Let’s get one thing straight: the kind of real estate investing you often see on the television flipping shows is not true real estate investing.
Sure, it involves putting money into a deal and expecting to make something back. And yes – sometimes these individuals make incredible profits.
However, the kind of real estate seen on the flipping shows is more closely related to the buy-wholesale, sell-retail model of a clothing store at your local mall than it does to real estate investing.
As Glen mentioned in his popular article, Seven Ways to Get Rich Quick, many people have tried to “get rich quick” by buying real estate only to lose it all when the market dropped out.
Flipping houses, as well as most development, raw land purchases, and betting all your chips on “black” is not investing but rather “speculation.”
Speculation involves taking a high risk with the potential of earning a high reward, often in a short period of time. Investing involves taking calculated but dependable risks with the assumption of earning solid returns.
It’s important that for you, as someone looking to grow their financial position in life, to make that distinction in your mind now, rather than later.
Now, don’t get me wrong: house flipping can be fun, profitable, and entertaining.
However, flipping houses involves heavy risk with a smaller hope of return. It’s a business, at best, and while it can be exciting and profitable if done correctly, it’s not what I want to talk about today. Millionaires are generally not made through speculation (at least not for the long haul.)
Let’s talk a bit about what true real estate investing looks like, without the speculation added.
Investing is About Cashflow
Imagine with me for a moment that you buy a piece of land. There’s nothing on it, it’s just empty. You buy it, hoping that someday the government will come through and decide to put an interstate nearby and you can sell out to an outlet mall or a McDonalds franchise.
And then you wait.
In the meantime, that property brings you nothing but taxes and trouble. You aren’t making anything. You might wait five years, you might wait ten or twenty.
The point is, every single month that property costs you money – and it’s all on the risk of making a big profit someday. Again, while I don’t want to beat a dead horse here, this is speculating.
Now, instead, what if someone decided to pay you, every month, to park their boat on that land.
They want to give you money each month. Now this is a measurable investment – you’ve now created cash flow.
Cash flow is the extra money in your pocket each month after all the bills are paid. Cash flow is the mortar that holds together wealth. Cash flow allows you to earn money now, but still leaves the potential for profit open later. This fictional piece of land may still, someday, be worth a large sum of money, but in the meantime, it will provide a solid return on investment.
Therefore, the first lesson about real estate investing vs. real estate speculating is this: always seek cashflow when making a real estate investment. Don’t fall for the “well, I can handle all the money I’m losing each month because some day the price will rise.”
This is not only un-scaleable, but also just plain dumb.
Investing is About Security
Secondly, investing requires a certain assurance of security.
The reason a bank requires you to bring them ten thousand pounds of paperwork before approving you for a loan is not because they have some financial stake in the paper industry – it’s because they have a financial investment in you.
They want to ensure that their investment (the money they are potentially lending to you) has an assurance of being paid back in a timely and responsible manner. If they simply lent money to anyone walking in the door – they would be speculating (hint, hint… subprime loans, circa 2005).
In real estate, security is built a number of ways. Let’s look at a few specific examples:
You wouldn’t drive from Alberta, Canada to Lima, Peru without a map. Knowing that Peru is South is not enough to get you there.
In the same way, true real estate investors have a plan for their investments. They know the path that has been traveled before, they know what to watch out for that could trip them up, and if knocked off course, they can easily navigate back on track. This plan could be as complex as a formal business plan or as simple as a blog post or scribbles on the back of a napkin.
Multiple Exit Strategies
Do you know how you will get out of an investment? Are there several exit doors?
In the example above, with the piece of raw land, if you bought that land with just one exit strategy (selling for a high price someday in the future) you pigeon hole yourself into having no options. You cannot escape unless your one exit door opens.
The same could be said for buying a house to “flip.” If your only exit is a quick sale – it’s not a good investment. Too many things can go wrong to have just one exit. Instead, if there are multiple exits, the chance for ensuring profitability rises high. Multiple exits could include:
- Sell to a retail homebuyer
- Refinance into a fixed-rate mortgage
- Sell to another investor
- Pay off in Cash
Keep it Simple
Finally, a security is found by not being the trailblazer.
Yes, in many aspects of business it is advantageous to be a pioneer in the industry, but when investing for security and long-term returns, you don’t need to reinvent the wheel. The path to real estate wealth is not a complicated journey, but rather is a simple, well-worn path based on the “buy low, sell high” and “cash flow” principles. If you are tempted to try following the latest “new idea” or fancy investing technique – take a step back first and look at the fundamentals beneath and decide if it is truly something you can afford to speculate on?
During the last run-up in the real estate market, many investors (and wannabe investors) lost site of this and began borrowing with ridiculous terms, crazy adjustable mortgages, and crazy no-money-down schemes that ended most in foreclosure.
Sometimes the simplicity of a 15 or 30 year fixed mortgage is just what you need to provide a solid return – especially with today’s low rates.
Is Speculating Ever Okay?
I don’t want to finish this article without first reaching out to those who want flip houses, buy raw land and wait, or place all their chips on black.
Speculating may have a place in an investors life, in the same way recreational casino gambling may have a place. It can be done, great fortunes have been made, and frankly – it’s a lot of fun.
However, I’d encourage you to keep the distinction in your mind separate at all times, knowing that the money spent on speculating may or may not return to you. Is this money something you’d be willing to lose? If not, stick with the basics of real estate investing and leave the speculating for those who can afford to play the game.