Real Estate Investing Versus Real Estate Speculation

Real Estate Agents, List Bank Reo, Foreclosure, Short Sale, Bpo.

Yes, there are potential deals out there that are so good that you can buy the property with little down, flip it in two years and possibly make money. Examples are bank owned foreclosures or short sales. However, many people who do this often forget to calculate expenses correctly. These expenses include carrying costs (negative cashflow), selling costs (5-6%), closing costs on the buy and sell, and capital gains taxes. You may find a great bargain, but when its all said and done it may not have been worth all the effort.

Rehabbing a fixer upper also falls into the category of speculation. You won’t be earning any money during the remodel, sale and closing period, but you will have expenses. Therefore you are still depending on the property selling at the price you want it to sell it. However, rehabbing is not all bad since it is short term and an experienced rehabber would know how much it costs to put the property in a position where it can sell fast and at a healthy profit. My thoughts on most rehab projects is that you can make a lot of money but you can also run into costly and time consuming hurdles. I would only approach a rehab project if the estimated ROI is through the roof and if the property is in a great area.

The Bottom Line

The bottom line is that if you speculate, you’re taking on more risk in hopes for more reward. You can take $50K and put down payments on five foreclosed properties in some markets. If you make $10k on each property after all expenses in two years, you’re return is 50% annually, which is astounding. However, the keyword in the last sentence is “if”. On the other hand, if the market doesn’t do what you want it to do, you can be paying those monthly expenses, also known as feeding the alligator, for five years straight with no end in sight. You’d be lucky to sell it later on and break even. If you don’t have enough of a down payment to ensure positive cashflow, either look in another market or keep investing in other assets until you can invest in real estate. Don’t become a speculator because all those gurus who sell books told you how easy it is to buy with little or no money down.

If you play it safe and invest in one property at a time that produces positive cashflow, you know for sure you’re earning a return on your investment regardless of whether or not the market does what you want it to do. What I try to do is find great deals, such as foreclosed properties or motivated sellers who will sell 10-15% below market value. I’ll then invest enough so that it produces positive cashflow that rivals stock market benchmark returns, and I’ll plan to hold it for at least 10 years. That way I know I’m earning a good return on investment. When I do sell, the appreciation and the fact that I bought it below market value produces those profits that are the icing on the cake.

The last thing I want to say about this is that if you’re producing positive cash flow, the market finds you. You don’t have to time the market since you’re earning cashflow anyway. You can wait for a great time to sell whereas a speculator may find themselves in trouble and are therefore be forced to sell even when the time is wrong, which is exactly whats going on nationwide at the moment. Positive cashflow investors are staying put and enjoying their cashflow.

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Written by Danny Tsang · Filed Under Investing, Pitfalls, Real Estate