If you’ve been considering investing in real estate, you’ve probably been bewildered by the array of strategies available, each claiming to be the “best” strategy. For this article, I’ll discuss the three most common real estate investing strategies considered by beginning investors:
- Flipping houses (Fix ‘n Flip)
- Investing for appreciation
- Investing for cash flow
Each strategy has sub-strategies and variations, but broadly speaking, these are the most common options.
Real Estate Investing Strategies Explained
1. Flipping Houses (“Fix ‘n Flip”)
We’ve all seen the Sunday morning reality shows about entrepreneurs who buy houses, fix them up, and then sell them for a handsome profit. These shows highlight many of the pitfalls, like unexpected termite or mold damage, unreliable contractors, cost overruns, and costly delays.
This strategy can be lucrative, but you must choose the right market and build the right team to make it work.
What an Investment Looks Like
A simple example is to buy a distressed property for $100K, put $25K of renovation into it, and then sell it for $150K, netting $25K.
If you can go through the purchase-rehab-sell cycle once a quarter, you’d net $100K per year. If you can scale and complete one such property per month, you’d net $300K per year, more than a first-year attending physician.
Picking the Right Market
Due to the hands-on nature of this strategy, the market where you operate must be near where you live.
It should also be a market that offers a steady supply of distressed property so you can get sufficient inventory.
Finally, it really helps if you’re in a market with rising home prices, as rising home prices can help cover any unexpected cost overruns.
If the metro where you live doesn’t have these characteristics, starting a flipping business may be an uphill battle.
What You Need to Succeed
To be a flipper, you need to cultivate a network of real estate wholesalers and agents who can find you properties suitable for flipping located in the right neighborhoods.
You will also need a network of hard money lenders to finance your acquisition cost and rehab budget, as banks do not lend on distressed property.
Finally, you need a network of reliable general contractors, handymen and tradesmen to do the actual work, and do it on time and within budget.
While building such a network may seem daunting, it is doable if you start small and grow your network over time.
The major downside to this strategy is that there’s no ongoing, passive cash flow. You buy, fix ‘n flip and get a one-time infusion of cash: your profit (or loss) on a given deal. To keep the cash coming after that, you must start the process all over again. And again.
This strategy gives you a job.
If you hate your current day job, flipping houses might be a good real estate investing strategy if you’re in the right market and like managing rehab projects better than what you’re doing now. However, this strategy is too hands-on and time-consuming for most aspiring investors who already have a day job.
2. Investing for Appreciation
Investing for appreciation involves identifying markets where demand for housing is strong and outstripping supply, causing prices to rise. It does not need to be where you live – you can invest remotely. Your intent for this real estate investing strategy and buying each property is to plant a seed and wait for it to grow over the next five to 10 years.
What an Investment Looks Like
As an example, you buy a new construction home near Orlando, Florida, for $260K. With all the growth in jobs and population in that area, that home should be worth $360K in 10 years or less, increasing your net worth by $100K. If you bought 10 such homes, your net worth would increase by $1M, not counting principal paydown.
This is the “ten-ten” plan: Buy 10 new homes in a growing area and wait 10 years.
Your cash flow may be above break-even at first but will grow over time as rents increase. Where you make your money, though, is not on the monthly cash flow but on the long-term appreciation. The role of the rental income is just to cover the property’s expenses while you bide your time and wait for the property to appreciate.
Picking the Right Market
For this strategy to work, you have to choose a market where job growth and population growth are strong, so that demand for homes outstrips supply. For example, Florida’s population has been growing by 300,000 people per year – basically 100,000 households – so builders can’t keep up. As of this writing, Florida and Texas both have booming job and population growth and major metros in those states would be good places to consider investing for appreciation.
If there’s a risk with this real estate investment strategy it’s overbuilding, which is when greedy developers put too many homes on the market at the same time and cause home prices to remain flat or even decline.
Finally, interest rates also have to not increase sharply, as that would affect the affordability of your properties when you decide to sell down the road.
What You Need to Succeed
If you pick the right market and the right property, there’s little more for you to do day-to-day. A new home rents quickly and requires little maintenance. It’s still under builder warranty, so the builder usually has to fix anything free of charge for the first year.
All that’s left for you to do is find a good property management company that can find tenants and manage the property for you remotely.
This strategy gives you wealth.
Though you may not experience immediate cash flow, building up your net worth gives you wealth.
3. Investing for Cash Flow
The last real estate strategy we’ll discuss is investing for current cash flow.
What an Investment Looks Like
Instead of buying that new $260K house in Florida that breaks even and banking on its appreciating, you buy two older $130K renovated homes in Cleveland that, combined, net you $500 per month in positive cash flow (after all expenses) from day one.
If you had 10 such houses – doable due to the lower price point – you’d have $2,500 per month in cash flow. You could use that cash flow to buy more houses, pay down your existing mortgages, or even reduce your hours at work.
Picking the Right Market
To pursue this strategy, you must find metros in which the population growth is flat and where there’s an abundance of homes available. In these metros, supply outstrips demand, enabling you to pick up properties inexpensively.
Midwestern markets like Cleveland, Cincinnati, and Detroit are good examples of this kind of market.
What You Need to Succeed
For this real estate strategy to work, you have to work with a local turnkey provider, who buys the properties, renovates them and then offers them to investors. Basically, your provider is the fix ‘n flip operator we discussed earlier.
You also have to have a good and trustworthy property management company, as these older homes require more maintenance and management.
This strategy gives you freedom.
The end goal here is to accumulate so many properties that the cash flow replaces the income from your day job, and you are job optional. This strategy gives you freedom.
Wealth vs. Cash Flow
Some investors I speak with get confused about the difference between “wealth” and “cash flow,” so it’s worth a minute to distinguish the two.
To illustrate the difference, imagine a person with a net worth of $10M, all tied up in expensive jewelry, art, and collectibles. Those possessions have value and make one wealthy on paper, but they don’t pay the bills or put food on the table. Such a person is said to be “asset-rich but cash-poor.” That’s “wealth.”
On the other hand, a 21-year-old heiress could have zero net worth but receive $20K per month from a Trust Fund. That’s “cash flow.”
Those are extreme examples, but they illustrate the difference between the two objectives. In reality, you will be accumulating both wealth and cash flow during your investing career, but you should be clear about where your focus is.
Real Estate Strategy Summary
The three strategies we’ve discussed are summarized in the table below:
It’s All About the Cash Flow
In closing, it should be noted that you always have the option of shifting your strategy over time.
You could start out by flipping houses, and for every four or five houses you rehab, you keep one – the best one – for your personal portfolio. Over time, you’ll accumulate a portfolio of properties that provides enough cash flow to replace the income from your day job.
Or, you could invest for appreciation at first and, after seven to 10 years, sell those properties tax-free using a 1031 exchange and replace those appreciated homes for duplexes, fourplexes, or other higher-cash-flowing properties. Those higher cash-flowing properties can also replace the income from your day job.
Or, you could start by buying high cash-flowing properties from the outset, using the cash flow to buy more properties and then paying off the mortgages until you reach a point where you own enough free-and-clear properties to replace the income from your day job.
Regardless of what strategy you start with, know that for you to truly achieve financial freedom, all roads must eventually lead to cash flow. I hope you find these concepts helpful when forming your personal real estate investing strategy.
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