In a recent interview with a major newspaper the reporter asked the following: “As a speculator weren’t you partially responsible for the current foreclosure crisis?”
I was actually glad he asked. It gets to two things that I believe are largely misunderstood – the difference between speculating and investing and that this “crisis” was caused by Wall Street, and K Street, not Main Street.
The difference between speculating and investing is that speculating relies on future changes in market prices, while investing does not.
When I began seriously investing in real estate in 2002, it quickly became apparent that most so called residential real estate investors were actually speculators betting that prices would go up. And for a number of years they were right. When appreciation was at 20% annually you really couldn’t make a mistake.
Or could you?
Take the guy that believed their big remodel resulted in the huge profit when they sold not realizing that the market was moving so fast they could have made more on the same property by doing nothing. And more importantly – if the market hadn’t moved they would have lost 80 cents of every dollar wasted on that remodel.
This is why so many speculators got caught when the market turned down &emdash; they fundamentally hadn’t made good investments. They over paid, over improved, and flat out bet on future appreciation that simply didn’t materialize.
So what does it take to make the jump from speculator to investor? The bottom line is in finding properties that provide the desired return regardless of likely near term changes in price. From there we need to divide investors in to two categories:
Short-term investors look for a purchase price that is at a sufficient discount to make a desired return regardless of likely changes in market price during the holding period. The truth is that is a pretty tall order right now. But I’m starting to see prices find some support from long-term investors and discounts at auction continue to improve.
Long-term “buy and hold” investors simply want a reasonable annualized return on their investment and as such have no reason to speculate on future price changes. My long-term investor friends and customers are now starting to find bargains that meet their investment criteria as rents have remained strong, and prices in some areas have dropped significantly. One customer recently mentioned that he is buying condos for $90k that he can rent for $1,250 (he wouldn’t want me to say where). Even after condo dues that is a great return.
The logic above applies to personal home purchases as well. If making the purchase relies on future price appreciation to work out that homebuyer is speculating. If on the other hand they have a comfortable payment, aren’t paying a huge premium over renting, take advantage of tax breaks and pay down principal over time, they will wake up one day to realize that they’ve made a great investment regardless of near term price fluctuations.
As you look for properties, or help clients look, be sure to always be asking yourself – is this speculating or investing?
Sean,
Great entry. What about the people like my wife and I who just wanted to buy a home, got caught up in the “If you don’t buy now you won’t get in” rhetoric, and bought a home at an inflated price. There’s a third party there that wasn’t concerned about a quick buck or turning a profit 20 years down the line and are now clumped in with speculators. Thank you.
I was more focused on real estate investors and future purchases when I wrote this. That said I do think a lot of homeowners speculated on their ability to make future payments on adjustable, teaser rate, pay option and other WMD loans. Yet I find it a little disingenuous when folks try to lay all the blame on the homeowners as I agree with you that there was a lot of pressure to “get in before its too late”. Just note for the future that when you are feeling pressured it is usually a good time to say no.
Frankly, after losing a pile of money, Im tired of hearing the argument that the deadbeat home buyer should have known better. Life circumstances required that I live somewhere. People act like doing nothing was an option. I do not have an ARM with a huge reset. Stndard 30 year mtg. I put 25% down, my life savings, and now I am upside down because the market is a mess. Collateral damage you might say but just dont give me that crap that I should have known better. And dont tell me that “we couldnt have foreseen what was happening” “its just too complicated for anyone to know what would happen.” This market was (-Expletive Deleted-) by poor lending practices and monitary policy. Some of the smartest people on the planet work in the financial industry and you’re telling me they didnt realize how leveraged it was? Give me a break. Better yet, give me a bail out and give me my money back.