When you start reading a lot of articles in the general news media about real estate investors it’s usually a sure bet that they’re not going to be flattering.
When the market was flying it would seem that everyone was making big bucks, if you took media coverage at face value. That led to a big increase in speculative buying. This hasn’t painted a pretty picture in many areas, and an ugly convergence of flattening/declining prices, declining sales, and a collapsing sub-prime lenders has turned many a get-rich-quick scheme into a sob story.
How about the Florida couple – an administrative assistant and a carpenter with a combined household income of $90,000 – who took out $750,000 in financing to buy three investment properties. Now that the market has tanked and they’re facing foreclosure they’re suing the lender – claiming that the bank never should have trusted them with the money in the first place.
These sordid stories aren’t hard to dig up, and they highlight a fundamental truth: There’s a difference between investing and speculating. Either approach may be right for you…but the danger comes when you think you’re doing one but you’re actually doing the other.
Investors and speculators have fundamentally different objectives and risk profiles, and consequently require two distinct skill sets. I’d argue that in today’s economy we all need to be investors. The job-for-life-guaranteed-pension world of previous generations has evaporated in recent years, and social security is looking increasingly rickety as it prepares to bear the weight of the retiring baby boomers. Many Americans are waking up to the fact that they’re gong to be responsible for their own future livelihoods.
Few of us, on the other hand, are cut out to be speculators. What’s the difference? Well there’s been no shortage of ink and pixels spent on the subject, but here’s my take:
| |
Investors |
Speculators |
| Objective |
Make money: Pursue investments that have sound, quantifiable fundamentals. |
Make money: Buy assets that are expected to appreciate rapidly in value, with the hope of selling for a large profit. |
| Risk profile |
Moderate risk: All real estate investments carry risk, but investors will look for properties with positive cashflow that will allow the investor to carry them through downturns in the market. |
High risk: Speculators stand to make big profits from leaps in the market, but are exposed to foreclosure if the market flattens or declines. Seeks quick profits but can tolerate large losses. |
| Time horizon |
Long: Investors will tend to seek out buy-and-hold quality properties, even though they may subsequently sell them in a shorter period to rebalance their portfolio. |
Short: Speculators look to get in and get out. Having funds tied up for an extended time is expensive, due to the fact that most speculative properties generate negative cashflow |
| Tactics |
Buy properties, preferably at a market discount, that will yield positive cashflow. Build equity by selecting quality tenants who make timely payments. Grow a portfolio of real estate holdings through 1031 exchanges. |
Buy properties in hot markets, catching trends early and getting out before the trend ends. |
| Skill set |
Strategic thinker. Strong people skills. Good negotiator. Disciplined. |
Intuitive and decisive. Risk seeking. High tolerance for losses. Financially secure. |
Most people can easily place themselves in one category or the other.
There’s a lot to be said for having the speculator personality and skill set in a market that is hot, but smart speculators know when to sit on the sidelines. Flipping and pre-construction investing are, almost without exception, speculative activities. Many of us have talked to people who purchased an ugly starter home, slapped a new coat of paint and fixed up the landscaping, and the sold it for a big profit. Here’s a news flash: it wasn’t the paint or the shrubs that pushed up the price of the house – it was the rising market. This is a strategy that only works in bull markets. It’s a speculative play.
Most of us, myself included, belong on the left column.
Which side are you on?