Re: Rentals vs Flips - Posted by John Corey
Posted by John Corey on March 13, 2006 at 04:23:09:
I get the impression that you have not been investing in RE for that long and that limited exposure to rentals. This is not a good or bad thing, just a reflection of what I take away from your comments.
Lets start by assuming that I agree with some of your points. Getting started is difficult, building cash is good and ultimately a balance is important.
What really separates the flipping from the rentals is the amount of work necessary to receive a check each month. The presumption with rentals is that you can get to the stage where you can receive a check even on days when you do not get out of bed.
Property management is a big issue. The type of property and how much you own can determine how hands-on the owner is when it comes to property management. A NNN commercial property will produce a check each month for 5 years or longer with no phone calls and no management. How to get to the point where a NNN commercial property makes sense is a long story and best covered over in the commercial forum.
I would make the following observations based on my experience of owning rentals in different states and countries.
Assume zero appreciation. If you have a repayment (amortized) mortgage the tenant is effectively paying off the debt. Hence you will have an asset (the property) that is debt free and producing monthly income at some point in the future. I call it a savings account into which the tenant deposits and the owner gets to make all the withdrawals. And the tenant is fine with the deal.
The government likes being a silent partner. They will let you buy and sell without paying any taxes if you continue to re-invest. They will let you shelter some of your present income from a job or other activities if you manage some rentals. Not a bad deal as most people do not have any similar alternative.
A property has to cash flow at more than the PITI. It needs to produce a surplus so that you can fund things that break or otherwise wear out. Sewer pipes are included in this model. Once you have 10 or more units you can use the surplus from the other 9 to cover a vacancy, etc.
The key message is RE as a business has to cover all its costs over the effective lifetime for RE to make sense in a zero appreciation environment. SFR property rarely does this but it can. Hence many RE investors assume positive appreciation and only look for break even cash flow. The comments you made about equity rich but cash flow poor fit when people are counting on appreciation rather than thinking appreciation is a bonus. Such investors really should restructure or move to a better cash flow position. That might mean flipping a few to build up a cash reserve or to reduce the LTV on the rentals so they do produce better cash flow.
Not all equity is good equity. Some is more like dead equity. Equity you can not tap, produces no real income and otherwise just looks good on paper is dead equity. If we are comparing RE to real businesses then we would expect a company to invest to make money. That investment is equity. There are very few business sectors that can even dream of getting 100% leverage. Hence having some equity tied up might just be a normal business practice. Getting a good return on that equity is important.
As Ray Alcorn will tell people, if you want to invest in commercial expect to have equity (cash normally) in the deal. Rarely will you see less than 20% equity in a commercial deal. It is residential where people think 100% leverage is minimal acceptable. With commercial you expect to have cash/equity in the deal and measure what sort of return that equity is earning.
In conclusion I think you have hit on a few good points while being a bit off on the rental side.
One comment not mentioned about flipping is the short term tax impact is pretty steep compared to the long term capital tax treatment plus other tax benefits of investment RE (flipping a property means it is not classified as investment RE).
Some flip for current income. Some enjoy their job and keep working. A few make more from a job than they can make from flipping so that is why they stay in the job. The only escape from a job or flipping (flipping being just another job which may or may not pay better) is when you have something that produce income independent of the time invested. Rentals, bonds, notes, the stock market, annuities, NNN commercial property are all ways to have passive income. There are more.
So, you are correct. A balance is important and sometimes the balance when you start is different than the balance once you have reached cruising attitude.