At some point the topic of Real Estate Investing may turn to consideration of whether someone is “investing” or if they are merely “speculating” with real estate. We’ve talked quite a bit about different kinds of investing; investing for cashflow, passively investing with rentals, and actively investing by improving the value of a property.
But what about purchasing real estate at retail market prices with the prospect of being able to sell it at a higher price in the near future?
This type of investing is one of the more risky strategies, and many will view this as “speculating” that the value of a property will appreciate simply based on market factors. With this strategy, the investor will have little, to no, control over the success of the investment.
Betting On Passive Appreciation
An “investor” (or speculator) may make the argument that their location knowledge, insights into future direction of the general real estate market and analysis of a particular property are superior to the general market, so they believe the risks are low. That may be true, but this type of approach is certainly further on the risk spectrum towards speculation than investing.
Other investors often benefit from this type of “passive” appreciation as well, but it’s not the primary measure they use for determining whether an investment is worth making.
Despite these caveats, these are factors that should be part of your analysis. You’ll want to ensure you are considering all aspects of an investment that could impact the outcome.
Location and Market Analysis
To be successful as a real estate speculator, a few skills are extremely important, location and market analysis are probably highest. A deep understanding of real estate market factors in the location you are investing are key. Many things can go right, and many can go wrong that are location specific.
What is happening with jobs and employment in your target location? Real estate rarely increases in value without an increase in demand and job growth is one of the biggest contributors to demand.
Are there any legal or political activities that could impact the value of your property – such as zoning or taxation changes? Any pending changes to laws related to rental properties?
What is the general direction of how properties are maintained by current owners surrounding your property? Neighborhood blight will limit the potential for property value increases. Conversely, neighborhoods undergoing gentrification will increase the potential for value growth.
Are schools desirable in the area? Are there changes in school boundaries that may positively or negatively impact your investment?
Is there significant new competing building and construction occurring or planned that could increase supply in the area? This could result in price stagnation for existing properties.
Are there constraints such as suitable available land, Limited availability of labor or material shortages, are there legal limits placed on new construction and building that will limit new supply from coming available? These housing supply shortages bode well for price increases if there is simultaneous increase in demand for housing.
What are broader real estate market factors occurring that could impact you? Where are we in the current real estate business lifecycle? Are interest rates increasing or decreasing? How will that impact demand? How long could you hold while waiting for the market to go your direction?
These and other factors become increasing critical when you don’t have a cashflow strategy, you aren’t making opportunities to increase value through property improvements, or don’t have an active supply of rental demand and high enough rents to cover your costs.
Interestingly, all these factors above are things you should consider with any type of property, however, for the speculator they hold much higher importance – and the costs of being wrong can be significant. You must know these many local market factors well, and also understand the broader economy and have your pulse on the macro real estate business lifecycle.
Thinking in Bets. Making Smarter Decisions When You Don’t Have All the Facts
by Annie Duke