Real Estate Speculation In Hot Markets

Why real estate speculation? You can make a lot of profit in a year or less if you have your timing right, especially if you have your cash split into small down payments on many properties. Of course it is easy to guess wrong when it comes to future price appreciation, and this can mean you get eaten alive by expenses on properties that don't go up in value fast enough.

This is a common method of investing when times are good. It is also very risky. The idea is simply to buy at a reasonable price and count on rising values to make you some money within a few months or a year. Often people who invest this way are losing money from month to month on their investments, planning on the profit when they sell to easily cover those losses.

When we moved to Tucson in 2004, the prices of homes had been going up by more than 20% annually for several years. Homes that cost $200,000 rented for as little as $650 per month. Even small apartment buildings were so overpriced that actually getting cash flow was just a dream.

There were hundreds of investors who were buying properties like these that made no financial sense. Upon purchasing them, they immediately had to start shelling out hundreds of dollars per month to hold onto them. Why did they do it? Because they could sell the home for $50,000 more within a year or so.

Of course, by 2006 prices stopped going up. What do you do when you bought a property that has a negative cash flow of hundreds of dollars per month, and the value stops rising? Well, hopefully you find a creative solution, but most often, you simply lose money. This is a risky game.

On the other hand, it is hard to convince those that made money this way that it was a bad idea. The real question, then, is how do you predict a fast rise in values? At the time we moved from Tucson (2006), everyone in our real estate investing club, including all the wealthiest and most experienced investors, were convinced that prices would continue to rise, so this may not be an easy task.

One way is to stop looking at the trend, which after all, can change starting next month, and is only a trend after it happens. More important may be a look at the job creation in the area, which drives the demand for housing and other real estate. A real estate boom may pass a city by if there is no growth in jobs, and therefore no growth in population.

Another important thing to watch is the direction of interest rates. As they fall, prices can easily go up without houses actually becoming less affordable. For example, when my parents sold their house in Michigan, it was worth almost double what they had bought it for, but the new buyer would make almost identical payments. This is because my parents bought at a time when interest rates were over 13%, and the new buyer was borrowing at 6%.

Of course the opposite is true as well. It is much less likely that people can continue to pay higher prices if interest rates are rising. This is certainly part of the reason why home prices are dropping in many areas as I write this.

The bottom line? Do your homework before you count on rising prices as an investment strategy - and even then remember that real estate speculation is closer to gambling than investing.