Investing Strategy & Tips
Better Strategy Than Speculative Purchases
By
Jan 28, 2006, 23:13

Speculative purchases are sometimes a matter of mental attitude as much as anything because value, like beauty, is in the eye of the beholder. One investor may look at a piece of property as a purchase for speculation while another may view the same property as a long-term investment. Both people could be correct in their analyses, as the property could be speculative during the short term and a highly profitable investment in the long term.

In general, slum housing in difficult neighborhoods is considered highly speculative because it is subject to civil unrest and is hard to operate. Rent collection and maintenance are difficult because the conditions in which you are buying are rough. Expenses are likely to be quite costly. These properties therefore demand a higher rate of return on capital investment to justify the necessary expenditures. Consequently, they tend to be regarded as speculative.

It is important to analyze the community in which you are interested in buying to see that you don't make a poor investment. For instance, you don't want to purchase property directly adjacent to a community road. Development project that will take time to rebuild and force you to take long-term negative cash flow. Granted, the property will eventually appreciate in value. But the question is, How long can you hold out? Sometimes, it is impractical to acquire property on a street where the city has planned a widening project. 

A real estate speculation doesn't necessarily entail a quick turnaround it could be long term, too. A gamble in real estate could also be long term. For instance, today you can go out to the California desert or Colorado Springs or to some other places where desert subdivisions have collapses because of their own costliness and buy up an old subdivision. Then you could sit on it for decades until growth catches up and somebody come along who is willing to market it.

A lot of people are in the business of buying older houses, fixing them up, and then selling them for a profit. Many of my friends and
associates have bought fixer-uppers and have done a beautiful job rehabilitating them. When the newly refurbished property goes up in value, they turn around and sell it and move into a better house. That's not what I would do, but a lot of people are successful at it.
Say a person buys a house for $300,000 and puts $50,000 into fixing it up. Then the market falls off and the property can't even be sold for $300,000, let alone the additional $50,000 cash the owner has invested. Possibly, his only recourse is to hold on to his investment over a longer period of time by renting the property to offset his loan payments and remodeling expenses. Obviously, timing the purchase and acquiring property in a foreseeable up market is critical when speculating like this. 

Buying houses, fixing them up, and reselling them can be very lucrative if you are careful in your timing and selection of the right properties. Speculating in real estate, in my opinion, is riddled with drawbacks. Even though it may result in a net profit, selling property exposes you to a tax on capital gains. Most people sell their real estate when they see a relatively small profit. Selling property in a neighborhood with appreciation land values prevents many income property owners from ever achieving a positive cash flow. It also limits the amount of equity they could have accumulated and borrowed against to make other investments. Buying and holding real estate for a brief period then selling is clearly a short-sighted approach to what is better regarded as a decades-long process of wealth accumulation by making a purchase that considers and allows long-term appreciation in value.

There are several inherent advantages to never selling the desirable real estate you acquire. Aside from qualitative attributes, there are four basic measurable benefits derived from ownership of income property abbreviated by the acronym SEAT:

Spendable Income: With income property, you can realize a positive cash flow.
Equity Buildup: Building equity allows you to borrow against you property to make other investments.
Appreciation: Never selling enables property owners to realize substantial appreciation in value.
Tax Benefits: Property owners reap tax benefits by taking depreciation on improvements and personal property.

People who finance second mortgages receive monthly payments from the borrower. Second mortgages can be a fabulous source of income.
But in down market, if the second mortgage comes due and the borrower doesn't pay, the property may have to be foreclosed on. Conversely,
if the first mortgage holder forecloses on his note, the holder of the second has the option of taking over the property by making the payments. If you know what you are doing, the market for second mortgages and trust deeds can be fabulous because you should be able to make 15 to 20 percent on your money. But it's not for the investor who is just starting out.

The purchase or acquisition of second mortgages or second trust deeds is also speculative because they are junior liens to the first mortgage. They are in a secondary position in the mortgage line. If the holder of the first mortgage defaults on his payments, the holder of the second mortgage isn't paid until the holder of the first mortgage receives the full amount of unpaid principal plus legal expenses. 

It is very difficult to plan a long-term real estate investment strategy around speculation. Look what happened to Donald Trump.