The layperson, or a non-businessman, has his or her best chance at money money through the field of real estate. This is because real estate is the easiest field in which you can acquire other people’s money, and it is the field in which a total loss of value is least likely.
Investment vs Speculation.
Investment and speculation are quite different from each other. One relies on hard facts, and the other relies on chance and good guessing. Most so-called investors are actually speculators, even though they think they are investors. These people often spend a huge amount of time “researching.” Research to them is reading market conditions and the opinions of experts and then trying to predict the future prices of their investments. A real investor’s only concern about the future, on the other hand, is the price dropping; he or she wants to guard against this. So, a real investor looks for two things: safety and profit. If either of these things are not present and are not assured beyond a reasonable doubt, then he or she will not consider it an investment, but a speculative operation.
Safety
Any piece of property has an intrinsic value; this value is what the property should be worth based on the amount of income it produces. It should be one hundred times the value of the monthly gross income. We always want to buy below this intrinsic value. If the market in your area is so inflated that there are no prices even close to the intrinsic value, then you should look elsewhere. While there may be many opportunities for profit in those areas, the prices are supported largely by emotion and market sentiment and not hard data.
The price that the property is bought at must be significantly below the intrinsic value, otherwise the investment is no good. Remember that the intrinsic value is not a fixed value, but a general ball park. If one buys something in a ball park substantially below the intrinsic value ball park, then one is sure of getting a good deal.
Eighty percent or below the intrinsic value: this is the criteria we use when looking at price to determine if we should buy the investment property or not. This will give us a margin of safety. If the price of the home should drop in the future, we have a twenty percent buffer before we feel any impact. Sure, the price may be lower than when we bought it, but remember that we are concerned with value. If the price does drop more than twenty percent, the impact is lessened by our safety barrier.
Relying on appreciation for profit is a speculator’s strategy; as investors, we think predicting the future is impossible and should not be relied on. If appreciation happens, so be it; we will enjoy it. But, we want to be sure that we will profit without it.
Find a home with a solid, firm foundation, but be sure it is in need of surface level repairs. Subtract the price paid for the home per square foot minus the new construction cost of comparable homes per square foot. This difference should be at least double the repair expense estimate. When we do this, we can buy and repair the property. For every dollar we put into it, we get two or more back when we sell. This assures us of a profit, and our margin of safety assures us of safety. If we follow these strategies, we are true investors.
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