Speculating Vs. Investing - How To Know The Difference
How to know if you’re a speculator or an investor; that’s the million-dollar question. A lot of people mistakenly believe that they're investing when in reality they're speculating. If you’re reading this article, the hope is that you desire to stake your claim as a professional investor. In this article, let’s explore the difference between speculating and investing and some thoughts on multifamily real estate, as it pertains to the topic.
The Difference Between a Speculator and Investor
The Oxford Dictionary defines an investor as a person or organization that puts money into financial plans, property, etc with the expectation of achieving a profit. On the other hand, Oxford Dictionary defines a speculator as a person who invests in stocks, property, or other ventures in the hope of making a profit. Therein lies the key difference between speculating and investing; the former takes action based on hope, unproven theories and conjecture, while the latter has an expectation based on evidence found in the fundamentals.
So, let's talk a second about evidence and fundamentals. All investing entails an element of risk, no matter what you’re investing in. Take the example of stocks. There is the risk of an economic downturn, a future pandemic, and government regulation that can suddenly affect the stock market. However, a savvy investor can minimize these risks by relying on fundamentals. By reviewing the fundamentals of a company, evaluating P/E ratios, analyzing profit and loss statements, and studying the product or service that the company provides, you can learn if the business is healthy, profitable, and able to withstand external pressures like these mentioned above. A speculator, on the other hand, relies more heavily on trends, headlines, tips, and hype. They hope for price appreciation and generally invest with the intention to buy low and sell high.
Moving this example to the world of real estate, it’s no different. A professional investor is more inclined to look at the actuals, financial statements, profit and loss, T12s, and examine the current and past cash flow on a particular property. While a speculator is usually speculating that property values will increase in the market while they force short-term price appreciation. However, in the market like we have this year with rising interest rates and a strong pull back in the stock market, gambling on price appreciation may not be the most profitable strategy.
Speculative Investments
Across the board, the most speculative of assets are being hit the hardest. We're seeing crypto, tech stocks and NFTs get crushed, and speculators are getting wiped out. In turn, mature companies with solid cash flow and healthy dividend paying companies are holding up much better in this environment. Historically speaking, these types of assets withstand recessions much better than speculative assets and unprofitable companies.
The real estate market is a slow-moving machine, so we haven’t seen a major impact yet, and the data suggests that we may not, but time will tell. The impact of rising interest rates, can take six to twelve months to develop with real estate pricing. Aggressive underwriting, house flippers and having unrealistic expectations of price appreciation may cause some real estate owners to find themselves in a tight spot.
According to a report by The Real Deal, residential home flippers are already getting crushed. Despite greater flipping volume, their margins have shrunk to record lows. https://therealdeal.com/2022/06/23/home-flipping-hits-22-year-high-but-profits-narrow/ Individual homeowners are starting to see the market soften up a bit as well, with buyer demand dropping, and price cuts occurring from the all-time highs that we saw earlier this year.
Furthermore, mortgage holders with an adjustable-rate mortgages, also known as an ARMs may find themselves in a tighter financial spot than they had hoped to be in as interest rates continue to rise and their mortgage payments increase as the Federal Reserve attempts to tackle the 40-year high inflation.
As a professional investor, you want to have a strategy that's going to work long-term, especially if you're going to dedicate the time, energy, and effort to learn something at a professional level. Ideally an investing strategy that works in up-trending markets, stagnant markets, and even a declining market. If not, two things inevitably happen:
- You can lose money in the short, intermediate, or long term.
- You will have to change strategies every five to ten years when markets go through cycles or retraction and your investing no longer works.
Multifamily Real Estate
Fortunately, there is one strategy and asset class that has been largely proven to withstand market fluctuations for arguably thousands of years, and that is investing in cash flowing multifamily real estate.
Throughout time, people have always needed a place to live. Those who can’t afford to buy a home have to rent, and many chose not to own homes by choice and they rent instead. Even in times of economic downturn throughout history, such as the early 1980s when mortgage rates reached nearly 20% and crushed the housing market, or in more recent examples such as the Great Recession (2008-2009), and the COVID-19 pandemic (2020). Cash flow positive real estate stood its ground.
In fact, according to Fannie Mae and Freddie Mac, commercial multifamily real estate experienced less than a 1% default on their loans during the Great Recession.
These are indicators to keep in the back of your mind of how stable multifamily can be. Of course, past performance is never indicative of future results, but if you're investing for cash flow, conservatively underwriting your deals, and buying for the long-term, as a professional investor, market volatility can take the back seat.
The Big Question
I encourage you to ask yourself the question, "Am I an investor or a speculator?" Take an introspective look at how you approach analyzing an investment and what indicators you use to make decisions. With this in mind, I am not suggesting that speculating is a “bad” strategy. There are thousands of people who have made millions, multi-millions, even billions of dollars by being a speculator. However, I view being a professional investor like a game of golf. Is it possible that you can hit a hole in one? Absolutely. But how sustainable is that as a long-term strategy?
To Your Success,
Travis Watts
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