As a real estate investor, are you an investor, or are you a speculator? There is a significant difference.
Speculating is when you form a theory or conjecture about a subject without firm evidence—for example, investing in the stock market. You’re buying shares of a certain stock in the hopes the stock is going to appreciate, or go up in price. Sometimes it does, and sometimes it doesn’t. But that’s the nature of stocks; you’re investing for appreciation.
This type of investing is considered speculative in nature. It is considered speculative because there is not much you can do as an investor to drive, influence or accelerate the appreciation of the stock.
Now contrast speculating with real estate investing. This is where a shift in mind-set is necessary.
Successful real estate investors are not speculators. Real estate investing is a more definitive way of investing and is a much more active—as opposed to passive—way of investing.
Real estate investors can literally define their returns on a real estate investment prior to executing the investment. They can take actions with the real estate investment in order to obtain the desired results.
At the risk of oversimplifying, they’re investing in three different ways:
1. Investing for cash flow
2. Investing for equity capture
3. Investing for both
Investing for Cash Flow
The most popular example of a real estate investor who invests for cash flow is the buy-and-hold investor. That investor buys properties with the intent of holding them as rentals to generate profit. Cash flow is the difference between the monthly rent and the monthly principal, interest, taxes, insurance and maintenance. And the investor enjoys the money that is left over at the end of each month as his or her profit.
Another example is the investor whose exit strategy is seller financing. For those investors, cash flow is based on the difference between what the investor pays on the held note and what the investor receives from the seller-finance payment.
You can see in both examples that the cash flow is a mathematical calculation. There is no theory or conjecture. It’s mathematical, and that is the difference between investing and speculating. That is what we, as real estate investors, do.
Investing for Equity Capture
Now let’s look at those investors who are investing for equity capture. Think of it this way: As a real estate investor, you’re buying properties at a discount. You’re paying cash, buying them as-is. You are paying the closing costs and closing quickly. You’re creating a value and service for the seller of the property and, in exchange, the seller is agreeing to sell to you at a discount.
Another way to look at it is the seller is agreeing to give you some of his or her equity. The seller may be thinking, “I know this house is worth a little more than I’m selling it for, but this investor is willing to pay cash quickly. I don’t have to do any repairs. The investor is covering the closing costs, and then I’ll be done. In exchange, I’m willing to sell my house for a little less than it’s worth and give the investor my equity.”
That is what we mean by investing for equity capture. These investors will then turn around and possibly wholesale the property to another investor. They will keep some of that equity for themselves and pass on some of that equity to the next investor. Or the investors might do a full rehab or fix-and-flip on the property where they’re going to capture and keep all the equity purchased from the original seller in the form of profit. They’re capturing a certain amount of equity immediately at the time of purchase. Then they’re going to make enhancements or improvements to the property in the form of rehab and increase the equity in the property to maximize their return.
You can see how definitive and mathematical it is for investors who invest for equity. They know the value of the property. They know the purchase price, and so they can clearly define the equity that they are capturing at the time of purchase.
Speculation is absent in this type of equity capture investment, due to the definitive and calculative nature of the investment.
Investing for Both Cash Flow and Equity Capture
Then you’ve got the investor who is investing for both cash flow and equity capture. This is, quite honestly, the best type of investing. It allows you to enjoy both types of rewards: cash flow and equity capture.
For a rental or buy-and-hold investor, you buy the property at a discount from a motivated seller, capture the equity and then you turn around, rent the property and capture monthly cash flow.
As you can see with the buy-and-hold or rental investor example, you’re enjoying the benefits of both equity capture and monthly cash flow. Both are definitive, mathematical and calculated, therefore eliminating any speculation.
This concept of cash flow and equity capture can also translate to seller-finance investors. They buy a property at a discount, enjoy the equity capture, then they turn around and seller-finance the property to an end buyer or owner-occupant. And they enjoy the monthly payment from seller financing to the end buyer.
Real Estate Investors Are Action-Oriented
You can see in these three examples that these investments are calculated, methodical and definitive—unlike our example of the stock market, which is much more speculative in nature and more passive.
As a real estate investor, you take more of an active approach. You can drive the gains through your actions and exit strategies.
And let it be said: Appreciation is not a bad thing. Appreciation is wonderful. It’s an added benefit to any real estate investment you make. There’s nothing better than buying a rental property for cash flow or equity capture and holding it over years as a rental property as you enjoy your equity capture and monthly cash flow. At the same time, you may also start to notice the property is showing some appreciation.
Experienced investors don’t invest purely on appreciation. They enjoy it when it occurs, but it’s not the single most important factor when they make an investment decision.
Invest for cash flow, invest for equity, or invest for both. If you get appreciation on the side, all the more benefit to you. Make sure you’re focusing on being an investor and not a speculator.