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A terrific group of personal finance bloggers got together to write about the current real estate and mortgage crisis. The result was a collection of great articles that I’ve linked to below. And if you were ever curious where the phrase–things that go bump in the night–came from, make sure you read to the end of the post.

Read the rest

Today’s insights from the blogosphere and beyond:

• The New Graduate’s Guide to Financial Freedom @ Get Rich Slowly: You can read some great financial advice for recent graduates. Not a recent graduate? The advice is actually good for all ages.
• Foreclosures Drift From Rust Belt to Sun Belt @ CNNMoney.com: What do the foreclosures in the rust belt (Michigan, Ohio, Indiana) tell us about our economy? These are all areas where there was no run-up in prices.
• A Good Defense and a Good Offense @ Mighty Bargain Hunter: A nice perspective on the debate between earning more and spending less.
• Prepaying on Your Home Loan is Just a Conservative Investment @ The Simple Dollar: Another installment in the debate on whether to prepay on your mortgage.

Happy reading!

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.

Here is what others had to say on this topic:

• Active Rain: Real Estate Speculation vs. Investing–Does Cash Flow Matter?

When I first began looking into real estate investing, I spent a lot of time trying to figure out what criteria I would use in selecting which property to buy. I have built many Excel spreadsheets with mind-numbing calculations and data, all geared to finding that perfect investment property. Having now purchased four rental properties over two years, I’ve developed a much easier way to evaluate whether a property will generate positive cash flow or not. I call it the 1 percent solution, and it works like this–

Will the property generate monthly gross rent equal to at least 1 percent of the total cost of the property?

The total cost of the property includes four things: (1) purchase price of the property; (2) fix-up costs; (3) financing costs; and (4) carrying costs from the time of purchase until the first tenant moves in. Of course, this requires making a reasonable estimate of what the rent will be and the cost to fix-up the properties. With enough experience and research, I’ve found that these estimates can be made with good accuracy. On estimated rent, for example, I usually estimate within a range of $100 and calculate the 1 percent using the mid-range of this estimate. Because my investment properties are all in the same area, I’ve got a very good idea of how much rental income a given property will generate.

A note of caution. In many areas of the U.S., finding a property that meets the 1 percent rule is next to impossible. I invest in the mid-west, and given the high rate of foreclosures, have been able to find properties that generate rents at or near 1 percent of total cost. I am able to finance nearly 100% of the total cost on a 30-year fixed rate mortgage that enables me to generate positive cash flow immediately, even after factoring in an allowance for repairs and vacancy.

I’d be interested in hearing if anybody else uses this or another guide to evaluate potential real estate investments. But I’ve found the 1% solution to be a great way to make money.