A Lesson in Speculation and Why it has NO Place in Real Estate Investing

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How do you know if you are making strong profits from your real estate investing and have you measured your opportunity cost if “plan A” doesn’t work out?

This is a short story of a very close friend of mine, Luka.

After a structured and involved Due Diligence process, Luka successfully eliminated many areas he could afford to invest in as there was no growth, no demand, no infrastructure developments, no new jobs coming etc, efficiently eliminating local property markets that were stagnant at best. 

Luka wanted to time the market to precision so that he can ride the wave of growth to quick profits inside 9 months.

As Luka was new to real estate investing, he needed to ensure he was very thorough!

After almost 6 months of intense research, Luka was very confident in the research, and could quantify the numerous amounts of investment, both by local and federal government, as well as private business owners into his chosen area. 

However, Luca was too optimistic about the time horizon of when these investments will have the desired impact into the property market because it wasn’t in line with his expectations. 

After all, Real estate investing is about more than just 1 variable !

The research he did, as comprehensive as it was , was missing a crucial piece of the puzzle and it wasn’t until after the fact that he had any idea how crucial a piece it was. 

Luka had wanted to ride that magic wave of growth which to him meant an influx of demand and rising values !

Luka was celebrating a couple of milestones here. Buying his first home in Victoria – (regional Victoria) and celebrating the start of his real estate investing career.

So Luka renovated a property in record time and under budget, delivering a product into a market that hadn’t moved in the time he had hoped. 

Before and After of Luka’s Renovation

He sold at a profit but it took a whole year longer than he hoped it would. One big lesson when it comes to real estate investing: Everything moves slower in regional areas !

So, did Luka achieve his desired outcome seeing as he made a profit anyway?

Well the answer is no

Luka could have made a better decision by consulting someone who would have not only given him advice about timing the local regional market, but helped him prepare for different scenarios

Projecting future growth and trying to time it when it isn’t happening yet is pure speculation.  Lukas biggest assumption was that his chosen suburb would benefit from the ripple effect of the growth happening in the neighbouring suburb.

This is unsophisticated thinking and too simple a mindset.

A mindset that almost stopped Luka’s real estate investing career even before it got started.

Even though Luka did amazing research that his mother would be proud of, the fact that he missed a couple of crucial points meant that the gap between his actual profit and targeted profit was very different. 

Given that it was a simple renovation and nothing more, I would even say that Luca was very lucky not to have taken a bigger hit on his profit than he already had – let alone make a loss. 

As a favour to Luka , I ran the numbers to calculate his real return because I was really curious and also slightly annoyed, at his blaze attitude to not knowing exactly what was happening to his money. 

In return for the favour Luka granted me permission to write
this blog so as to help other people thinking about getting into real estate investing.

Luka is one of the smartest people I know. He is a successful executive in a high paying job. You would think that he would be able to read the numbers better than most, but understanding theory and practical application as it pertains to wealth creation through real estate investing are very different things. 

Theory and practical application are very different things.

We calculated that Lukas initial target profit was $39000 or a cash on cash return (COCr) of 25% annualised with a project period of 6-9 months.

Luka assumed, after he ran the numbers, that he ended up with a 8% cash on cash return (COCr ) after almost 2 years since purchase- however when I crunched the numbers I showed Luka that in fact his return after the cost of the first failed sales campaign, an unreported important last minute renovation expense, replacing the hot water system that blew up, and the damaging cost of negative gearing while renting + vacancy – Luka barely made a 3% COCr.

He would have been better off leaving his cash in the bank for a very safe 2% return rather than dabble in real estate investing without advice with all the risk that comes with it.

Add to that the fact that while renting the property out waiting for the market to recover, the property was no longer “freshly renovated” when he did sell it.

The negative gearing and opportunity costs of not maximising his profit in that first year meant that the real loss is in fact far greater than the tiny profit he made with the sale 2 years after.

An all too often scenario in real estate investing in Australia that is destroying a lot of potential wealth in many a real estate investor.

I know some of you might be wondering…

“You only had to hold the property for 12 months –  that’s not too bad is it?”

The secret to building wealth with profit via real estate investing is the magic of compounding returns.

Lukas’ money and borrowing capacity was tied for almost 12 months . He had lazy money that just was not working as hard as it could be. Instead of making strong returns in a profitable investment, the value of his cash AND potential returns were deteriorating by the minute locked up in that property deal. 

I always work with my mentors words in mind when it comes to wealth creation, our goal is always to “make the most money, in the quickest time, with the least risk and lowest aggravation.” 

Luka was empowered by the experience.

With the help of hindsight and ability to calculate real returns,  I can guarantee that Luka won’t be speculating in his real estate investing career ever again !

The truth is , we know of many “Lukas” out there getting involved in everything from renovations to developments and have no idea what real returns they are making! It is madness. 

Opportunistic people have over simplified real estate investing. There is no context to doing it – they just do. “Margin is margin” as someone once said to me and that is simply not true.

Sure if you are looking for a once off profit here and there or don’t care how much you make then margin is margin.

However without context, education and the right help you will find it almost impossible to enjoy a long and fruitful real estate investing career.

Never assume how fast, or how slow, a property market is going. Instead, study it and know for sure. 

How do you study it ? What performance indicators and what data do you read and study to understand the market ? 

Well perhaps that’s a blog for another day.  

If you would like to understand if your investments are making the best return possible with all the options and strategies available to property investors, book a chat with me using the link below.

Shehan Tambinayagam

Click here to book a chat with me

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