Difference Between Speculating & Investing

Q: I am a ‘newbie’ real estate investor. I want to buy property but prices have been going up so much recently, I’m afraid of a crash. Frank, Englewood Cliffs, NJ

A: The Economist John Kenneth Galbraith said, “Genius is a rising market.” When property values go up, investors tend to get sloppy about the prices they pay. Red hot real estate markets like the one many of us are living through now attract speculators and fools who think that they can’t lose if they invest in the right market at the right time. This is dangerous thinking that often leads to dangerous investor behavior which is why you are justifiably concerned, Frank.

When you buy any asset at current retail price and hope the value goes up, you are speculating. Real estate investing is different in my view.

There is a well known saying in real estate that you make your money when you buy. When you buy an asset below current market value, you create an equity cushion, which is what Warren Buffett’s mentor Ben Graham called “a margin of safety.” As investors, we benefit from rising prices while we own property, but if your investment is predicated and contingent on rising asset prices you are playing a very dangerous speculative game. The best way to protect yourself for the inevitable time when property prices fall is to buy below current market price with an equity cushion from the beginning. That is easier said than done, but it is necessary to avoid ending up ‘upside down’ on a real estate investment. Thanks for your question, Frank.

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