RealTMOR Asset Mgmt LLC and RealTMOR Apartment Mgmt LLP
Investment and speculation are different, investment entails planning and making money work with calculated risk-taking. While speculation is akin to gambling and looking for “outsized” returns without fully factoring “high-risk”. Many people confuse one with the other!!!! Real estate purchases can be both investments and speculative buys.
Often property purchases, in an area, are recommended because something “good” will happen there. Includes building of a road, a bridge, a public transport event, an airport, an economic zone, a township etc. Each of these events could, no doubt, create value and enhance demand. However, there is risk associated with project execution in terms of time, money, business cycle and political will. So, buyers are taking many additional risks. Is there potential for adequate compensation for these additional risks?
The key risk is the effect that the change would have on demand/price for that area. Is the possible valuation enhancement being overestimated initially? Speculative buyers have shorter time horizons for returns generation from investments. There might be value enhancement resulting from the changes but will it happen in the time frame and to the extent desired by the investor?
Pricing of assets, in financial and real estate markets, reflects the value of potential future cash flows. I believe, the “standard” beneficial effects, of the potential future enhancements, are built into the price and expected growth rates, today. Expecting higher returns involves believing that the enhancements would actually be more advantageous than normal. Now, this could be a real rationale for investment.
There has been much buzz around the Panvel airport but Panvel property prices from 2001 to now have not significantly outperformed New Bombay, Thane etc. Arguably, current prices and growth estimates include the positive economic effects of the airport. This information could be gleamed from the marketing materials of developers selling real estate in Panvel. The airport’s existence is being marketed as a foregone conclusion. However, there is downside risk, the airport not getting completed in time or the quality of the economic activity not being as robust as estimated. Then there is danger of the market there underperforming other areas going forward.
There is always buzz around “townships” while they are being marketed. Every township markets the promise of transforming peoples’ lives. However, not all townships are created equal, like everything else, some will do exceedingly well but many others will fail. Specific features of the township matter and the merits/demerits of the individual projects should be researched. Currently, there is a feeding frenzy in Hebei province, China. The president has announced a new Special Economic Zone to rival Shenzhen and Shanghai. According to Reuters, it’s so bad there that the government had to ban real estate sales. No one knows how these plans would materialize but the speculation has started. Importantly, there are examples of many “ghost towns” strewn all across China. The best example is another city in the same province that was promoted by the past president. With his retirement that city was forgotten. These “ghost towns” have gleaming office towers and various features such as malls, amusement parks, modern residential towers but not many people nor much economic activity. It is a herculean task to attract a disparate variety of businesses, people and other services to make “the whole project work”. That could take years and even if the township becomes successful the time-lag might be prohibitive for an investment’s returns.
At times, infrastructure spend is a political exercise. So, during the time the project is undergoing approval in the legislature its promise is obviously “boundless”. But once the project is completed and is put into use it becomes clear that it was not the most efficient/effective use of time and money. The infamous “bridge to nowhere” in Alaska (USA) is a great example.
Business cycles matter too, when there is a boom in infrastructure spending and in the real estate cycle people believe “any” project is good. Land is bought at steep prices and construction spend is exorbitant. Logically these properties are marketed at steep valuations in comparison to that area or to historic prices. The common mistake is that prices in the “emerging areas” are compared to prices in established areas. Hence, these “high prices” are considered as “discounted”. If these projects are being constructed and sold at the “wrong” time in the business cycle then the risk of non-completion is very high. The developer could face financial difficulties or the project may become unviable due to a downturn in the business cycle. Additionally, political calculations could change over time and could result in unforeseen problems that could seriously erode value.
So, all in all, when one blindly buys real estate on the basis that it will have some “known beneficial changes” in the future and one expects outsized returns then that is a “speculative buy”.
Now, if the information about building of a highway/road, bridge etc is not known publicly and one is in knowledge of that information through “reliable sources” then that is “insider information” in market parlance. Trading on insider information is illegal and immoral. I wouldn’t want to dignify that strategy by talking about it. Further, such secret information could also be highly unreliable and then one is stuck with a bogus purchase. How many times has the “reliable/sure” tip that one has received turned out to be wrong? I would venture to guess more often than it turns out right.
One could buy real estate in an area, genuinely expecting beneficial events to happen, based on research. And if certain positive things do happen then that strategy, in my opinion, is not speculative. In this case the decision has been made before the event occurs and hence the price would obviously not reflect the effect of the event at the time of purchase. In this case, one has made a riskier investment and one is banking on a higher return to compensate for the riskier investment. This strategy is akin to buying a mid-cap stock after researching the company.
Finally, I am not saying that speculation doesn’t make one money, it does in some cases. But as with speculation/gambling there is a good chance that one could lose and lose big. So, one should be aware of that risk. Also, I am not saying that making purchases based on expectation of positive activity shouldn’t be undertaken. But one should be clear that higher returns expected would be a result of “higher risk” being undertaken.