Are You A Real Estate Speculator Or An Investor?

There are definite strategies required to deliver success in the purchase and management of real estate properties.  As a participant, the first decision you need to make is whether you are a REAL ESTATE SPECULATOR or a REAL ESTATE INVESTOR. 

Much like stock traders are only interested in fast capital gains and have little interest in the actual business, real estate SPECULATORS are only interested in quick, short term capital gains on any property purchase.   These are the folks who talk about FLIPPING properties for profit.

It is possible to make money with either strategy but in my opinion, speculators are taking a much riskier and more limited profit potential approach. 

When interest rates are low and demand is high, it’s difficult to purchase properties at a low enough price. You want to be able to quickly make the required improvements so you can sell for a substantial profit. 

Unexpected events like the COVID-19 pandemic, can very suddenly change the real estate market. 

With lower demand, prices may drop and it could take longer to sell the speculative property. This could result in a lower sale price and longer carrying charges on the property.  It also takes considerable experience and knowledge to be able to inspect candidate properties and accurately determine all the factors:

• what needs to be done to the property
• how much it will cost
• how long will the renovations take

A few small mistakes could cost the SPECULATOR all their profit, and possibly more, than was first thought.

If the SPECULATOR is successful in buying, fixing, and selling the property for a profit, it is then necessary to find another property to renovate and sell.  This isn’t always easy to do.  Once the speculative home or building is sold there is no more profit potential from that property. Flipping homes is not for the faint of heart.

A typical example could be a $200,000.00 property that required $75,000.00 worth of work and that sold for around $350,000.00 after it was finished.  Most of these properties need a 35% or more down payment plus the carrying and renovation costs in cash. 

After realty fees, carrying costs, lawyer’s fees, and renovation costs the speculator would have made a one time profit of approximately $45,000.00 which would likely represent about five months of work. 

That would provide a return on the speculator’s work and efforts of about ($45,000.00 / 5 months) = $9,000.00 a month or a return on cash invested of around ($45,000.00 / $175,000.00) = 25.7%.  This is assuming no mistakes were made and the market allowed the property to be completed and sold within five months.  This strategy works better when interest rates are higher and demand is lower. 

If a property is purchased as part of a long term portfolio there are four streams of income possible from that investment:

•  The first would be from the rental income cash flow.  This is the money remaining after the mortgage, property taxes, insurance, repairs and maintenance, and any other legitimate charges have been deducted from the rental income.  This should provide a minimum of 4% to 6% return on the cash you have invested into the property. 
•  The second stream of income is from the paydown of the mortgage principal over time.  This is not immediate cash in your hand but if you keep the building for 20 to 25 years the tenant will have paid off the mortgage financing for you.  The actual paydown will depend on the interest rate, term, and amortization period used on the mortgage financing.  Many software programs can provide these figures for you on a year by year basis.  This is usually a 2% to 3% return on the cash invested into the investment. 
•  The third source of income is capital gains over time.  Past performance is never a guarantee of future performance but very conservatively most income properties increase at an average of at least 5% a year.  This is never in a straight linear line as political, community, and the world and local economy events can influence these.  This means based on historical precedents an example $200,000.00 investment today would likely be worth in excess of $675,000.00 in 25 years and the tenants would have paid off the mortgage balance for you.  If the average capital gain is about 5% a year this can represent an approximately 12% to 16% return on the cash invested. 
•  If the investor wants the property can be depreciated for tax purposes.  The depreciation can only be on the building and not on the land.  Depending on what the building is and the date you purchased it the depreciation amount can be 4%, 5%, or 10% per year.  Most are in the 4% to 5% range.  You will need to check with your accountant to see exactly where your building(s) fit.  While this can lower your income tax cost during the year of depreciation you must bear in mind when you sell the building ALL of the depreciation will be recaptured and you will be taxed fully on the recaptured amount as well as the capital gains on the building.   

It would seem obvious that long term investing will provide more reliable and superior results than short term speculative endeavors.  Using data from investment property sales I have arranged during the last 45 years, many have shown average yearly returns in the 30% to 35% range with a few above that. 

MOTIVATION

Without the motivation to make a commitment to taking action, everything you read here is purely academic.  The question you need to answer is why you would want to become an investment property owner.  Most investors need reasons and goals to undertake a long term investment property acquisition.  Each person is an individual and their motives are as distinct and personal as they are. 

Some are motivated by what they can do for their family.  Others want to be able to help mankind.  Contributions to religion have inspired still more.  A desire for riches and comfort have encouraged others. 

You will need to find your own reasons to want to acquire long term investment properties.