Real Estate Speculation: Don't Fall Into This Trap

When we become overwhelmed by uncertainty there are often two extreme behaviors which ensue:

1. at one end of the spectrum we have complete inaction
2. at the other end, is rash action without really knowing what we are doing, which we often call "jumping in"; or in the investing world, speculation.

In my previous post about risk reduction techniques we looked at various ideas to help reduce the risks that might be preventing you from taking action and doing your first deal.  Following on from that, I thought we should address the other extreme since we want to find a happy median that allows measured but confident action.

While taking a leap of faith in some ways is admirable and often gets the desired result of creating momentum it can also mean financial suicide. One of my favorite sayings is "you cannot steer a parked car" so I would probably prefer to see people taking action rather than doing nothing but let's take a look at the differences between smart investing and just plain speculating.

The following are things you should do to ensure you don't find yourself in the dangerous territory of real estate speculation when making an effort to get started.

1. Deal Analysis

First and foremost is deal analysis. If a deal stacks up on paper then that's just about all you need to know. You really aren't speculating if you have done a thorough and accurate analysis that shows you what profits to expect and when. As I've mentioned before, the key to successful real estate investing is knowing your profit BEFORE you do the deal.  So, if you haven't already, go and check out my post on how to evaluate a real estate deal.

2. Don't get caught up in the hype and excitement

We saw the hype before the markets crashed and to some extent we are seeing it again. Now the hype itself is not a bad thing because it gives us information about what is likely to happen. The problem is when it results in pure speculation that ends badly.

It's worth noting that such speculation can and does work out very well for some people who get very lucky with their timing. There were those who bought and sold before the credit crisis and made a handsome profit and there are people who a speculating now by snapping up foreclosure bargains. Some will falter and some will do very well. The key is to realize when your greed gland has been activated, not get swept up in the excitement, and invest wisely rather than just following the crowd.

I believe now IS a fantastic time to be buying real estate in the US but you should not just go and leap in without doing an evaluation of each deal. Let the hype guide you but do not get swept up in it and speculate blindly.

3. Don't bank on appreciation

You can invest for appreciation but do not BANK on appreciation when starting out. In other words it can be factored in as a potential upside but you should never put something that requires a crystal ball into your deal analysis – how can you? So the deal should stand up on cash flow analysis and any appreciation that you forecast should purely be a nice upside.

I will not get into the cash flow versus appreciation debate here (maybe another time) but when getting started your investments should not be costing you money every month unless you have deep pockets and are prepared to lose money. ie. unless you are choosing to speculate.

4. Don't try to time the market perfectly

Some macro analysis will provide you with valuable information about whether you should be getting ready to buy or sell. Such information will certainly improve your odds of success but don't get too clever and imagine that you need to time it perfectly. Remember: anything requiring a crystal ball falls into the category of speculating rather than investing.

I hear very confused individuals wondering if now really is a good time invest because many people are saying that prices will continue to drop for some time. So? It's a time to buy, not a time to sell. Maybe they are confused because their notion of investing doesn't include anything other than flipping – I don't know. But that brings us to the next point.

5. Choose your strategy wisely

Real estate investing is not a one-size-fits-all affair. Unless you have a clear strategy in mind, you are speculating and not investing. And unless you choose a strategy that suits market conditions and suits your strengths and weaknesses you are also taking undue risks.

There are more options available to you than just flipping, so get an idea of what strategies you have available to you and then think about which ones suit you and suit the market you are operating in. Check out my 5 Step Plan for Getting Started for more information.

6. Don't treat the markets as one big market

Real estate markets have quite different dynamics from region to region and one problem with listening to the hype and the news is that they are often referred to as "the real estate market". For the sake of simplicity, averages are often used to report trends but a smart investor knows that investing based on averages is quite dangerous.

Realize how different real estate markets are from city to city and even within different areas of a city. And then choose a market accordingly. That is smart investing rather than speculative approach of basing your decisions on averages.

Summary

You don't need to get everything perfect so don't let any new information here paralyze you. But you MUST get the deal evaluation right. So if there's one thing to focus on here, it's that.

In terms of how to ensure you take action without undue risk I'd suggest the following. Put a bit of a plan together based on the points above, the getting started plan and the risk reduction methods, then start looking at appropriate properties in your market that suit your strategy. Most importantly, do a financial analysis of each property you are considering and when you find one that stacks up on paper go for it. When you've taken the preliminary steps mentioned you will have covered your bases sufficiently.

Yes, there will still be things ahead that you will need to figure out as you go along but with your contingency planning and other risk management in place you will be well equipped to handle it. So this leap of faith at the end is just a matter of overcoming that final hesitation.

To Your Success,

Scott Roemermann.

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