One of the first things that intrigued me about real estate was the unique opportunities that are available to outperform the market. In the stock exchange, it’s nearly impossible to pick consistently winning stocks, though there are whole industries who will tell you otherwise. Over the long run, very few manage to outperform market averages. That is due, primarily, to the combination of fees and lack of skill and judgment. All in all, it boils down to the fact that the stock market values are unpredictable, volatile, and emotional, but efficiently reflect the immediate value of the asset.
Warren Buffet said, “I’d be a bum on the street with a tin cup if the markets were efficient.” What he means is that he seeks underpriced stocks, ones worth more than the market values them. Market inefficiency doesn’t apply to only stocks. If you become adept at recognizing inefficiencies in a marketplace, you can position yourself to take advantage of those inefficiencies and prosper.
The real estate market is considered an inefficient market, in which prices are set solely by the meeting of the minds of the seller and the buyer, who make decisions based solely on their particular circumstances, and having little if anything to do with the market at large. This makes the value in real estate very much a moving target. Often enough, that the property you just bought for $90,000 could be worth $125,000, or it might only be worth $75,000, in which case you paid too much.
Confounding any assessment of the value is that different economic factors hit different locations differently. Since the economic news will have different effects on a property in State A as opposed to State B, and it becomes difficult to determine an effect on any given property, and the various neighborhoods within each town, and the streets in each neighborhood – it quickly becomes overwhelming!
Another major inefficiency is the lack of information in the debt market. Lenders and investors rely heavily on relationships for opportunity spotting (aka “deal flow”) and asset understanding. On the other side of the deal, asset owners have limited options for capital often going with broker-fed funding options rather than seeking multiple lenders and letting them compete. With access to deal flow and capital in the hands of a few, the market is naturally opaque and one-sided. Commercial real estate brokers depend on 3rd party data service providers to continually update data on tenants and property owners. This information is in continual flux and as such isn’t feasible for an in-house solution.
“In short, change in supply and demand are going on all the time, however, due to the vast size of market participants not understanding the effects of that change – or even that change took place in a particular area. The people who do realize that values have changed will be in a position to take advantage of and in a position to exploit inefficiencies in the market”.