The 5 Year Comparison on Flipping Vs Holding
This is a post for myself. It’s me, thinking out loud. Welcome to the nightmare. I’ve got a property that I am renovating. It’s a pretty big renovation job. The timeline has also been long. And I have been thinking, should I hold this bad boy, or sell it. My investment strategy has always been holding, so I may be biased in how I look at it. So, here is how I am looking at it.
I want to single out this investment only.
I bought this property for $250,000 with a line of credit and $1,250 in closing costs. I will put in about $60,000 and the property will hopefully be worth (appraise for) $375,000. It is a 2-bedroom, 1 bathroom and will be nicely finished. It is located on a busy road, but 3 houses from Mountain Avenue and 1 block from Old Town Square. Solid location.
My two options for a hold on this property are, a long-term rental or because it is in commercial zoning, I can legally get it as a short-term rental.
Long Term Rental Calculation:
Gross Potential Monthly Income: $2,000 Less Vacancy: 3% =Net Rent Income: $1,940 Less Operating Expenses: $485/Month – I went with a 25% ratio here, because this place is going to have new plumbing, new electrical, new HVAC, new floors, fixtures, bath, everything. So hopefully, low maintenance. =Net Operating Income: $1,455 Less Debt Service: $1,384 – 30 Year Fixed Loan at 4.25% with a loan balance of $281,250 =Net Cash Flow: $71/Month or $852/Year
Short Term Rental Calculation:
Gross Potential Monthly Income: $6,000 - $200/Night at 30 Nights/Month – This number was found by asking a couple of people who are in the short-term rental game. I was in it briefly, operating 3 short term rentals, between 2015-2017. This is a best guess and I am not an expert at short term rental figures. Less Vacancy: 30% =Net Rent Income: $4,200 Less Operating Expenses: $1,890 – I went with a 45% ratio here, because when you operate a short term rental you will now have to pay lodging taxes (10%), annual licensing fees as well as monthly supplies to stock the rental. =Net Operating Income: $2,310 Less Debt Service: $1,384 =Net Cash Flow: $926/Month or $11,112/Year
Pros of operating a long-term rental are that we already have systems in place. Software, leasing, accounting, maintenance, everything. The property would slide right in and require little to NO headache for years to come.
Pros of the short-term rental are clearly the increased cash flow. The cons though, are severely increased labor times. Coordinating check-ins, check-outs, cleaners, supplies as well as tenants not accustomed to your property. There may be little quirks like a shower handle that needs to be pulled out and not turned. That may be an 11PM call (I got that one before).
An artistic approach to a short-term rental issue, would be to look at the amount of TIME it takes you to earn the extra $10,000 in cash flow. When I was operating 3 AirBnbs, I averaged 2.5 turns per week. In general, the people down town would stay 2-3 nights and the next people would be coming in right after they checked out. Check out would be 10AM and check in would be 3PM.
Coordinating check outs and check ins along with your cleaner CAN be systematized. You can allow them access to the calendar, show them exactly what you expect, but there is still going to be time allocated to answering/solving problems that arise. Because problems do arise. Conservatively, yet to be fair, I think you could safely assume, even having all of the systems in place allocating an extra 2 hours per week to the AirBnb business. 2*52 = 104 hours. $10,000/104 Hours = $96/Hour. That’s a pretty good hourly rate.
5 Year Out Look (30,000 Foot View):
Long Term Rental: *Assumption is that your rent revenue will increase at 5% and your expenses will increase at 3%. The appreciation is calculated at 5%. Historically, since 2007, Fort Collins is at 5.29% appreciation. Principal pay down numbers are brought in from a loan amortization table. The depreciation expense is the actual dollars saved from the depreciation expense assuming at 25% tax bracket.
Short Term Rental: *The numbers and assumption remain the same as the long-term rental. The only number that changes is the cash flow number.
Possibilities with both the long-term rental and the short-term rental would be the ability to pull money out on a cash out refinance, tax free. You are able to pull out (generally) up to 70-75% loan to value. There is a cost associated with refinancing. Typically, 2% of the loan value. Here is a table of the available funds you COULD pull out on this property over the 5-year life.
Only using this property and these funds, you could you pull out enough to afford another investment property assuming a price of $400,000 and needing to put 25% down after year 5. Your cash is tied up in this property during this time.
The Fix and Flip Option:
I do about 2-3 deals a year. I should say, I find about 2-3 deals a year that make sense. I spend roughly $1000/month on off market deal finding and close about 2-3 deals a year. So roughly $4,000 to $6,000 is what it takes for me to find a deal.
When I go under contract to buy one of these homes, I put the contract on a 20-day closing schedule. The general turnaround time on a home that needs some loving is about 1-3 months. If it is a sale, there would be an additional 45 to 60 days of marketing, going under contract and closing. So, to be conservative, each deal when operating as a flip takes 140 days. In a perfect world, if I were to roll over each fix and flip, I could do 2 deals/year using the same funds.
Risk of Flips: Budgets higher than originally expected. Unknown secrets on the home (mold, permitting issues, foundation, roof leaks). Suggested sales price is inflated and actually sells for less than you originally thought. Tax burden on your gain is taxed at ordinary income rates. Each flip can be emotional with higher stress.
The numbers on this potential flip:
Purchase Price: $250,000 + $1,250 Closing Costs Plus Rehab + Holding Costs: $75,000 – I put $75,000 because if I am going to do a flip, I will put in a little bit higher finishes and finish the landscaping a bit better. = Total Costs of $326,250 Suggested Sales Price: $400,000 Less Closing Costs of Sale: $32,000 Net Proceeds From Sale: $368,000 Less Total Costs of Purchase, Rehab and Holding: $326,250 Gross Profit: $41,750 Less Taxes (25% Rate): $10,438 Net Profit After Taxes: $31,312
I did a flip in 2018 and prior to taxes had a gross profit of $30,000. After taxes was a net profit of $22,500.
Recently, I met an individual who does flips in Fort Collins and does about 20-25 of them, suggesting that a profit of $20,000 to $25,000 was what they are shooting for.
For our comparison sake, lets assume a net profit after taxes of $25,000.
At 2 flips a year and 5 years, using the same funds and just banking those funds you would have in your bank:
$25,000 * 2 * 5 = $250,000; MINUS 10 * $5,000 (cost of finding each deal) = $200,000
There are no hard assets, no equity, just $200,000 in the bank at the end of the fifth year. That being said, I will have done 10 flips and would need ALL of them to go smooth and average me a $25,000 profit after taxes. I think we need to put an increased risk factor on that $200,000. What would be a good risk factor? Do you think that 10% of all of your deals turn sideways? So 10%? Or 2 out of every 10?
I am going to use a 15% risk factor. Giving me a risk adjusted number in the bank of $170,000
That’s all I am going to leave you with. The great thing is you could pick apart my analysis above all over the place. “You should use a 35% expense ratio for your rentals.” “You’re not including the cost of finding a deal in your long-term hold.” “What about the opportunity cost of having your capital tied up.”
Yes, those are all valid points, and probably something worth thinking about. I believe, when the time comes, making the best decision for you in that moment with the information you are provided and sticking to that decisions until circumstances change or you change. And being happy with that decision and having faith that you did not make the decision lightly.
So please, I would love your in put on this project I am doing.
Thanks for reading!!