Are You An Investor Or A Speculator?

April 27, 2007

I’ve spent quite a bit of time on the phone this week with investors from all around the country seeking financing for their investments. Some are buying foreclosures to rehab and keep as rentals, some are buying high end luxury homes hoping to flip them after making some needed upgrades and some are looking at buying apartment buildings to increase their cash flow.

The one thing that many of the people I speak with have in common is that their deals are just bad deals. The margins are literally so thin that there is zero room for error. If the house takes a few weeks longer than anticipated to sell or if some unforeseen structural problem appears they will be in some seriously deep… trouble.

Too often after attending some seminar or teleconference given by some guru, these new investors go out and get a “deal” only to discover that no one will finance it. They have been told that if the deal is good enough the money will appear. Unfortunately the deals that they are getting are not that good so the money does NOT appear. That’s when they get desperate and that’s when they call me.

With the way the housing market is going lately, it is a great time to be an investor. BUT the competition is fierce even though it is a buyer’s market and deals abound. You can succeed as an investor if you do your due diligence, stay patient and wait for the great deal (not just the OK one) and have some cash reserves to fall back on. I cannot stress enough the importance of having cash reserves when going into this business.

I spoke with a guy a few days ago from Mississippi that called about a rehab loan. He wants to buy a foreclosure, fix it up and flip it. He is seeking a loan for 100% of the purchase price, 100% of the closing costs and 100% of the rehab costs. He has no rehab experience.

When I asked him how much money he has in cash in the bank he said none. I told him that even a conventional lender would require six months reserves in order to qualify for a 100% loan and these days the rehab lenders are no different. He asked, “How much would I need?” I answered, “If your loan amount is $150,000 you’re looking at approximately $9,000.” He said to me, “Maam, this is Mississippi. Ain’t nobody with that kind of money down here.”

Poor guy.  I wonder how much he spent at the seminar he just attended.

Let me tell you about another investor I met this week. We’ll call him Larry. Larry is 55 years old and is a full time real estate investor. His wife has a good job and is a middle manager at a Fortune 500 company.

10 years ago they filed bankruptcy. Today Larry specializes in high end fix & flips and currently has two projects in process. One home is completely renovated and has been listed for sale for almost 30 days. The average “days on market” for this type of house in this area is 104 days, or 3 ½ months.

They bought the house for $674,000 in October 2006, put $100,000 into fixing it up and it was initially listed for $950,000 - $19,000 less than the appraised value. He dropped the price last week to $899,000. The monthly payments are almost $6,000.

Another home they purchased in November 2006 and paid $1,260,000. It is valued at $1,800,000 and will be listed on the market in a few weeks. The monthly payments are about $11,000. Once it is listed the “days on market” average is 82 days or three months.

They are paying $17,000 every month in mortgage payments (holding costs) on these houses until they sell. They have $77,000 cash in the bank, which for an investor specializing in lower end homes is a great cash reserve cushion, but for them, it’s not even six months’ reserves. It will cover their holdings costs for 4 ½ months.

They have a 30 day “cushion” before they run out of reserves and can no longer make the mortgage payments.  He was literally begging me to help him get cash out of any of these properties to make his payments because he sees the writing on the wall and he is scared.

What a terrifying position to be in. Holding two high end homes in your portfolio hoping that they sell faster than the average days on market so you don’t go broke for the 2^nd time in your life at age 55.

Folks, the scenarios that I just described are not investing. What I just described is speculating.

Speculating is defined as “Taking large risks, especially with respect to trying to predict the future; gambling, in the hopes of making quick, large gains.”

Successful investors do not take large risks. They don’t have to.

The definition of investing is “To engage in any activity in which money is put at risk for the purpose of making a profit, and which is characterized by some or most of the following: sufficient research has been conducted; the behavior is risk-averse; a systematic approach is being taken; emotions such as greed and fear play no role; the activity is ongoing and done as part of a long-term plan; ownership of something tangible is involved; a net positive economic effect results.”

Successful investors have a systematic, long-term plan in which greed and fear play no role.

I encourage you to take a good look at yourself. Are you a speculator or are you an investor?