Investing and speculating are very different – Investing is putting time or money into an asset for the purpose of generating an ongoing income. Speculating is buying in anticipation of selling at a higher price and making big profits.
In real estate, if you have to sell a property to make a profit, you are not an investor. Betting that rapidly rising prices will assure you a profit is risky speculation. Buying properties, fixing them up, and flipping them for a profit is speculating. It’s a job you have to repeat over and over.
Income and wealth are not the same. Wealth is not the big house in which you live. It’s not the expensive car you drive. It’s not the fancy clothes you wear. It’s not your country club membership or your boat or plane. These things may all be indicators that you have a good income, but they don’t mean you are wealthy. Wealth is measured by how long you can maintain your standard of living if you are suddenly no longer able to work and earn.
Wealth is an income stream, a source of passive income that doesn’t require you to trade your time for money. Passive income is interest, dividends, royalties, or other instruments in which you have invested prior earnings or expertise. Income from rental real estate investments qualifies as passive income and is possibly the best way for average working people to build wealth.
Real estate is known as the world’s greatest wealth builder because it’s the only investment where ordinary working people can purchase a large asset using a small amount of their earned income, yet it can produce enough revenue to pay for itself and provide a return on the cash used to leverage the purchases. In the stock market, you can borrow up to 50 percent to buy stocks and bonds, but real estate can frequently be financed at 100 percent or more. Under the right circumstances, you can buy properties with little or no money down, finance the full purchase, and not have to dip into your wages to pay for it.
One caution with the ability to highly leverage real estate is that it attracts speculators who have no intention of holding the properties for ongoing income. Buying at or near the top of a real estate cycle can be financially devastating. When the economy begins to drop, mortgage funds dry up, prices start to fall, buyers disappear, and many speculators suffer huge losses trying to hang on until the market rebounds. These speculators acquire real estate to sell to others, which works fine as long as there are buyers willing to pay enough to give them a profit. But, when the market goes cold and buyers aren’t there, it can be disastrous. We’ve all seen this happen recently, worse in some areas of the country than others.
Have you ever played the board game Monopoly? The way to win is to buy as many properties as possible, put houses and hotels on them as soon as possible, then sit back and collect the rents. Gradually, the players who were afraid to take risks and chose not to invest early in the game are forced out because it takes all their money to pay rent to those who did. In Monopoly, the winner is strapped for cash early in the game. He keeps nearly all of his money invested and often borrows more against properties he already owns in order to continue buying.
Monopoly teaches some real investment truths. The winner keeps very little cash early in the game and invests for the future. The winners in life do the same thing. Those who spend everything they make on fancy cars, motorcycles, boats, big screen televisions, designer clothes, and other things that go down in value rarely have as much over their lifetime as those who invest. While they may initially appear to be more successful, people with this flashier lifestyle can find themselves in an increasing struggle to keep up financially with those who sacrificed in the beginning and invested for the future.
The losers at Monopoly sit with a pile of cash and pass up buying opportunities rather than risk running low on money. Other players buy the properties and eventually force them out of the game. Without investments, their only income is to pass GO and collect $200 (their salary). In real life, properly-leveraged real estate produces an income stream that barely breaks even in the beginning. It is not exciting or stimulating until you look at the impact of owning it over the long term. Initially it takes all the income it generates to pay expenses and mortgage payments, but over time the rents go up and the mortgages pay down. This produces an ever-growing cash flow that starts as a trickle but becomes a substantial and growing income stream the longer you own the properties.
The recent market crash forced speculators out of the real estate market, and falling prices have made it increasingly more attractive for long-term investors. Granted, if you’ve never invested in real estate, it can be scary. When I bought my first investment property, I had sweaty palms and butterflies in my stomach. Like many first-time investors, I saw the mortgage payment coming from my personal income. Although I hoped the property would produce enough to make the payments, I wasn’t sure.
Fast forward to today and what’s amazing is the fact that there are now more deals that meet our investment criteria than we could ever possibly buy. Deals, which were so hard to find a couple of years ago, are begging for buyers today.
Investing is putting time or money into an asset to generate passive income over time. Speculating is buying in anticipation of selling at a higher price and making big profits today. Which do you prefer? Why?