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Investing or Speculating? Your Call.

posted Oct 14, 2009, 11:11 PM by Joshua Durrin   [ updated Dec 10, 2014, 8:24 PM ]
A few days ago I finished a blog on overcoming some obstacles in flipping, a well-known and popular strategy in real estate investing.  At the end of it I promised to shed some light on why I kept the term flipping in quotes throughout the blog post.

There is much debate as to whether flipping is actually investing at all, but rather more like speculating. Novice real estate investors tend to overpay for their investment property banking on a continuation of an historical rising trend in the real estate market… or rather, speculating that the market will continue to rise. Well, in 2009 the nation as a whole, not just our local area, saw otherwise. You must have heard the old adage a million times, “what goes up must come down.” The real estate market did indeed plummet and those flippers that had overpaid for their properties assuming that the market would continue to rise were found “holding the bag.”  (I couldn’t resist.) 

This type of investing is common even in the stock market.  It has a name even… technical investing.  The fact is, however, there is nothing technical about it.  It’s speculating, or worse, gambling.  The technical investor banks on the same continuation of a similar rising market trend assuming that future returns will mimic those of the past with a given company.  Sometimes, just like in the hay-day of the early 21st century real estate market, the gambling pays off… the company does perform historically the same or better.  However, the investor is sometimes misguided by the winnings into thinking he/she made a good investment because they saw positive returns.  Sometimes they’ll even boast about being a good investor when in fact they only got lucky on their roll of the dice. 

The technical investor is not much in control of their investment at all.  What they often fail to realize is that their investment is at the mercy of the market often driven by other speculators up and down, often influenced by the seasons, often influenced by the political environment, and certainly influenced by the company management.  So, unless you’re a board member of the company with which you invest, perhaps have some political clout, have visibility into the adaptability of the business of which you invested with regard to market and seasonal changes, you are entrusting your money to someone else to manage it for you and banking that all those involved are going to continue to perform just as they did or better.

A stronger investor is the fundamental investor, one that does take the time to fully evaluate the fundamentals (not just the financials) of a given company.  This is the Warren Buffet type of investor.  That is, this type assesses the earnings against the assets and liabilities to find the real value in each share of a company versus the perceived value based on the emotion or seasonality of the market (and then often compares the two when finding the investment opportunity).  They may take an active role in the management of the company, perhaps by purchasing the majority share or otherwise participating in the governing board.  They also keep on top of the management of the company if they’re not directly involved and essentially review the resume of the new CEO upon any sort of changeover to understand the potential for the company to change directions entirely or review the capability of the new CEO to maintain the company’s performance. 

So, how does all this relate to flipping?  Flipping, if done haphazardly, can result in the same trouble as that often experienced by the technical investor… or the passive investor.  The best results come from being actively involved in your flips and really assessing and understanding the quality of the PURCHASE.  (Emphasis is obvious there, no?)  The savvy flippers quickly realized the difference between investing and speculating after the market crash of 2009.  Those that didn’t went back to work their day jobs. 

Flipping is still a reasonable exit strategy and often a good one when the investment is analyzed properly up front.  To do so, one has to stick to their business plan and work the numbers based on the current market value rather than the future market value.  Not that the future value or market trend shouldn’t be considered, but your business plan rather than your purchase price should be what’s revised if the market conditions shift.  Your purchase price and your business plan should be strong enough to withstand most short term market fluctuations (note, flipping is defined as reselling within 90 days per my prior blog), but certainly strong enough to capitalize on the long term gains. 

Our business plan involves purchasing properties at a wholesale price versus a retail price.  Additionally, we have a series of criteria used in determining our maximum purchase price for a given property.  As such, we often purchase at a discount… albeit properties that aren’t in retail condition.  However, it’s because of this that we’re afforded the opportunity to work with seller and execute a plan that enables us to be profitable within reasonable expectations. 

Setting reasonable expectations is vital to responsible investing and running a small community-oriented business.  I’ll go into more detail on this and other topics in future blog posts.  Thanks for reading.