A few days ago I wrote an article entitled, Real Estate or Stocks: Which is the better investment? In response, Enough Wealth wrote a comment worth reading. Of interest here, Enough Wealth wrote:
The problems experienced with both stock or property investments are more often due to the investor rather than the asset class.
This got me to wondering, is flipping a house investing or speculating? I think the answer depends on at least three factors that usually are present in almost all speculative endeavors:
Rising Prices: Gains from speculation almost always depend on anticipated, significant changes in price, without any change in the value of the asset. Remember, price is what you pay, value is what you get. Day trading is a perfect example, as traders jump in and out of stocks in the hope of taking advantage of short-term changes of price, even though the underlying value of the asset is unchanged.
Quick Profits: Speculators are looking for quick profits. Thus, the anticipated changes in prices occur (or at least a speculator hopes they occur) over the short-term, ranging from a few hours (day trading) to weeks or maybe a few months (flipping houses). You won’t ever hear of a speculative endeavor taking 20 years.
Leverage: Speculators often borrow most of the price of the asset. During times of rising prices, the use of leverage can significantly increase returns. During times of declining prices, leverage could be disastrous, as the current rash of foreclosures in a declining housing market demonstrates.
So back to our original question–Is house flipping investing or speculating? I think the answer depends on the circumstances, as these two examples demonstrate:
Example #1: An individual draws down their home equity line to purchase a condo that will be completed in five months. The plan is to sell the condo when it is complete. The rising prices in the condo market make this a sure thing.
Example #2: An individual purchases a foreclosed property that needs substantial work. Some of the purchase price is borrowed, but a substantial down payment is made, and the individual pays for the rehab costs in cash. The plan is to improve the property (and thus the value of the asset) and sell at a reasonable profit.
Example # 1 is speculation. Example # 2 is investing. It’s worth noting that a lot of money can be made speculating, and money can be lost investing. But in the end, speculation will catch up with the speculator in unpleasant ways. For the real estate investor, patience, consistency and perseverance will eventually pay off by building wealth for the log run.
To see how real wealth is built with real estate, check out this interview with Brandon Turner. In about seven years he went from making minimum wage to a full time business investing in real estate.