Where Real Estate Investing and Speculation Collide

Title: 

Where Real Estate Investing and Speculation Collide

Word Count:

865

Summary:

Investing vs. Speculation is a collision of epic proportions!  What's the difference? Lots. Read on.  The difference can be the difference between big money and big trouble!

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Article Body:

Some uninformed folks would describe someone who rehabs distressed property as a "speculator" or even a "property speculator." Don't be fooled! There is a VAST CHASM of difference between rehabbing and property speculation.

Let me explain. According to Dictionary.com, the definition of speculation where business is concerned is:

     "Engagement in risky business transactions on the _chance_ of quick or considerable profit."

     "A commercial or financial transaction involving speculation."

While all investing...in anything... has some element of risk to it, I want to highlight a key difference between speculation and investment. When you speculate, risk is higher and by the nature of the word speculation, more risk than usual is implied. 

So, in that context speculation doesn't fit what I advocate at all. I'll explain further, but first let me illustrate the difference between investment and speculation in real estate rehabber terms from something that happened to me just this week.

I got a call; a "hot" lead from my wholesaler. The property was located on the fringes of a hot area of my town called Riverside. Riverside is an area where historic homes are being bought at inflated prices and fixed up very nicely! Put simply, properties in Riverside at in demand.  Well, that's in the heart of Riverside, but this house was on the distant edge of that part of town. 

The house was 934 square feet. Great area, yadda yadda. My wholesaler needs $81,900 and he was the house's "repaired value" will come in at around $120,000. He continually repeated something he heard from an appraiser about values "around" Riverside being a great investment over the coming years. 

I agreed to go and take a look. Before I did, I do some of my own checking. From the tax records available online, I learned that the house was built in 1942, just changed hands last year for $72,000 and was of wood construction with asbestos shingling on the outside. 

It didn't look good when I looked at the numbers. IF...and in my mind a big if...the appraisal came back at $120,000, then the 70% I can get a hard-money mortgage for is $84,000. So, my mortgage would only cover a portion of my closing costs, but none of the rehab. In addition, a few months ago, I bought a property a few blocks away for $38,000.  I'm just not seeing the value in this property BEFORE I look at it. 

When I looked at the property, it had some things going for it. It looked to be in pretty good shape and was on a corner lot. In truth, it needed $10-12K rehab. One negative is that it was square and there is no porch under the roofline to easily add square footage for increased value. The neighborhood is fair but two things jumped out at me:

  - There is a couple of very old apartment buildings on the street. Normally this would not bother me in the least, but these will prevent the yuppie crowd from rushing into the area in a buying frenzy.

  - Every other house within sight was also very small and of similar construction. This means the houses on this street are not the architectural gems in the historic and sought-after areas of Riverside. 

If the money situation would have been better, that is to say, if this was a better investment, I would buy, Buy BUY! If the spread allowed me to buy and rehab it with little or none of my own money, I would have. 

But, if I bought this house and rehabbed it with considerable out-of-pocket investment, I would be speculating on the area, and I had my doubts. 

Of course I didn't buy it, but if I had, that would be speculating!

So, how would I define speculating?

  - Speculating involves taking on more than usual risk.

  - Speculating involve banking on values that aren't there today, and aren't projected to be there based on NORMAL conservative appreciation rates.

  - Speculating is banking on external or environmental factors to make you money. 

     ***External and Environmental Factors (that pertain to property) are factors that are not part of the property itself such as neighborhood, infrastructure, city, the paper mill down the road, rental demand, etc. ***

What is investing, but not speculating?

  - Buying property that you are "safe" in, meaning you could rehab it and sell it in the short term and make money. 

  - Buying property that will make you money based on what you bought it for, current environmental factors, and conservative appreciation rates.

  - Buying property such that hope is not part of the strategy! 

One of the key factors in STAYING a successful real estate investor is strict adherence to your investment strategy and criteria which are tied closely to your investment goals.  

A good real estate investor does what works over and over again and does not take on more and more risk as they go.  Smart investors only ventures into other, uncharted investment areas (e.g., single family homes to commercial property) after careful investigation.  

I think I can safely speculate that the most successful real estate investors incrementally decrease their risk as they gain experience.  Not the other way around.