Investment or Speculation

[ZanderRobertson]

Benjamin Graham`s definitions of investment and speculation from "Securities Analysis" are as follows: "An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."

By that definition, was any property purchased in late 2007 or early 2008 and currently valued lower than it`s purchase price a speculative investment? Or is safety of principle just a function of holding period?

Does anyone know of a more compelling definition than this?

 

[Thomas Beyer]

QUOTE (ZanderRobertson @ Nov 18 2008, 07:40 PM) Benjamin Graham`s definitions of investment and speculation from "Securities Analysis" are as follows: "An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."

By that definition, was any property purchased in late 2007 or early 2008 and currently valued lower than it`s purchase price a speculative investment? Or is safety of principle just a function of holding period?

Does anyone know of a more compelling definition than this?

Speculation: you buy an asset that MUST go up in value to make money ! Example: gold, most non-dividend paying stocks, buying call or put options, flipping condos, expensive single family homes, NFL franchises, diamonds, paintings, antique cars ...

Investment: you buy an asset with income, that even in a flat or declining market you can make money with !

If you buy an asset with a 20% down-payment, and no positive cash-flow for 10 years, with:

a ) No appreciation (equity upside) you have DOUBLED your money as the mortgage has been paid down 20% !

b ) 20% price increase (less than 4% annually compounded, below Canada`s long term average !!), you would have TRIPLED your money.

c ) 30% price increase (less than 6% annually compounded, about Canada`s long term average as house prices in Canada have doubled every 15 years in a normal economy !!) you would have made 250% on your money.

d ) 40% price increase (slightly higher than Canada`s long term average as house prices in Canada have doubled every 15 years in a normal economy, and AB has a better economy than the rest of Canada !!), you would have made 300% on your money, i.e. quadrupled it!

How about an asset decrease:

e) even with a 20% market DECREASE in 10 years you would have lost no money ! Wait 15 more years (assuming 25 year amortization) and you would have paid the mortgage to zero and quadrupled your money (from 20% to 80% of property value)

f) even with a 50% market DECREASE in 25 years you would have have paid the mortgage to zero and made 150% on your money (from 20% to 50% of property value)

WOW .. that is an investment !!

Of course, we appreciate equity upside .. and usually get it in a healthy market over a longer period of time ... but I would not call this speculation .. just common sense ..

The goal is, of course, that you have an asset that allows you to sleep at night and collect enough (positive or zero) cash-flow allowing you to hold 5, 10 or 25 years !

 

[RedlineBrett]

Wow, great post Thomas!

QUOTE (thomasbeyer2000 @ Nov 18 2008, 08:52 PM) Speculation: you buy an asset that MUST go up in value to make money ! Example: gold, most non-dividend paying stocks, buying call or put options, flipping condos, expensive single family homes, NFL franchises, diamonds, paintings, antique cars ...

Investment: you buy an asset with income, that even in a flat or declining market you can make money !

If you buy an asset with a 20% down-payment, and no positive cash-flow for 10 years, with:

a ) No appreciation (equity upside) you have DOUBLED your money as the mortgage has been paid down 20% !

b ) 20% price increase (less than 4% annually compounded, below Canada`s long term average !!), you would have TRIPLED your money.

c ) 30% price increase (less than 6% annually compounded, about Canada`s long term average as house prices in Canada have doubled every 15 years in a normal economy !!) you would have made 250% on your money.

d ) 40% price increase (slightly higher than Canada`s long term average as house prices in Canada have doubled every 15 years in a normal economy, and AB has a better economy than the rest of Canada !!), you would have made 300% on your money, i.e. quadrupled it!

How about an asset decrease:

e) even with a 20% market DECREASE in 10 years you would have lost no money ! Wait 15 more years (assuming 25 year amortization) and you would have paid the mortgage to zero and quadrupled your money (from 20% to 80% of property value)

f) even with a 50% market DECREASE in 25 years you would have have paid the mortgage to zero and made 150% on your money (from 20% to 50% of property value)

WOW .. that is an investment !!

Of course, we appreciate equity upside .. and usually get it in a healthy market over a longer period of time ... but I would not call this speculation .. just common sense ..

The goal is, of course, that you have an asset that allows you to sleep at night and collect enough (positive or zero) cash-flow allowing you to hold 5, 10 or 25 years !

 

[CalgaryExpert]

Thomas, you are a smart man and wise investor however i am curious how do u measure risk in real estate..


QUOTE (RedlineBrett @ Nov 18 2008, 08:43 PM) Wow, great post Thomas!

 

[Thomas Beyer]

QUOTE (CalgaryExpert @ Nov 18 2008, 09:43 PM) Thomas, you are a smart man and wise investor however i am curious how do u measure risk in real estate..
risk comes in many forms, much of which can be mitigated through knowledge, education, smart management, awareness, discussion, action taking or preparedness .. some of which of course is "unexpected" and has to be dealt with when it happens, such as:

risk of poor property due diligence (before purchase)
risk of poor macro-location due diligence (before purchase)
risk of poor micro-location due diligence (before purchase)
risk of poor value analysis / due diligence (before purchase)
risk of overleveraging
risk of poor property management
risk of interest rates rising
risk of lack of cash at hand
risk of paying too much when buying
risk of selling too early
risk of selling too late
risk of high vacancies
risk of poor location choice
risk of poor people skills
risk of poor money management skills
risk of lack or poor education
risk of lack of awareness
risk of environmental issues
risk of major unemployment in area
risk of exchange rate
risk of legal or regulatory changes
risk of illiquidity
risk of taxes
risk of re-pricing
risk of CAP rate increase
risk of competition
risk of co-investing with someone that has little or no experience


.. there may be other risks .. but those are the ones that come to mind ..

 

[GarthChapman]

QUOTE (ZanderRobertson @ Nov 18 2008, 07:40 PM) Benjamin Graham`s definitions of investment and speculation from "Securities Analysis" are as follows: "An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."

By that definition, was any property purchased in late 2007 or early 2008 and currently valued lower than it`s purchase price a speculative investment? Or is safety of principle just a function of holding period?

Does anyone know of a more compelling definition than this?

Good definition, but it is missing the element of time, which is a component of all investing and speculating. So, as an example, if you bought a house in 2007 in Cgy or Edm with a time horizon in mind that was short term, say 1-3 years, you were speculating. If your time horizon was long term you were investing.

 

[ZanderRobertson]

so it seems to me that land banking is speculation then. i don`t know how that industry works very well, but from what i gather the original company (Walton is the one i`ve heard of most) makes their profit when the land is syndicated, but the individual investor only gets a return when the land appreciates in value. is this correct? and if so, is what the Waltons do speculating or just what the individual does or both or neither (based on the criterion of needing an income outside appreciation)



QUOTE (thomasbeyer2000 @ Nov 18 2008, 07:52 PM) Speculation: you buy an asset that MUST go up in value to make money ! Example: gold, most non-dividend paying stocks, buying call or put options, flipping condos, expensive single family homes, NFL franchises, diamonds, paintings, antique cars ...

Investment: you buy an asset with income, that even in a flat or declining market you can make money with !

If you buy an asset with a 20% down-payment, and no positive cash-flow for 10 years, with:

a ) No appreciation (equity upside) you have DOUBLED your money as the mortgage has been paid down 20% !

b ) 20% price increase (less than 4% annually compounded, below Canada`s long term average !!), you would have TRIPLED your money.

c ) 30% price increase (less than 6% annually compounded, about Canada`s long term average as house prices in Canada have doubled every 15 years in a normal economy !!) you would have made 250% on your money.

d ) 40% price increase (slightly higher than Canada`s long term average as house prices in Canada have doubled every 15 years in a normal economy, and AB has a better economy than the rest of Canada !!), you would have made 300% on your money, i.e. quadrupled it!

How about an asset decrease:

e) even with a 20% market DECREASE in 10 years you would have lost no money ! Wait 15 more years (assuming 25 year amortization) and you would have paid the mortgage to zero and quadrupled your money (from 20% to 80% of property value)

f) even with a 50% market DECREASE in 25 years you would have have paid the mortgage to zero and made 150% on your money (from 20% to 50% of property value)

WOW .. that is an investment !!

Of course, we appreciate equity upside .. and usually get it in a healthy market over a longer period of time ... but I would not call this speculation .. just common sense ..

The goal is, of course, that you have an asset that allows you to sleep at night and collect enough (positive or zero) cash-flow allowing you to hold 5, 10 or 25 years !

 

[ZanderRobertson]

right. so the question: is the principle safe over time, and is there a reasonable expectation of adequate return over time. and these necessitate cash flow (especially if leveraged as in RE)

QUOTE (GarthChapman @ Nov 19 2008, 11:55 AM) Good definition, but it is missing the element of time, which is a component of all investing and speculating. So, as an example, if you bought a house in 2007 in Cgy or Edm with a time horizon in mind that was short term, say 1-3 years, you were speculating. If your time horizon was long term you were investing.

 

[Thomas Beyer]

QUOTE (ZanderRobertson @ Nov 19 2008, 07:56 PM) so it seems to me that land banking is speculation then. i don`t know how that industry works very well, but from what i gather the original company (Walton is the one i`ve heard of most) makes their profit when the land is syndicated, but the individual investor only gets a return when the land appreciates in value. is this correct? ...

indeed.. many land syndicators uplift syndicated values 200% + (on their purchase price) on going-in ... a great and low-risk business model .. for the land syndicator !!

 

[MikeMcCrae]

Buying with value increase as your only (or main) objective is speculating.
Buying with steady income and long term measurable (mortgage pay down) gains is investing.

Not so eloquent but that`s my measure.

 

[invst4profit]

My definition is even simpler:

Investment: A property that produces income (positive cash flow)

Speculation: A property with potential future income or profit at time of sale based on variables beyond the control of the individual.


My approach is that any estimate of value tomorrow regardless of how educated the approach is speculation. The higher the risk the greater the speculation.
Many count the monthly mortgage down payment as money in the bank but it still depends on the price achieved at time of sale therefore educated speculation based on assumptions rather than fact.

My approach does not quantify the amount of speculation nor does it evaluate the degree of educated speculation it simply separates Investment and Speculation.

Everything in life has risk therefore investment could be negatively impacted but at time of investment the facts support immediate income.

 

[Nir]

Hi guys, I think there is some confusion here.

Speculation is a relative term. what one sees as speculative another sees as a great investment. What is a "reasonable" amount of research/due diligence?

To understand the term "speculation" we need to understand and distinguish between 2 things:

1. The fact that there are different types of investments – some with higher risk and higher expected gain and some with less risk and less return. This has NOTHING to do with speculation!

2. Speculation is referred to when not doing enough research (again "enough" is relative) to estimate the risk mentioned above. See the difference? In other words the risk or the investment parameters and the expected gain are unknown. you "don`t know what you are getting into". It`s not the high risk that makes it speculative, it`s not knowing the risk that makes it speculative (can also have low risk).

Zander, the result itself - value drop from 07 to 08 in your example, is not at all a sign it was a speculative investment but simply a reminder that there is risk in any investment (weather speculative or not).


Tim, risk is the standard deviation (std) from the expected gain, expected cash flow, expected appreciation, etc. an example of zero risk or zero variation is when you put the money in the bank in a GIC knowing you`ll get 3% interest a year. (well, in the current situation even that is not 100% safe). I do not really measure the risk, not to say we do not analyze properties thoroughly doing out due diligence. The reason is I prefer buying properties than collecting and analyzing statistical data at that level.

Cheers,
Neil

 

[ZanderRobertson]

Hi Neil,

I just saw your post now.

Benjamin Graham goes further into depth regarding the distinction;

- "thorough analysis" = "the study of the facts in light of established standards of safety and value"

- "safety of principle" = "protection against loss under all normal or reasonable likely conditions or variations"

- "adequate return" = any rate or amount of return, however low, which the investor is willing to accept, provided he acts with reasonable intelligence"

So, I think a reasonable amount of research for REIN members or users of the ACRES system would be to complete all of the steps in the system. That is our established standard. Sure, it`s somewhat relative but we can approximate an accepted standard enough to shoot for it.

the depreciation from 07 to 08 is, i think, "protected against loss under all normal or reasonable likely conditions or variations" because a property purchased should cash flow, that`s the beauty of RE

Thanks for the great definition of risk.



QUOTE (investmart @ Nov 20 2008, 11:43 PM) Hi guys, I think there is some confusion here.

Speculation is a relative term. what one sees as speculative another sees as a great investment. What is a "reasonable" amount of research/due diligence?

To understand the term "speculation" we need to understand and distinguish between 2 things:

1. The fact that there are different types of investments – some with higher risk and higher expected gain and some with less risk and less return. This has NOTHING to do with speculation!

2. Speculation is referred to when not doing enough research (again "enough" is relative) to estimate the risk mentioned above. See the difference? In other words the risk or the investment parameters and the expected gain are unknown. you "don`t know what you are getting into". It`s not the high risk that makes it speculative, it`s not knowing the risk that makes it speculative (can also have low risk).

Zander, the result itself - value drop from 07 to 08 in your example, is not at all a sign it was a speculative investment but simply a reminder that there is risk in any investment (weather speculative or not).


Tim, risk is the standard deviation (std) from the expected gain, expected cash flow, expected appreciation, etc. an example of zero risk or zero variation is when you put the money in the bank in a GIC knowing you`ll get 3% interest a year. (well, in the current situation even that is not 100% safe). I do not really measure the risk, not to say we do not analyze properties thoroughly doing out due diligence. The reason is I prefer buying properties than collecting and analyzing statistical data at that level.

Cheers,
Neil