Not long ago I wrote a post on Real Estate Speculating vs. Real Estate Investing. My main point was that  speculating and investing are two different activities which require two different skill sets and risk appetites. Either might be right for you, but the danger comes when you think you’re doing one but you’re actually doing the other.

At least that’s the point I wanted to make. But it would appear from some comments that my post was interpreted as bashing speculators. That’s not my view.  Sometimes you gotta roll the dice. 

So today as we stand in the shadow of Enron and the collapse of the dot.coms and foreclosures pop up all around us like mushrooms who in his right mind would try and defend the defamed speculator?  Well...I would.  Risk and reward are correlated in efficient markets, so there's nothing wrong with taking a risky position if you know what you're getting into.  So..here are four points that I like to keep in mind when it comes to speculation:

• Buy what you know: Ever had someone tell you “my brother’s roommate says that nanotechnology is the next big thing…and here’s a penny stock in the sector that’s about to go through the roof!”   That's bad advice, probably. Take your money and go to Vegas instead – at least you’ll have some fun in the process. However, taking a speculative view in a market that you know intimately is a different proposition. Example: I recently bought a fourplex that had yielded a decent return, but the real reason I bought it is that I’m bullish on the neighborhood, and I expect that the city might announce a light rail station a block away. This was a speculative view, but it’s a risk-reward that I’m happy to shoulder.  I know the market.  I know the risks.  And I accept the trade-off.
• Be ready to lose: Speculators win big and lose big. Gambling your retirement on a speculative position is silly. Having some speculative purchases in your portfolio is a good diversification strategy, in my book, but don’t bet more than you’re willing to lose. USA Today wrote a goofy article recently about real estate investors which was really about speculators. It was full of misinformation, but it did highlight the fact that people sometime do foolish things when it comes to real estate.
• Flippers are speculators, not investors:  Well, most of them are. If you have mastered techniques that allow you to consistently buy at 20% below market value then you have a strategy that’s fit for all seasons. But by now most of us have noticed that the flippers come out of the woodwork during a bull market and they disappear back to their day jobs once the markets correct and cool. Why is that? It’s because flipping in inherently a speculative activity. Here’s a news flash: it’s not the tile that you put in the foyer or the paint job that added $50 thousand to the price of that house you just bought and flipped; it was the rising market. In a falling market you can’t make money making cosmetic improvements to an ugly house.
• Buying in an overheated market? You’re a speculator:  Here’s a test – do you need a double digit rate of appreciation to get a decent rate of return on a property? If you’re buying right now in most areas of California, Florida, and a lot of other hot markets then that’s going to be the case. If you’re investing in a property that doesn’t immediately yield positive cashflow then you’re betting on a rising market. Again – that might be okay – as long as you realize that’s what you’re doing.

So here’s to the real estate speculators - at least to the prudent speculators who don’t get in over their heads and don’t bet more than they’re willing to lose. But with investors suing to back out of underwater deals and states like Massachusetts taking measures to protect overleveraged investors from foreclosure  it would appear that prudent speculators are outnumbered by the get-rich-quick guys who get themselves in trouble.

But that’s okay…a rash of foreclosures just means more distressed below-market properties for smart investors to scoop up.