10.11.07
Real Estate Investing? Or Speculating
Real Estate “Investors” Investing Or Are They Speculating?
Defining Terms
It is very easy to lump everyone who calls himself or herself an investor into the same pot. This would cloud the issues and make any solution ineffective.
Speculators tend to rush into something for the prospect of short-term gain, rather than a clear-headed evaluation of the long-term factors that are relevant to the choice to get involved.
In the context of real estate, I am using the term speculator to refer to a person or organization that purchases a piece of property for the sole purpose of reselling it for a profit in the not-too-distant future. I am also refering to related practice of taking a lease in order to sublet at a profit as speculating, especially for those with longer leases. Finally, I refer to the whole “buy with little or nothing down to rent out and then pyramid these properties into an empire” type of scheme as speculation.
Why do I label these perfectly legitimate practices with a term like speculation? Let us take a look at the effects to answer the question.
What Happens In Those “Nothing Down” Schemes?
The first thing that happens is good: rentable properties that are available get purchased. However, the new owner starts out with a relatively high debt load that can only be lightened by doing things like cutting back on maintenance and on-site management. Given enough time, the earlier properties become derelict slums, tending to attract criminal elements that damage the building and threaten the tenants. The other thing that happens is that the landlord is continually refinancing to take out any equity in order to buy more properties, so when the economic cycle flips to the downward portion, the landlord often cannot generate enough cash flow to continue making the payments on the properties. Banks and previous owners then wind up foreclosing and losing money.
What Happens In Those “Buy It And Sell Next Week” Schemes?
During times of increasing prices, they speed up the increase and spread it to other areas. Sometimes, they buy a “fixer-upper” and repair it, but more often, they buy already acceptable properties and quickly put it back on the market.” This increases the cost for real buyers, although it does shorten the wait for sellers to dispose of their properties.
In times of decreasing prices, these “investors” may resort to panic selling in an effort to cut their losses. This has the not-unexpected consequence that market prices may fall more rapidly than otherwise. Taken to its logical conlusion, this practice may even contribute to bank failures.
As you can see, the effects are both positive and negative, depending on whose viewpoint you take. However, this practice appears to act as a feedback loop to amplify price swings and volatility.
Conclusion: Advice For Politicians
When there is a financial decline caused in part by speculators, it is best for the market to let the speculators feel the lash. Any “rescue measures” should target the residential homebuyers who suffer because of speculative excesses and lenders who knew that the government would bail them out rather than let them suffer the consequences of their lack of discipline.
