I believe that the equity and bond markets are very efficient, as there are millions of investors all valuing the same securities. We are simply price takers, and our returns will simply be average. Your goal in equity and bond investing should be to build a diversified portfolio at the lowest possible cost.
On the other hand, real estate presents opportunities to generate above-average returns. You are not competing against millions of other investors, but only a few investors and some first-time homebuyers in your local market.
Here’s why I think it is theoretically possible to generate good, even above-market, returns with real-estate.
Real estate is local, while equity and bond markets are global
Everyone knows that the three most important things in real estate are location, location, location. Because of this, property values do not lend themselves well to formulaic models. Even using comparable home sales can give highly inaccurate home value prices, because nothing can replace local knowledge and actually visiting a home.
Zillow even ran a competition on the machine learning website Kaggle to try to improve their home valuation algorithm. They offered $1.2 million in prizes to the teams that could produce a computer model that could outperform their current Zestimate model. It’s hard to know whether this model can outperform human assessors, but ask anyone who has ever been on the site and most people would say that the Zestimate is not very accurate. In my market, it typically overestimates home values.
As a result, if you put in the work, you can value home prices better than others. And if you do so, you can purchase homes at below-market prices and sell homes at above-market prices, which is money in your pocket.
Who is on the other side of the trade?
When you are trading stocks, you are frequently trading against professional traders who have studied the market and have tools and other advantages against you.
On the other hand, in a real estate transaction, you are often selling or buying a home from a family that has little interest in real estate investing. This may be the first time they have ever bought or sold a home, and their negotiation skills could be subpar or non-existent. They may fall in love with a home, and decide to purchase it for significantly higher than its worth. Through good marketing and staging of a home, you can increase its value to regular home-buyers.
Transaction costs and commissions are significantly higher in real estate
However, what you can gain by buying and selling from regular homeowners can often be lost through transaction costs.
The cost of “trading” in real estate is significantly higher than in the stock market. In the stock market, you only have to pay a nominal commission of a few dollars and a bid-ask spread that can often be less than 0.01% of your buying price. Holding a stock does not incur any costs.
On the other hand, there is a long list of transaction costs when you buy and sell in real estate. Just to name a few, you need to pay for the following costs when “trading” real estate:
- Buyer’s / seller’s agent
- Mortgage closing costs
- Home inspection
- Home maintenance
- Home insurance
- Property taxes
- Property manager
- Contractors for renovations
These transaction costs can wipe out any edge you have from shrewd home valuation and negotiation skills.
It’s not easy to invest in single-family homes. You could try to flip homes like they do on TV, but it is often a lot harder than it looks. You can choose to put sweat equity into the home, or hire contractors, but that eats into your profit margin.
Conclusion
There are opportunities to make above-market returns in real estate, because the market is not as efficient as markets with millions of players like the equity or bond markets. It takes a lot of work and skill, and transaction costs and contractors could erode your returns. If you’re not careful, real estate trading could become like stock trading: a losing proposition.
What do you think? Do you think the residential real estate market is efficient? Are there opportunities to make above-market returns? Have you ever invested in single-family homes?
So I guess what you are proposing here is buying a home and then selling to make profit as opposed to buying a home and renting it for an income stream.
I think buying homes to sell is a much tougher prospect than buying homes and letting renters pay down the mortgage while you are making money.
I’ve always been scared of either prospect because of the massive potential they both have to eat into my time. I don’t have a passion for real estate like I do for my website… So while my website is fun when I work on it, I think real estate would feel like a second job.
Is this something you have dabbled in, WSP?
The key to making buy and rent work is buying at a good price 🙂
I have not and do not dabble in this, but the potential is theoretically there for the motivated real estate investor.
Thanks for the article. Real estate investing is one of my favorite topics.
I don’t know where you live, but buying a SFR in California, where I live, to invest in for cash flow can be very challenging. Some investors are counting on appreciation while pouring money in monthly to pay for the mortgage. I’ve been searching for nearly a year, but haven’t found any that that sense in terms of cash flow after all expenses/cap ex reserve. Multi-family units that cash flow are easier find, but they can be in rough neighborhoods. At the my rate of finding a great deal, I probably will put money in syndicators or hard money lending funds in the near future.
I agree that real estate is much more inefficient. There are large risks with miscalculating though. If you buy a money pit, or mid time the market, you can lose big time.
It all depends on two factors:. How well do you understand the market you are buying in and what is your cost basis? Everything can cut into your profits but if there is no value in the purchase price the chance of recovery goes down and you are in it for the long hall. This is fine if the investment horizon is 10+ years, but we don’t have the luxury of time in most circumstances. Risky? Yes, rewarding it done well.
There are opportunities for excess returns to the expert. I’m not an expert but I do buy real estate for the cash flow, tax benefits, learning experience, and diversification.
The risk depends a lot on the magnitude of the cost and the amount of leverage. If you buy a $100K house with cash and it has a tenant paying $1,300 a month (an actual example in my experience) I don’t see a lot of risks.
My name is Tom Peacock from USA, I want to say thank you to Dr Emu for the good thing he has done for me, Though am not sure if this is the best forum to show my joy and happiness for what he has done for me but i can’t hide my happiness and my joy so i have to share it with people, my marriage got crashed about two years ago and i tried all i could within my power but to no avail. I saw a post and testimonial about the good things Dr Emu has been doing so I decided to give it a try. though he is always a busy man but when he responded back to my email, he gave me 48 hours for my marriage to be restored really just like he said my marriage was restored since then I am happy and i am living happily i am so grateful to Dr Emu you can always email him here: {emutemple@gmail.com} or WhatsApp: {+2347012841542}
TRACE AND RECOVER YOUR LOST CRYPTO THROUGH ULTIMATE HACKER JERRY.
Learn more;Web http://www.ultimateshackjerry.com
Last year I stumbled across a cryptocurrency platform Advertisement online and I felt compelled to watch them since I had little knowledge of how profitable cryptocurrency is. I was immediately intrigued by it and decided to invest with the investment firm., on my first trial, I deposited $113,000 to the platform.My profit had accumulated so quickly after 48hrs that I became more interested and decided to add $215,100 to my initial investment.on attaining my profit target I requested for withdrawals. This company then began asking for more funds to activate my withdrawals.This made me suspicious, so I decided to consult a Crypto Expert. I came across Ultimate Hacker Jerry who advised me that I had been scammed but was also an Expert in Crypto Recovery Services. This expert Ultimate Hacker Jerry was able to recover all my Crypto a total of $328,100.I must recommend this erpert to any Scam victim that has been defrauded and have your Crypto recovered back by Ultimate Hacker Jerry.
CONTACT;Mail Ultimatehackerjerry@seznam. cz \
Whatsapp +1(520)282-7151.
HOW I FINALLY RECOVERED MY LOST CRYPTO: I lost all my crypto to a fake investment scam to someone I met online. I started searching for help legally to recover my funds, and I came across a lot of Testimonies about HACKER STEVE. I contacted him, providing the necessary information and it took him and his team of experts about 36 hours to locate and help recover my stolen funds. I am so relieved and the best part was, the scammer was located and arrested by local authorities in his region. I hope this helps as many out there who are victims. I strongly recommend Steve professional services for assistance with swift and efficient recovery (Crypto, Credit card, Forex, NFT, etc) on Gmail: Hackersteve911@gmail.com | https://hackersteve.great-site.net/