Think This Real Estate Investing Play Makes You Money? You're Dead Wrong

If you're a fan of reality TV, you've probably come across those shows where people buy homes in disarray, fix them up, and flip them for a nice profit. It's a great idea in theory. But in practice, house flipping can be a challenging endeavor, and often one that doesn't end up being all that profitable.

Profits are shrinking

At first glance, it's easy to see the appeal of house flipping. Rather than tie up money in a long-term investment and wait years to get anything out of it, you could instead buy a home, renovate it, and move it off the market. And seeing as how real estate inventory is sorely lacking these days, it's easy to make the case that selling a flipped home shouldn't be too difficult.

A person holding a cabinet in a kitchen.

Image source: Getty Images.

But while it's true that buyer demand is up, so too is the cost of purchasing and renovating a home. So unless you're really an experienced house flipper, you may find that fixing up homes in disarray isn't the solid wealth-building play you think it is.

In fact, in 2021, an estimated 323,465 single-family homes and condos were flipped, according to ATTOM, a provider of real estate data. At the same time, though, gross profit margins dropped to their lowest level in over a decade.

Homes flipped in 2021 generated an average gross profit of $65,000. That's down 3% from $67,000 in 2020, and it also amounts to the lowest margins since 2008.

The reality is that right now, home prices are sky-high, and building materials are more expensive due to supply shortages. So even experienced flippers may find that it costs more than ever to purchase a home (even one in desperate need of work) and procure the materials and labor needed to get it into marketable shape.

A better route to take

Not only are profit margins shrinking for house flippers, but it's a fairly risky business to be in. It's not always easy to estimate the cost of extensive renovations, and if you end up in over your head, you could wind up making very little on a house flip -- or even losing money.

That's why you may want to take a different approach to real estate investing -- one that has you holding assets for a long time rather than trying to make a quick profit. And you have a few options in that regard.

First, you could buy an income property in the hope that it gains value through the years. Granted, you'll pay a premium for a home in today's market, but if you're able to command enough rent to cover your mortgage costs, you may find that your home appreciates steadily in value over time.

An even less risky and more hands-off option, however, may be to invest your money in REITs, or real estate investment trusts. Buying REITs is comparable to buying stocks in that you don't have to do any real legwork other than some up-front research.

With REITs, you don't have to deal with tenant issues or maintain a property. You can simply sit back, collect dividend payments, and wait for the value of your shares to grow.

Granted, you'll need to be patient to grow wealth with REITs, whereas flipping houses could get you there much more quickly -- if the stars align. But given the risks involved and the way profit margins have been shrinking, you may want to abandon the strategy of flipping homes and focus on long-term income properties or REITs instead.

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