On today’s show we are asking the question is flipping a legitimate form of real estate investing?
A lot of people enter the world of real estate investing because they are drawn by the lure of mailbox money. They are drawn by this thing called passive income.
Well folks, money comes in one of three ways.
- Earned income
- Residual Income
- Capital Gains
Most of the wealth in the world has been created through a combination of #2 or #3. The simple test of whether what you’re doing is earned income is to ask a simple question:
“If you took two months vacation, would the business come to a stop?”
If the answer is yes, then you’ve just purchased a job. It might be a job with greater freedom than being chained to a desk. But it’s a job nevertheless.
It gets confusing because sometimes a job requires investment of capital to do the job. Just because it requires investment doesn’t make it the same as investing. It’s the presence of that active component that makes it more like a job.
I know a number of professional volume flippers. They perform anywhere from 20 to 1,000 homes per year. Once you put some scale behind it and it becomes a self sustaining business, there is dedicated staff in each of the key roles. You have acquisitions specialists, construction managers, sales people, a legal team. At that point the business owner can step away from the business and the business will continue to run itself. The cash generated by that business falls into the category of residual income. But it’s business income, not passive investment income. The properties are held for as short a time period as possible. The profits are unlikely to be considered capital gains.
So is flipping investing? My answer to that question is no. It’s a business, like any other active business that produces a product. It’s the same as a bakery, or a business that manufactures children’s toys. It takes in raw materials and manufactures a new product which gets sold. That product happens to involve real estate and buildings. The raw materials consist of an existing property that is in some level of distress. You add new materials, some design sensibility and transform as property that was less desirable into one that the market really wants.
You need money to fund the inventory for the manufacturing business. If you’re baking muffins, you need to buy flour and yeast and all the other ingredients. If you’re product is toys, you may need to invest in the manufacturing capacity, and purchase the raw materials. Flipping houses is exactly the same. It’s more like a manufacturing business than an investing business. Yes, the numbers are bigger because the sale price is not under $10, the sale price is in the hundreds of thousands. It’s a high price low volume business. An effective bakery would probably be a low price high volume business.