Is It Wrong to Make a Profit as a Real Estate Investor?

As a nation on edge and in the midst of the worst economic crisis since the Great Depression, many of the daily aspects reflected in “Americana” seem to have become taboo. For the past two years our stunned and gun-shy population has wandered through news of continued job losses, store closings, grim foreclosure statistics driving the economy south, and consumer confidence to all time lows.In times of chaos and turmoil it’s normal to wonder who is to blame for our collective misery as it is expected that we all seek solutions to our temporary slump. However, one unfortunate by-product of this circumstance is the blurred distinctions between actions that lead to recovery and those that caused our loss. In the real estate industry this has become most evident in the grouping of profit with greed, and investment with speculation.Profit vs. GreedIn a recent article for the Washington Post, conservative columnist George Will writes, “Greed, we are agreed, is bad. It also is strange. It has long been included among the Seven Deadly Sins, which suggests that it is a universal and perennial facet of the human fabric.” He continues on with the example of ticket brokers, like Stub Hub, to illustrate his point that the open market properly punishes greed with missed opportunities and sudden collapse due to improper timing. “Greed is worse than a moral defect, it is a cause of foolish pricing. That is why markets know it when they see it.”Without entering a conversation about regulation versus free markets I would concur that greed unchecked leads to downfall. Further, the collapse of the US housing market shows that the unfortunate side effect of unchecked greed is the collateral damage done to those who were not greedy but remain caught in the crossfire.Profit on the other hand is a basic tenet of Capitalism and the cornerstone to our free market society. Profit is the engine that propels entrepreneurs, investors, and jobs, manufacturing, creativity, and expansion alike. In his seminal book “The Science of Getting Rich” Wallace Wattles explains that one must always give more in “Use Value” than they receive in “Cash Value.” His clear yet sometimes lost point among business ventures is that a properly functioning marketplace allows for a reasonable entrepreneurial profit to those who add value to the business process. This distinctive balance lies within the intent of the business performing the service.In illustration of this point can be found in the real estate industry by comparing investors to speculators.Investor vs. SpeculatorA real estate investor is an individual or entity that invests equity into a real estate asset for the purpose of generating income from or adding value to the existing improvements. Investors can have long term or short-term strategies. They may use their own capital or they may borrow (leverage) equity to varying degrees. Some create value by curing defects either physical (dilapidation) or financial (cash buyers with quick closings), while others employ long-term hold strategies that gather value from timing and appreciation. Yet all prudent investors share the distinction of returning to the marketplace “Use Value” for the profits or “Cash Value” they earn.Speculators can share timing and leverage strategies with investors, yet that is where the similarities end. The intent of a speculator is not to add value to the economic engine; rather they look to take advantage of the marketplace by simply getting in line first. The speculator is driven by greed. Profit margins and financial gain are not based on business strategies that help balance supply and demand, thus making the business plan viable in the long term. Instead the speculator looks to horde or corner markets to their advantage intending to reap exceptional short term profits before quickly exiting the marketplace without regard to what is left behind.The Soap AnalogyMost all of us bathe on a regular basis. To do so effectively we use water and some form of cleaning agent. For this example let’s assume we all use soap.If one were to plan for a shower and find all the soap gone, the reasonable response would be to go down to a convenience store (grocery store, warehouse store, or drug store) and buy another bar. Most of us would look for the best bargain or our favorite brand and gladly pay the store’s asking price. For this transaction to occur we realize that some other business distributed the bars of soap in large bulk quantities to that store to accommodate our smaller purchase. Before that, a manufacturer bought raw materials mixing together bars of soap to later package and sell to that same distributor.Each step along the way a business invested their capital to provide a service both for the entity before them and customer who comes after them in the economic process. For this privilege and purpose each investment entity earns a tidy profit. By charging too much for their service they lose customers and go out of business. By contrast, not charging enough leads to loss, inhibiting the ability to remain a viable and profitable concern. Either way, free market forces act to keep profits in balance and all of us clean. Further we support these profits and welcome the service provided by continuing to buy bars of soap.But what happens when someone only seeks to take advantage of system for the short term and their own personal gain. Let’s imagine we’ve all taken a two-week cruise across the Pacific Ocean. Forced to share close quarters for an extended period of time it would quickly become apparent that good hygiene practices are necessary to the shared enjoyment of the passengers. Again, enter the need for soap.For this example let’s assume that the passengers did not realize this need until the boat was long to sea and the boat’s sundry shop was grossly undersupplied with the sudsy necessity. Enter the speculator. Realizing that other passengers have nowhere to turn, too little supply and extraordinary demand, he quickly gathers all of the available soap and waits for the pandemonium to begin. Beyond the myriad of possible disasters awaiting the group one outcome remains certain – Imbalance and market failure.The Real Estate WorldExamples of our ship bound soap pirate were seen all across America this past real estate cycle. From Brooklyn to Las Vegas, Florida to California speculators bought or reserved condominium units before homeowners could find their place in line. Speculators bought income property that did not earn enough income to support the prices paid intending to sell it in short order by way of rapid appreciation. Eventually the music stopped. The result – Imbalance and market failure.Yet amid the ashes born of greed and speculation, comes the profitable investor intent on creating value within the economic system. Recognizing a need and providing a valuable service, the investor uses free markets to find balance in the economy and provide profits for its coffers. Identifying “Use Value” in exchange for “Cash Value” the profitable investor solves problems, creates jobs, provides a service, fuels growth, inspires innovation, and is the cornerstone to the American Capitalist System.That is never wrong.

Allan S. Glass is a real estate broker in Los Angeles, Californiaspecializing in REO and Short Sale transactions. Allan is also a featured blogger on Realtor.com. The ASG Real Group has over $1 billion and 17+ years of transaction experience.

Great post, One of the things that I see in my market is that most of the speculators and greedy investors are actually loosing their homes to foreclosure. In the past 6 months I have to list several homes that were rentals owned by slum lords with tenants living in really bad conditions.

Also I have listed some great renovations and overkills that were done by speculators, and unfortunately for them most of those speculators were the average hard working folks who saw an infomarcial of how to make money in real estate, or the ones who joined an investor's club run by a scam artist who was just trying to assign contracts and make a lot of money, but who never taught them the ins and outs of real estate investing. I know most of those good folks had the best intentions to make money not to harm anyone.

I know a lot of good investors who are making a lot of money in this market, they are buying cheap, and they are doing good renovations, good products, and they are selling below market value to first time buyers, giving them closing cost help, where they are making their profit is at the time of the purchase and in the renovation.

I help them with the numbers, current value, after repaired values and they try to purchase 15 to 20 percent below value and sell 10% less than the market value, but the renovation cost have to be right. believe me they wont do an investment if they are not sure they will get at least 20% ROI. And the best thing about it is that the product is good, they don't cut corners or just cover defects, they do good renovations.

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Comments

Luis Gonzalez February 5, 2010 at 6:16pm

I"ver been in R.E for over 20 years as a Broker/Owner. and like many Owners we do not have a Boss. But we can pick mentors I chose 2. Both retired now.The first one I chose was over 15 years ago. His name is Bob and he was already 30 years into the R.E Bussiness before I came into the Area and yes He is over 70 years old. He went thru 3 market crashes before this one. Things that he said that are memorable to me are: " IN REAL ESTATE NEVER BE a SPECULATOR be an INVESTOR" he also said," EVERY TIME is the same,BANK'S GREED GET'S THEM INTO THIS MESS,BUT GREED WILL GET THEM BACK INto BUSSINESS only much smarter but w/ better technology". He also said " AS an Investor Always leave some for the next guy", " FIRST Learn to read ,the market , the people and washington, and you will now when to sell" , and in in 2004 he said "Luis is time for us to Sell, too many Speculators".So I DID. And many other interesting and important things. We as Realtors have to know, understand and Identify a True Investor vs. Speculators.
True investors culd teach you & vise versa. Speculators are Brain cell suckers. & You do not have the time. Spring market will bloom early this year , if it has not already started in some areas. Great Post ALLAN! .
Cynthia McKenna February 3, 2010 at 2:30am

I agree that greed is not good. That is how we ended up in this mess. However, to head toward socialism and have the government take care of us is not good. Look at the mess they get themselves into! I think that capitalism should be allowed to fix this mess, and the goverment should take a step back.
If the government feels they should help, why don't all of the senators and such that are sitting on large pensions and have different health care than we do, put their own money up? They don't even pay their own taxes correctly!
How can we fix things if the mice are in charge of the cheese?
I am not trying to be bipatison here either, this should go for all parties and our highest elected official.
Jose Rivas (DGRA) CDPE, SFR February 2, 2010 at 3:50am

Great post, One of the things that I see in my market is that most of the speculators and greedy investors are actually loosing their homes to foreclosure. In the past 6 months I have to list several homes that were rentals owned by slum lords with tenants living in really bad conditions.

Also I have listed some great renovations and overkills that were done by speculators, and unfortunately for them most of those speculators were the average hard working folks who saw an infomarcial of how to make money in real estate, or the ones who joined an investor's club run by a scam artist who was just trying to assign contracts and make a lot of money, but who never taught them the ins and outs of real estate investing. I know most of those good folks had the best intentions to make money not to harm anyone.

I know a lot of good investors who are making a lot of money in this market, they are buying cheap, and they are doing good renovations, good products, and they are selling below market value to first time buyers, giving them closing cost help, where they are making their profit is at the time of the purchase and in the renovation.

I help them with the numbers, current value, after repaired values and they try to purchase 15 to 20 percent below value and sell 10% less than the market value, but the renovation cost have to be right. believe me they wont do an investment if they are not sure they will get at least 20% ROI. And the best thing about it is that the product is good, they don't cut corners or just cover defects, they do good renovations.

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