The difference between speculation and Investing
Like clock work, every time the market cycle heats up, the opportunist in us comes out to play.
The slow-and-steady-wins-the-race mentality gets abandoned as people chase the sexier, faster buck.
Great people with admirable intentions to do right by their families look to “invest” some of the freshly minted equity in their home into something that has the potential to pay off big.
The right idea, but lately the conversation has begun to shift from solid, yet agreeably less sexy investments like single-family homes with suites, and duplexes, to this idea of “buying” three units in the latest pre sales condo development.
The thinking is: I could spread out my $150,000 by putting deposits on three units and then in a year or two, when the market has climbed up another 10 per cent each of my $500,000 units are now worth $550,000.
Since I only have a deposit of $50,000 with the developer, I have doubled my money on each unit just for sitting on them for a year.
Is the above scenario possible? Sure. Is it a forgone conclusion? Absolutely not! There are countless other ways this can go, including losing all your investment.
I use that word reluctantly because although the intention of the person was to invest their equity, what they were actually doing is speculating.
Speculation means: Ideas or guesses about something that is not known.
The cruel teacher of experience has taught me that to win big in this real-estate game you must avoid guesswork at all costs.
- Forget about timing the market.
- Forget about trying to predict where pricing is headed, and focus on the fundamentals.
- Focus on positive cash flow.
- Focus on creating your own appreciation through value-adding renovations.
I fell into the trap of speculating the last time the market was hot in 2006/2007.
I put $1.5 million worth of the hottest condo project under contract for $150,000 and had expectations of doubling my money at least.
I wasn’t alone as I waited at the front of a 300 plus person line from 2 a.m. the night before the sales centre opened to the ravenous public.
I lost every penny of my six-figure investment when things went sideways in 2008. And that hurt like a you-know-what.
Contrast that with a duplex I bought around the same time in 2007, at the peak of things.
I put a similar amount down on this property, $140,000. I bought this property because the cash–flow made sense.
I wasn’t trying to guess what the market would do; I was investing my capital into a proven revenue stream.
In this case, it made about $1,000 per month net. Between that, and the equity I was building each month through my mortgage being paid off by the tenant, the returns were actually pretty good (18 per cent) despite paying peak pricing for the duplex.
Around the same time my $1.5 million in a half completed condominiums saw their values sliced by 20 per cent, my duplex value had plummeted to a mere 80 per cent of its former value as well.
The difference between the two was that I wasn’t forced to sell my duplex at a loss, it cash flowed through the entire five-year market slump.
My mortgage got paid down by nearly $50,000 and I had approximately $50,000 in cash flow paid to me during that time.
Today, that duplex is worth about 10 per cent more than what I paid for it and the cash flow is about 20 per cent better than what it once was thanks to rents climbing at about three per cent per year.
The $150,000 I dumped into the condos was an expensive lesson, but one I’m glad I learned as we go into this next boom cycle.
As exciting and alluring as some of these shiny new projects seem as an investment, sinking that same money into a boring, old duplex or multi-family building will always be my choice.
I know what I’m getting into. I know where I can add value, and I know that as long as it cash-flows, there’s no down turn in prices that will ever force me to take a loss.
As an investor, I like control; I don’t like putting my fate in the hands of bankers, politicians or even public opinion. I like to see my returns on paper in black and white and I like to be able to influence my upside.
My challenge is I also love the smell of opportunity and, if I’m honest ,I love the thrill of a good wager as well.
Knowing this about myself, I have to work hard at finding the discipline to stay the course with my investments and follow the plan I’ve laid out, as unsexy and tortoise like as it may be.
If you’re a boring old tortoise as well and want to see my hand-picked selection of painfully unglamorous cash flow properties with PDF analysis of each showing the predictable double-digit returns, click here and prepare to be underwhelmed.