this going to affect investors? It\u2019s hard to say just yet, but we know that some of the numbers are shifting on traditional investment models. Let\u2019s revisit two of the most popular investments \u2014 house-flipping and rental properties\u2014 and see how they hold up in 2020.<\/p>\n
The Pros of House-Flipping<\/strong><\/p>\n \u2022 Fast Profits<\/p>\n When done correctly, house-flipping can pay big dividends. According to data from industry analyst Attom Data Solutions, flipped houses in the third quarter of 2019 were bought at a median price of $160,000 and sold at a median price of $224,900. That comes to an average profit of $64,900.<\/p>\n And with many local markets setting record prices right now, despite the pandemic, that average profit could be significantly higher.<\/p>\n Of course, that\u2019s the gross profit. Flippers will have to subtract all their renovation expenses, transaction costs, and carrying costs to figure out their true net profit, and therein lies the difficulty. Once you learn to minimize your costs through discount brokers like Redfin, honest contractors, and local lenders, your profits can skyrocket.<\/p>\n If it takes longer than planned to sell the house, the carrying costs \u2014 all the miscellaneous costs of owning a home \u2014 can add up fast. And if your renovation lands over budget, your profit margins will suffer. Still, the average profit from a single house flip is greater than the median US household income.<\/p>\n \u2022 Demand is Higher Than Ever<\/p>\n One of the biggest risks of house-flipping is if your rehabbed home sits on the market too long. Carrying costs add up quickly, and if your house takes a month or two (or longer) to sell, you could be looking at a losing proposition. The risk of this has significantly gone down in the post-pandemic market, though. Studies have shown that, nationally, buyer demand is at an all-time high and that inventory is still very low, as sellers wait out the coronavirus.<\/p>\n The percentage of homes that sell within two weeks of listing is higher now than it was at the same time in 2019, which is a great indicator that homes are flying off the market.<\/p>\n \u2022 Building a Network and Knowledge Base<\/p>\n House-flipping is very much a team effort. Successful flippers have a time-tested group of people who they know they can rely on \u2014 everyone from wholesalers and agents to lenders and contractors.<\/p>\n That means starting up can be tough. But as you become more experienced, you\u2019ll build a team around you. And as you gain more experience, you\u2019ll expand your knowledge base.<\/p>\n House-flipping is a game of margins, so the better you get at selecting and rehabbing properties, understanding how much renovations cost and how long they take, and what kind of materials and finishes are preferred by your target buyers, the more you\u2019ll be able to increase your profits. As in most things in life, success breeds more success.<\/p>\n The Cons of House-Flipping<\/strong><\/p>\n Don\u2019t believe the weekend seminars and reality TV shows; house-flipping isn\u2019t risk-free. Let\u2019s look at some of the potential pitfalls of fixing-and-flipping.<\/p>\n \u2022 Inventory is Low<\/p>\n Many sellers yanked their listings off the market when the pandemic lockdowns began in March and April. Although the market has mostly recovered, the number of active listings right now is lower than it was at the same time in 2019.<\/p>\n Whether homeowners decided not to sell because of financial problems or if they\u2019re betting on a big post-pandemic boom, a lot of potential sellers just aren\u2019t selling right now.<\/p>\n That means it\u2019s harder than ever to find cheap, undervalued rehab properties. Is it impossible? No. But there are a lot more people competing for a lot fewer properties.<\/p>\n \u2022 You Could Lose Money<\/p>\n As we stated above, house-flipping requires a significant cash investment upfront, and even the fastest house flippers take a few months to buy, rehab, and resell. If the market fluctuates during that time, that deal could turn into an overpay.<\/p>\n There\u2019s also a significant risk of expenses ballooning out of control. A $64,000 gross profit sounds like it gives you a big margin for error, but a new roof or foundation can easily take a $20,000 chunk out of that.<\/p>\n \u2022 It Can Feel Like Walking a Tightrope<\/p>\n Let\u2019s say you buy a home, rehab it, and flip it. If you achieve that within a year, your profits are taxed as regular income. That means you\u2019re in a tax bracket of around 22-37%.<\/p>\n But if you hold onto the house for more than a year, the profits are taxed as capital gains, at the much lower tax rate of 15-20%.<\/p>\n That means that, from a tax perspective, it\u2019s in your best interests to hold onto the property longer than a year. But from a risk perspective, knowing that the market is unpredictable, the longer you hold onto the property, the greater chance there is for an unfavorable downturn.<\/p>\n Now add that to the fact that your carrying costs mean that every day you own the property literally costs you money.<\/p>\n Triangulating these dynamics can be extremely difficult \u2014 and extremely stressful.<\/p>\n The Ups and Downs of Rentals<\/strong><\/p>\n House-flipping is a short-term, high-risk game; owning rental properties is the opposite.<\/p>\n Owning rentals can be a fantastic source of a steady, predictable cash flow, but there isn\u2019t a huge potential for short-term profit.<\/p>\n The Pros of Rentals<\/strong><\/p>\n \u2022 Steady Cash Flow<\/p>\n Once you get a tenant settled into your rental property, you\u2019ll have money coming in at a steady pace \u2014 money that you can use to service the mortgage, invest in other properties, or simply pocket.<\/p>\n There are very few other investments that will generate cash flow right off the bat.<\/p>\n \u2022 Great Tax Benefits<\/p>\n Landlords have access to a whole spectrum of tax deductions \u2014 including expenses, property improvements, mortgage interest, and depreciation. Depreciation is an especially powerful deduction, as it can help you produce a net loss for tax purposes, even if you have a positive cash flow.<\/p>\n The 2017 Tax Cuts and Jobs Act also added another powerful tax deduction for landlords; if you meet certain requirements related to how you structure your business, you could deduct 20% of your net rental income right off the top. There\u2019s an income cap of $157,500, but if you qualify, this is a huge tax benefit.<\/p>\n The Cons of Rental Properties<\/strong><\/p>\n \u2022 A Lot of Things Can Change Over the Long Term<\/p>\n The pandemic has reminded a lot of people that unforeseen \u201cblack swan\u201d events do happen. You could have an ideal tenant in one of your properties yet it can become unprofitable virtually overnight if the wrong thing happens. And it doesn\u2019t even have to be something as dramatic as a pandemic; changes in the tax code, adjustments to local zoning, or skyrocketing expenses such as insurance or maintenance could take you from the black into the red.<\/p>\n In addition, a location that\u2019s hugely desirable today could be out of fashion in five years. Rentals are relatively stable investments, but over the long term, nothing\u2019s a sure thing.<\/p>\n \u2022 They\u2019re a Lot of Work<\/p>\n If you own a rental property, you\u2019re either going to have to act as a full-time landlord or hire a property manager.<\/p>\n If you decide to do it yourself, that means getting phone calls at 4 a.m. to unclog a toilet. If you hire a property manager, they\u2019re going to charge a percentage of your rents \u2014 often up to 10%. That\u2019s a high price to pay, especially if you have easygoing tenants.<\/p>\n \u2022 Instability Trickles Up<\/p>\n Even though the housing market has recovered after the initial shock of the pandemic, many Americans haven\u2019t. Renters have been especially hard hit by the economic slowdown, with some experts predicting more than 10 million evictions over the next few months if the government doesn\u2019t extend its eviction moratorium.<\/p>\n There\u2019s no good news here for landlords. Analysts said up to a third of Americans didn\u2019t pay their rent or mortgage payment in July, and that affects a lot of landlords. But the eviction moratorium also prevents them from removing tenants who don\u2019t pay and getting paying tenants into the properties.<\/p>\n To make matters worse, widespread job loss and historically high unemployment means that qualified, financially solvent tenants are in short supply. In short, it\u2019s a very bad time to be a landlord \u2014 and things might not improve for months.<\/p>\n House-Flipping Versus Rental Properties<\/strong><\/p>\n Although renting usually offers an enviable combination of cash flow and predictability, today\u2019s economic climate has hit tenants hard. Even if you found a qualified tenant, they could lose their job any day and be unable to pay their rent.<\/p>\n On the other hand, buyer demand is at an all-time high. Finding undervalued houses to rehab and flip has likely become more difficult, but the rewards have also increased.<\/p>\n There are pros and cons to both house-flipping and investing in a rental property. It\u2019s up to you to decide which investment is best for you.<\/p>\n