How can we differentiate between real estate investing and real estate speculation? Perhaps we can apply Benjamin Graham’s stock market distinction to real estate - "An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."
A real estate investment that “promises safety of principal and an adequate return†is certainly one that immediately provides positive cash flow for the capital investment required (i.e. if you invest $100,000 to buy a $500,000 property and your required return is 10%, you should make (or save) at least $10,000 per year after all expenses are deducted). All real estate purchases that provide less than $10K per year can be considered speculative in this example.Â
The distinction is not trivial. Buyers will realize the risk of their action if they know they are speculating and not investing. Underwater homeowners who continue to pay their mortgage should also realize they are speculating if the market price is not supported by rental rates because the property value could fall further. Even "shadow inventory" sellers are speculating if they refuse to sell at a market price that is higher than rent rates.      Â
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How can we differentiate between real estate investing and real estate speculation? Perhaps we can apply Benjamin Graham’s stock market distinction to real estate - "An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."
A real estate investment that “promises safety of principal and an adequate return†is certainly one that immediately provides positive cash flow for the capital investment required (i.e. if you invest $100,000 to buy a $500,000 property and your required return is 10%, you should make (or save) at least $10,000 per year after all expenses are deducted). All real estate purchases that provide less than $10K per year can be considered speculative in this example.Â
The distinction is not trivial. Buyers will realize the risk of their action if they know they are speculating and not investing. Underwater homeowners who continue to pay their mortgage should also realize they are speculating if the market price is not supported by rental rates because the property value could fall further. Even "shadow inventory" sellers are speculating if they refuse to sell at a market price that is higher than rent rates.      Â
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