4 Ways It’s Possible to Speculate in Real Estate (& How to Make Sure You’re Investing Instead!)
Ever heard of the 17th century Dutch tulip bubble? Tulips had been introduced to Holland from Turkey in the late 1500s. The Dutch people loved them, and within a few decades, their love turned to obsession. Throwing aside all reason, people began “investing” in tulips like there was no tomorrow.
At the height of the market, tulip bulbs sold for as much as six years of an average worker’s annual income. Tulips were trading for the same price as 12 acres of land, and in some cases, for the price of a small estate. Yes, we’re talking about one tulip.
Of course, it all came tumbling down, and the price of tulips eventually returned to the price of a common onion. Thousands of “investors” lost their homes, their fortunes, and their self-respect.
So what does this have to do with investing?
As a lifelong serial entrepreneur and investor, I have been on a decades-long quest for the perfect investment—or the perfect business—though I wasn’t always aware of it.
- I invested in oil and gas.
- ROI: -100%. Lost hours: hundreds.
- I invested in a wireless internet company.
- ROI: -100%. Lost hours: a thousand.
- I invested in and built a nurse staffing company.
- ROI = 0%. Lost hours: countless.
- I invested passively with a genius who came up with a scheme to multiply profits through currency exchange. He exchanged his mansion for a 153-year term in the Federal Pen. (He still won’t tell anyone where he hid his 2,000 investors’ $18 million.)
- I invested in speculative penny stocks with two companies that were about to blow up. They blew up alright, but not in the way I planned.
This doesn’t include a dozen or so other ventures that never got off the ground. Now you know why I recently launched an iTunes podcast called How to Lose Money!
I didn’t fail at everything. My first company, an HR outsourcing firm, was quite successful. My partner and I sold the firm for nearly $3 million after five years, and I was two-time finalist for Michigan Entrepreneur of the Year along the way.
But this initial success and profit led me to a series of entrepreneurial ventures and investments that sent me back to school for a decade and a half. This school was harder than my engineering degree, more challenging than my MBA, and more costly than I would have ever imagined.
I tried one venture and investment after another, largely losing time and money—until I learned the power and profit of real estate investing.
It was 2001, and I had burned through a lot of the proceeds I had made in the sale of my company. My friend and I, mostly on a whim, attended a real estate auction on the courthouse steps in Martinsville, Va. We were the only bidders that day, and we paid $34,000 for a home assessed at $65,000.
The great news was that it only needed a coat of paint and a good cleaning. We sold it by noon the same day we stuck the FSBO sign in the yard.
This began a multi-decade career investing in over 60 house flips, dozens of high-end waterfront lots, modular homes, rental homes and trailers, two subdivisions, a Hyatt hotel, a multifamily community, a workforce housing marketing firm, an online real estate portal, and a multifamily investment firm. Though I've had a few losses along the way, overall I've learned that real estate investing is a predictable, powerful, and stable source of income and long-term wealth creation and preservation.
Are You Investing or Speculating?
“Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.” —Paul Samuelson, First American Winner of Nobel Prize in Economic Sciences
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After starting off so well, why did I fail so often in investing? Was I really investing at all? Or was my investing more like a trip to Vegas without the dancing girls?
I failed because I confused my speculating with real investing.
Some of the world’s most successful investors use a theory call “value investing.” Value investing was conceived by Benjamin Graham and David Dodd in their 1934 book Security Analysis. Though focused on stocks, their theories applies to all types of assets.
The authors make the distinction between investors and speculators. Graham and Dodd said, “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”
So I boil it down this way:
- If you’ve done a thorough evaluation and you’re reasonably sure your principal is safe—and you have a chance to make a profit—you are investing.
- If you are “investing” in an asset that has uncertain protection of principal—and you have a chance to make a profit—you are speculating.
I am sad to say that many of my investments over the years were nothing more than speculating. I might as well have gambled away my hard-earned cash at Vegas tables.
Is it okay to speculate? Of course, as long as it’s clear in your mind that you’re doing so. Millions of people have made billions of dollars investing in little startup companies like Apple, Microsoft, and Airbnb. But the overwhelming majority of speculators lose their money, their time, their energy, and sometimes their relationships and health.
Unlike many asset classes, real estate provides an opportunity to invest rather than speculate.
- Chosen wisely, real estate provides a safeguard on principal.
- In many cases, real estate has a high likelihood of producing an ongoing profit.
- In carefully chosen locations, real estate is likely to appreciate in value.
I told you earlier about how I lost money in all types of businesses and investments. Since I started investing in real estate, I’ve had the opportunity to:
- Make up to $100,000 a piece flipping overgrown waterfront lots before the crash.
- Average over $20,000 per flip on over 60 houses.
- Make a 55% profit on a subdivision I developed.
- Provide stable ROIs to many investors in projects I’ve sponsored.
Real estate investment has been good to me, and I would never trade it for any other profession.
4 Ways It’s Possible to Speculate in Real Estate
Let me count the ways…
1. Market Selection
Poor market selection can be a form of speculating. I recall getting a “screaming deal” on a house in Ridgeway, Va., in 2001. Not only was it rural, but the recently departed textile industry left them with an unemployment rate of about 22 percent.
Needless to say, I didn’t make a killing on that deal. But even so, I survived, got almost all my principal back, and lived to see another day. Many high tech speculators only dream of getting out that well.
2. Asset Selection
You can overpay or overspend on upgrades for a property. You can buy an asset with structural problems. You can fall in love with the style of a home and overestimate its resale value. All of these are forms of speculation.
I have done all three. But again, I got out of all three OK.
- I over-spent on upgrades for a home I recently flipped. Rehab budget was $80K, but we went overboard finishing the basement and more, and spent over $100K. The damage: I made $16k profit rather than the $40K or so we hoped for.
- I bought a home with hidden structural problems. We chose to forego a pre-purchase inspection and closed quickly to get a better deal. We later spent $10 or $12K on basement wall repairs. The damage: We still made over $20,000 in profit.
- I once fell in love with a charming Cape Cod in need of significant upgrades. I didn’t know the area well (this was 2001 and I was new at this), and the resale was far less than I’d hoped. The damage: We lost about $3,000 on it.
Do you see the trend here? Even when speculating in real estate, the underlying value of the asset sometimes mitigates losses. I made over $30,000 in total profit on these three speculative mistakes.
Speculating in stocks or precious metals or startups or oil and gas rarely fares so well.
I’ve invested in gold and silver three times in my life, and I lost tens of thousands. I invested $92,000 in a tech startup that didn’t work. I invested $75,000 in an oil and gas deal that came up dry. (My petroleum engineering degree didn’t help there.) Real estate investing has been better for me and most people I know.
You can speculate on timing. All real estate is local. So I wouldn’t say, “The real estate market is in a bubble.” I may say, “The San Francisco market is in a bubble.” It is possible to speculate by buying too high in the wrong market.
My friend Mike made his first foray into rental real estate after college in the late ’80s. He and his three friends went in on a Bay Area house that had doubled (or tripled?) in price over the previous years. Five bedrooms for $500,000 sounds cheap for San Fran today; however, that was pricey three decades ago. But they felt secure in knowing how fast prices were climbing.
Then the bottom dropped out.
My friend and his partners lost their money and their home.
I bought my first home in metro Detroit about that same time for $50,000 and sold it a few years later for $55,000. I was happy with my 10 percent, especially after hearing Mike’s story.
4. Speculative Development
Real estate developers are among the wealthiest folks on the planet. Or perhaps I should say, “Some of the wealthiest folks on the planet are real estate developers.” Some of the brokest are, too. (Is that a word? It should be.)
While many developers are uber-successful, there are probably many more who have gone broke and have moved on to higher paying jobs now, like delivering pizza. And many developers who succeeded wildly in one market cycle lost all that and more in the next.
Do you want to be a developer? Go for it. I’ll cheer you on. But realize that the stakes are very high, and you’ve left the safety zone of many other real estate investments. You’ve definitely entered the speculation zone. (It’s like The Twilight Zone, but it’s even scarier.)
You may protest: “Paul, didn’t you say you made a 55 percent profit on your subdivision?”
Yes, that’s true. But I’m going to be honest and tell you that I didn’t really calculate the significant risk I was bearing. I almost lost my shirt in that deal, and I could have easily landed in bankruptcy court. I would never knowingly take on that level of risk again—not for me and especially not for my investors.
Sometimes you only see your path clearly in the rear view mirror. I am currently involved in one of the safest, most stable, profitable real estate classes on the planet—syndicated commercial multifamily investing. And I look pretty wise to the young guys in my sphere of influence. (Don’t show them this article. They think I’m pretty smart.)
But my path was riddled with mistakes and risks and miscalculations. I spent years thinking I was investing, while I might as well have been pulling the handle on a slot machine. I plan to never confuse speculation for investing again. Especially when I am handling other people’s money. And mine. And my children’s and future grandchildren’s.
You don’t have to make the mistakes I made. You can stand on my shoulders, renounce speculation, and invest wisely to create a multi-generational wealth-creating real estate empire.
Have you ever confused speculating with investing? Do you see this happen amongst inexperienced investors in your market?
Let me know your experiences with a comment!