Today Theo and Travis will be discussing the differences between a speculator and an investor.
We also have a Syndication School series about the “How To’s” of apartment syndications and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening and I will talk to you tomorrow.
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Theo Hicks: Hello Best Ever listeners and welcome to the best real estate investing advice ever show. I’m Theo Hicks, and I’m back with Travis Watts for another edition of the Actively Passive Investing Show. Travis, how are you doing today?
Travis Watts: Theo, doing great as always. Happy to be here.
Theo Hicks: Yeah, thanks for joining us. And today, as you can see if you’re watching on YouTube from Travis’s background, How To Invest Like A Pro, Speculating versus Investing. I think that we have a very good topic. It’s simple but it’s very important to understand the difference between speculating when you’re investing and then actually investing.
So Travis, maybe again, as usual, tell us a bit of background to why you wrote this; because this is based on a blog post that Travis wrote. And then we will dive into the differences between speculating and investing.
Travis Watts: Yeah. To your point Theo, really it’s a basic concept; it may not even warrant a blog post. I did it as a blog post because I felt it was important enough to share this with people, and because I have so many conversations with investors, week to week, and oh my goodness… The term investing is just not created equal, especially in the real estate space. It gets thrown around loosely, but I don’t think a lot of people have a good grasp of what it even means to be an investor, so I really wanted to hone down and clarify.
If you’re listening, you probably think you understand already and maybe you do, but I want to break it down a little more in-depth, to paint some real examples of speculating versus investing. So that’s kind of why I wrote it and what we’re going to talk about.
Theo Hicks: Perfect. So Best Ever listeners, if you’re a loyal listener and have been listening for a while, you’ll know that Joe has his three unbeatable laws of real estate investing. And the first law is to buy for cash flow, not for appreciation, and the distinction made between natural appreciation and forced appreciation. So that law of real estate investing is going to apply to what we talk about today.
Travis Watts: Yup, 100%. It goes hand in hand. So lesson #1 I put in the blog is about the velocity of capital, which is something not widely talked about. And the velocity of capital is just the simple concept that your money has to continually be moving; you have to be constantly re-investing, re-allocating, doing a re-finance, having a sale, moving money around. The minute that you start taking cash and shoving it under a mattress or putting it in the safe putting it in the bank, it begins to die, not only because of inflation, but potential loss. And when you’re locking a bunch of home equity in, let’s say, a stagnant market, all that cash is just sitting there locked up and there’s nothing you can do about it in order to access it.
So you can think of it as electricity; electrical current has to constantly be moving. The second that stops moving, it starts to dissipate, erode and go away and die. That’s the same with your money, so think about it that way. So a couple of things I wanted to define upfront is what is speculation, what is investing. Let’s get some simple bullet points here. And by the way, there’s a lot of ways to invest, and I’m not advocating one is better than the other. I just want to paint a scenario and let you sit with that, to think if maybe that could apply to you. I’ve made money, Theo’s made money, a lot of people have made money in the speculation space, and in the long term approach.
So speculation is like, let’s say that you’re going to flip a house. Why is that speculation and not investing? Well, you’re speculating that the rehab budget is going to cost what it’s going to cost. You’re speculating that it’s going to take you about 3 months to turn that property over. You’re speculating it’s going to sit on the market one month after that. You’re speculating the purchase price – someone is going to be willing to pay for that. That’s a lot of speculation, and that’s why it’s not investing. You have to constantly be repeating that process and gambling in a sense; it’s an educated guess hopefully, but it’s still speculating.
Another example… I hear this a lot in The Real Estate Guys; I’m a big fan of their podcast, but they have callers that call in and they’ll say something like, “Hey, I bought this property out in California, and it has a negative cash flow, or it’s a breakeven, it doesn’t have any cash flow to it. I’m renting it long term. But hey, it’s in California. It’s an appreciation market, right? So like in 5 years hopefully I’m going to sell it for twice what I paid for it.” Again, you’re speculating the market is just going to up up up and away forever. Look at what’s happening in California right now; that may not be the case. So there’s an element of speculation to that without having any cash flow. And a development deal, whether syndication or your own, you’re speculating the cost, and the build, and the timeframe, and the permits, and what’s it going to sell for, what it’s going to rent out… There’s a lot of speculation in that.
Of course, you don’t have to agree with me on this point, anybody is listening, but I see these things as speculative, opportunistic types of plays, and less about investing.
So let’s talk about investing. What do I mean then, who’s an investor then? Well, cash flowing-real estate, primarily… Because what are you banking on? You’re banking on the current income. You’re actually buying an income stream; you actually have tenants in there right now; you have a long history of people paying, and what the collections have been, so that’s what you’re really banking on.
So it’s still a little bit of speculation… That would be the speculation that people are going to continue renting your property over the next few years. That’s your speculation, but it’s a lot more conservative than thinking you’re going to lease-up a 400-unit building from scratch in 12 months; you may or you may not.
A dividend-paying stock. A lot of people buy stocks because they had a consistent distribution of dividends for 20 years, let’s say. So that’s an investor, you’re investing for cash flow, or same with like a bond. Most people aren’t buying bonds because they think it’s going to up in value, they’re buying it because of the yield on the bond. That example in today’s world; but historically speaking, you can get 5, 6, or 7% on bonds, that would be the case. So any thoughts before I move on, Theo, from that?
Theo Hicks: Yes. I’m glad you made that distinction at the end and said that “If you’re buying for cash flow, there’s still some small level of speculation, but it’s minor”, compared to some of the other investment strategies where most, if not all of the moving parts are based off of speculative assumptions, assuming that things will continue to go the way that they go.
It reminds me of something that we are putting in our Passive Investing Book that should be coming out in early 2021. It’s related to risk in different investments, and the possibility versus probability. So no matter what you’re investing in, there’s always a possibility that something goes wrong. There’s no investment that’s 100% guaranteed to perform exactly how you expect it to perform. So it’s possible that that won’t happen for all investments… So the question isn’t, “Is it possible to lose money?” Yeah, obviously. The question is, “What is the probability of you losing money on that investment?”
So the more assumptions that are put into this deal, the more probable it is that money will be lost. Again, it’s not always the case, but usually the more probable it is that you lose your money, the also more probable is that you’ll make a lot of money. So when it comes down to speculation versus investing, when you’re speculating, the probability of you losing money is a lot higher because of the number of assumptions that are made… As opposed to when you’re investing – sure, you’re still making money, sure, it’s still possible that you lose money, but the probability of losing money is much lower.
Travis Watts: That’s a great point, I appreciate you pointing that out. That’s 100% the case; I couldn’t agree more on that. So I point out a couple of things, I say that professional real estate investors understand two things. Number 1 is the need to continually move money into new investments, and number 2, how cash flow is used to create exponential wealth. So let’s talk a little bit about that.
I’ve put in the blog an example of a gambler… So just to paint a picture of a term that I used in the blog, called house money. So if I go to a casino, and I have a thousand dollars, and I go place a thousand-dollar bet and I ended up winning $1500… Okay, that means I now have $500 more than I started with. I still have the thousand, plus the five. So if I take the original thousand that I had first bet, that I won back essentially, and I put that in my pocket, and now I only have $500 left in my hand, now I’m playing with house money. What is my risk at this point, right? I can go around and just bet here and there a hundred bucks, a hundred bucks… I’d go to zero, but ultimately I didn’t lose anything, because I still have the $1000 I walked in the door with.
So you can play this game without being a gambler, in terms of being a cash flow real estate investor. So the example I layout in the blog is if you had, just for example, say $500,000, and you decide to spread your risk into 5 different investment, 100k, 100k, 100k, 100k, 100k. Let’s assume each of those cash flowing pieces of real estate give you a 10% annualized return. So that means at the end of the year you’re going to have $50,000 in passive income, in collections, in dividends, or interest, if you want to relate it to other assets. So here’s the thing – at the end of that year, let’s say it’s December now, and now I have $50,000 more that I started with – I can take that 50 and go make a new investment. I can go put 50 into syndication, or private placement, or some stocks, or whatever… And I’m now playing with house money; I now reduced my risk, because now I’m going to go leverage and make even more cash flow and have even more tax advantages, but not have to be worried about that $50,000. And every single year, assuming these are multi-year deals, you can do the same thing. Every year you get to take another 50. Actually, it will be a little bit higher, because you’re compounding the earnings on the new investment as well, the 6th investment.
So every year you’d play with more and more house money, to the point that you’re playing mostly with house money, so you’re therefore reducing your risk… As compared to, now let’s look at the opposite situation. I have $500,000 to invest, and I spread that into five development deals that are going to take multiple years to develop. Well, that means, A, there’s probably no cash flow in the meantime… And what happens if in three years down the road the market shifts, we go into a great, huge recession, and now our assumptions, our speculations, they’re way off. We’re never going to sell those properties for what we thought. It’s costing more in construction cost, because of bad trade deals that politically happened… So many things can happen. The city is denying different permits, who knows. It’s not leasing up, because someone built right next to us, and they’re leasing up before us, and therefore we can’t collect enough tenants… There’s a lot of things that can happen with that.
So now my principal, my initial $500,000, is at risk. I’ve had no house money in the meantime, I haven’t been able to reduce any risk, and now I’m looking at a loss of a potential principal. So just think of this idea of, again, the two things that professional investors know – continuously moving over into new investments; as cashflow is rolling in, you’re making new investments using that cash flow, and that’s how you create exponential wealth. You keep stockpiling on to the cash flow.
A big way that Robert Kiyosaki, Rich Dad Poor Dad author, invests is he calls at the infinite return. So he’ll go in, add some value to a property, do a refinance, pull a lot of that initial equity out, and go do another deal, and then add value and refinance and pull as much equity out as you can, and he’ll go and do another deal. Well, meanwhile he’s holding all of these properties, and they’re also cash flowing; so this is the exponential growth curve that he’s creating that way. So there are different methods to it… I honestly don’t prefer that method, believe it or not. I like the shorter sale points. I like to sell between 3 and 5 years, potentially, and move it into more investments myself. But hey, it doesn’t matter. Me versus anybody else. I just wanted to paint the picture of what this is all about, so that’s really what the blog is about.
Theo Hicks: Yeah. There’s a lot of people that I’ve talked to on the podcast that started off with a chunk of money… Usually, it’s not 500k, it’s a lot less than that. And they’re active investors obviously, but the same concepts apply; they use that 30 grand, and then they will — you call it the Robert Kyosaki’s strategy… Let’s call it the BRRR strategy. He’ll buy it, he’ll rehab it, he’ll rent it, he’ll refinance, and he’ll repeat it. And after that first investment, that repeat, you’re now using that same money again. So you’ve got a house, and you got your 30k back. The only difference now is that I have a house, plus I’ve got 30k to do it again. And so they continue to use the same money over and over and over again to build up a portfolio, while at the same time generating cash flow from those properties, so they can then use that house money to go ahead and continuously re-invest.
And as I mentioned in our conversation — I think it was last week when we talked about this… Because I remember I made the spreadsheet where we compared 401K versus investing… I remember I did it and I realized that with the 401K you can keep putting money in here over and over and over again, whereas in this scenario I’m putting in $50,000 or whatever it was, and then that’s it. I’m not investing again. So that way my net worth is way higher in this investing category, but the amount of money I’m inputting is also different; so the ROI is just massively different, because of the fact that, again, I don’t need to keep putting money into a 401K, I can just re-use that same capital over and over and over again while at the same time generating house money.
Travis Watts: Exactly. So the lesson is when you re-invest cash flow, you’re essentially reducing your risk at the end of the day. As you said, really at the end of the day this is a very simple concept. And I’m sure anybody who is professionally on LinkedIn, or I think Instagram – those are probably the two worst for being hit up by these Bitcoin and cryptocurrency traders who call themselves investors… It just drives me nuts. Maybe that’s where I derive those, because deep in my subconscious I’m angry. But you know, I just want to get the reality out there that that is not investing; if there’s no cash flow to it, if it’s speculating, which of course crypto is speculating… You’re not an investor. You can call yourself that, and that’s the problem though – there’s a lot of people that like to call themselves investors. So that’s my rant on it.
Theo Hicks: Bitcoin is the future, Travis. Don’t you know that? It’s the future.
Travis Watts: Well, it may be… But we have to acknowledge that it’s a speculative play, and that if we’re going to buy Bitcoin at 10,000, the hope is that it’s going to go to 20,000. That’s the hope, that’s the speculation. If we buy at 10, and we sit on it for 20 years and it goes to 5… [laughs] That’s the whole concept there.
Benjamin Graham has a great quote I’ll close with here on this concept. He says confusing speculation with investment is always a mistake. That sums it up; it couldn’t be more true.
Theo Hicks: Yeah, in our Three Immutable Laws post we talk about it, similar to the gambling scenario, that if you’re playing Blackjack or whatever, and I think maybe it’s talking about roulette… And you bet on black, and it happens to hit black 10 times in a row and you look like a genius, because you have 10 times your money. And then you put it all on black and then it lands on the green, and it’s all gone. You’re like, “Oh, what happened?” There’s no skill in roulette.
There’s still some skill to this; it’s not exactly like gambling, but it’s much closer. Speculating is much closer to gambling than what we talked about as investing. So is there anything else you want to mention before we sign off?
Travis Watts: Just one more quick concept… I’m sure a lot of people who are stock investors or have heard the term the lost decade in the stock market… It was just that had you bought in at a particular time in the last decade, 20 years ago actually, and then held stocks long term, we went from basically the peak of the market to financial collapse, and there would have been a 0% return in a full decade. Well, had you been invested in cash flowing anything, anything that provided interest, dividends or cashflow, like real estate, you at least would have had that. Over the course of a decade you could have potentially doubled your money, who knows?
So that’s the whole thing – I never want to place a bunch of capital on something, wait 15 years to find out if it’s going to pan out. To me, it gets back to the 401K thing we talked about earlier. But anyway, I could go on and on. But no, I don’t have anything else, so we’ll cut it off.
Theo Hicks: Perfect. Alright, Travis. Well, make sure to check out his blog post, How To Invest Like A Pro, Speculating versus Investing. I’m assuming it’s on BiggerPockets; it might be on joefairles.com, too. Travis, thanks again for joining me. Best Ever listeners, as always, thank you for listening. Have a Best Ever day and we’ll talk to you tomorrow.
Travis Watts: Thanks, Theo. Thanks, everybody. See you later.
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