Monday, November 26, 2012

Efficient Market Hypothesis and the Creation of Multiple Real Estate Markets

Efficient Market Hypothesis and the Creation of Multiple Real Estate Markets

The Board of Realtors®

The first and most obvious source of profitable real estate opportunities exist within each localized market's board of Realtors®.  A market is a place where buyers and sellers come together in an attempt to fulfill individual financial goals.  Semi-strong theory EMH states that buyers and sellers have access to all publicly available information and are able to participate in the market place, excluding insider information.  Does this theory work for real estate?  In a word, no.  Texas is a non-disclosure state, meaning that all information regarding real estate transactions is not available to the public but only to licensed real estate agents.  How does this effect the market?  In addition to several other major contributing factors, such as the uniqueness of each parcel of land, this aids in slowing the transaction speed thus helping to make real estate a non-liquid asset.  Below list some of the attributes of the BOR transactions

  1. Access to information - Restricted to Realtors® 
  2. Transaction speed - Slow, often 2-6 weeks
  3. Capital required - Low, lenders plentiful and funds easily accessible
  4. Opportunity to compare substitutes - High, options period allow for verification of condition

The board of Realtors® is a financial market.  Sellers enter the market with a product, in this situation a house for sale.  Buyers also enter the market with capital ready to purchase these goods.  'Financial institutions lend against real assets, securitize the debt, then sell it as an interest bearing note.   Each city has it's own board which has little to no interaction with boards in other cities thus making each individual area's board of Realtors® it's own independent and self sufficient market place.  Sales records in Texas are not recorded except by each market's BOR which typically only provide access to licensed real estate agents paying dues to that specific BOR.

The compartmentalization of the real estate market as a whole into each area's BOR restricts access for out of area buyers to readily participate, and in many cases, even individuals in that market.  It also allows for very different climates to occure in adjacent markets (such as the real estate markets in Dallas, Houston, Austin, and San Antonio).  Prices, regulations, inventory, lending practices, and zoning ordinances are just a few of the areas in which two markets can differ drastically.  To further complicate matters, products (properties) can not be transferred from one market place to another.  These factors will be discussed later and provide for very unique possibilities that simply do not appear in other markets such as the stock market.

The Foreclosure Auction

As if gaining access to reliable and readily available information did not already seem complicated, there are multiple markets that take place independent of one another in the same geographic area!  These markets also can contain the same products, simultaneously. How is this possible?  When a property is delinquent on debt payments and is filed for foreclosure a completely separate market is created by the judiciary system which investors have come to refer to as Texas Tuesday.  In contrast to the BOR the court auction involves transactions that happen almost instantly and completely in cash.  Information is publicly available to everyone or can be obtained from private providers for a nominal price (I think I paid $15 the last time I purchased a foreclosure listing book).  The court auction does not provide you physical access to the properties making the job of verifying the condition nearly impossible.  Below are listed some of the attributes of the foreclosure auction:
  1. Access to information - Public record, easily available 
  2. Transaction speed - 2-5 minutes depending on length of bidding
  3. Capital required - High, all purchases are cash and non-refundable
  4. Opportunity to compare substitutes - Low, houses are usually occupied and non compliant with investors.

Wholesale Property: The Third Market

The prevalence of investors in the market place leads to the generation of an entirely new and separate market place; the wholesale market.  These are properties that an individual contracts at a low price and then sell their interest to another individual.  These function in a similar way as stock options, futures, and forwards in the stock market in purchasing a contract for a good that can be purchased at some point in the future for a given price.  This produces a hybrid market of the BOR and the court foreclosure process with the following characteristics:

  1. Access to information - Available only through the wholesaler.  
  2. Transaction speed - 3 to 14 days in most cases
  3. Capital required - Medium, financing in the form of interim bridge loans is available
  4. Opportunity to compare substitutes - Generally low.  Depending on the amount of inventory your wholesaler is capable of providing you with.
These characteristics allow for some interesting things to take place.  Firstly, the availability of financing, despite much higher interest rates, allows individuals who wish to be come investors but do not have substantial amounts of capital to participate.  For investors who do have larger access to capital it allows them to minimize their exposure to each individual property.  This can also allow one to diversify their risk across several properties and increase their potential profits via economies of scale.  A longer period between date of contract and closing allows for investors to sort out the most profitable source of funds and to begin receiving bids from contractors so that the day after closing can also be the first day of construction. A large wholesaler can provide you a significant amount of opportunities in your market.  This benefits the investor by allowing them to make a purchase that they truly feel good about and have some time to inspect.

How does someone who simply sells a contract create value for an investor without increasing the value of the property?  Check out my article on Why it Makes Sense to Use an Investment Professional to read more about the benefits of utilizing wholesalers.  They are essentially the "One simple price" guys of real estate.  As opposed to conventional transactions that require submitting an offer and some intense negotiation (especially on the investment side), if you like the product that you see you can purchase it at a set price that day.


  1. Efficient market hypotheses shown by you is too good. Thanks for sharing the information

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