Is Flipping Houses Investing or Speculating?

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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.

Published or Updated: April 21, 2014
About Rob Berger

Rob founded the Dough Roller in 2007. A litigation attorney in the securities industry, he lives in Northern Virginia with his wife, their two teenagers, and the family mascot, a shih tzu named Sophie.

Comments

  1. Engineer says:

    Way back in college, I took an economics course. IIRC, investing is defined as the purchase of capital equipment, i.e. improving the ability to produce.

    So, no, flipping houses is not investing.

  2. DR says:

    Engineer, in example 2 above, the house flipper makes improvements to the house. In my experience, the improvements generally include cosmetics (paint, carpet, etc.) and more substantial renovations (new kitchen, doors, windows, mechanicals, etc.) Under your definition of investing, would this not be improving the ability of this asset to produce?

  3. Paul says:

    I just invested $20K into a house I purchased to flip. I think that investing in a roof, windows, furnace, etc. is comparable to buying machinary for a business. It improves the value of the property to produce more income. This is the essence of investing. Whether I choose to sell that improved asset now or 20 years for now is irrelevant

  4. Engineer says:

    @DR
    I would agree with your point, except I would call example #1 clearly a flip, while example #2 is not.

    And example #2 is further distanced from being a flip if you live in the house long enough (24 months) to get the $250,000 exemption on income taxes from your gain.

  5. DR says:

    Engineer, why do believe #2 is not a flip? The plan is to rehab and then sell. It’s something my business partner in Ohio does quite often. I think the point is that flipping a house is not per se speculating–it depends on other risk factors. Don’t you think?

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