Real Estate Investing vs Speculating
The decision to become a real estate investor or to speculate in real estate is one of the most significant decisions you’ll make. What is the difference between the two? Fundamentally it comes down to risk tolerance – the risk vs reward trade-off.
What is Real Estate Investing
Real estate investing is the act of exchanging currency for real property with the expectation of receiving a regular return on that exchange. With real estate investing, that return comes in the form of rents. More accurately, it comes in the form of the net profit that is left when the operating expenses are subtracted from rents. For a more detailed look at What is Real Estate Investing? check out our blog.
Investing in real estate is no different from investing in anything else. For example, when you invest in stocks from a profitable company, you receive a regular return in the form of dividends.
What is Real Estate Speculation
Real estate speculating is the act of exchanging currency for real property with the hope that the real property will appreciate and you will sell for a profit. This happens when the market for real estate increases over time.
People also speculate in companies. For example, people buy stocks in a company with the hope that those stocks will increase in value over time and they will sell for a profit.
Rate of Return – The Trade-off Between Risk and Reward
The rate of Return is the net profit (or loss) that an investment receives over a period of time. A rate of return is expressed as a percentage of the investment's initial cost. As investors, we aim to achieve the highest rate of return possible. It is fundamentally important that a savvy investor see rate of return as a function of risk.
All else being equal, the higher the rate of return on investment, the riskier that investment is. Let that sink in for a minute. It’s a fact of market economics.
To put it another way, to attract riskier investments, investors have to pay a higher rate of return. This is why Guaranteed Investment Certificates offer such a low Rate of Return when compared to the winner of the lottery! Everything else (penny stocks, blue chip stocks, real estate, etc.) exists somewhere in between on the same continuum.
What is More Profitable, Real Estate Investing or Speculating?
Again, all other things being equal, real estate speculating is more profitable than real estate investing. As we’ve seen, the flipside is that it also carries more risk. Imagine you speculate on a small apartment building in a not-so-great neighbourhood because the current City Council has developed a plan to gentrify the neighbourhood. You’re expecting to make a seriously healthy profit. But, before the gentrification process can begin, the national economy takes a turn for the worse. The existing City Council is ousted in the new election, and the new council scraps the gentrification plan due to their changing values and shifting economic climate. Your expectations for a big profit just turned into a huge loss. Of course, it’s important to mention that it could have gone the other way.
Now, imagine you invest the same money into a smaller apartment building in a solid working-class neighbourhood. Over the years, the rents come in regularly, and the expenses remain relatively consistent. Each year you earn a nice 15% rate of return. You’re not going to get fabulously wealthy off the investment, but you are getting richer by the year. It’s important to note here that the economy could turn for the worse, putting downward pressure on rental rates, and increasing vacancy rates, causing the rate of return to drop.
How the Real Estate Markets Affects Return
Both real estate investing and speculating carry risks. Those risks come in many forms, but the most critical is market conditions. As mentioned, vacancy rates and rental rates are both affected by the overall real estate market. You’ll want to do everything in your power to understand the current real estate market and project future market conditions before exchanging money for real property.
Of the two, real estate speculation is far more dependent on market conditions. After all, the entire concept is to use changing markets to make a profit. You can speculate on a changing neighbourhood market or on the entire community market. Your profit or loss will directly result from your ability to predict market changes correctly.
Which One is Better for You
Deciding to become a real estate investor or a real estate speculator is a personal decision with no right or wrong answer. It all depends on your risk tolerance, the stage you are at in life, and your level of confidence in your ability to predict the market. If you're interested in learning more about real estate investing, Real Estate Investing for Beginners is a great resource.
One last note is that another form of profit in real estate can be made from real estate development. Real estate development is the improvement and/or construction of land to create value. Real estate development is undoubtedly related to real estate investing and speculating, but it is its own complex discipline.