Efficient Versus Inefficient Markets

by Mr. Cheap

I recently read John T. Reed’s “How to Buy Real Estate for at Least 20% Below Market Value” (Vol. 1) and enjoyed it.  He warns that the book is only applicable for buying in America (and actually refuses to sell it internationally, an American friend got it for me for Christmas).  He’s right that the specific techniques won’t work in Canada, however there’s an underlying theme to the book that I think *is* applicable anywhere.

In the introduction he relates when he was a real estate agent and would hear about people buying property for dramatically lower than market value.  He didn’t believe it, as he had access to the MLS and could see what properties sold for (and he NEVER saw a property that sold for much less than market value).  Eventually he realized that the problem was his source of data.  The properties selling through MLS were selling close to market price because it was an efficient marketplace.  In order to buy property for dramatically under market price, buyers needed to go to inefficient, non-MLS markets.

To me, an efficient marketplace is good at bringing together equally motivated buyers and sellers.  Inefficient marketplaces are bad at this, and often goods remain unsold or sell for far less than they’re worth.

I’ve never sold anything on E*Bay (I don’t *THINK* I’ve ever bought anything on it either).  Some of my friends have used it and like it, but I’ve found that typically they either are selling on it (and getting top dollar for what they’re selling) or are using it to buy hard-to-find goods.  I’ve never heard about people getting killer low prices on E*Bay.  Again, this is an efficient market, and its good for getting market price on goods, but not a great place to find deals.  One technique I’ve heard for finding good deals on E*Bay is looking for items that have been misspelled (like a search for “Bufy the Vampyre Slayer”).  If someone posts the item with the name spelled incorrectly, its often overlooked by the majority of buyers, and you have the chance of getting a good deal.  This is an example of an inefficient market hiding inside an efficient market.

The examples he gives in his book are situations like foreclosures, buying properties with title problems, tenants-in-common (when multiple people share ownership of the same property), and execution sales (where a lost legal judgement can be used to seize a property from its owner).  In each of these situations, real estate agents (and the vast majority of buyers) don’t want to touch these properties with a 10-foot pole.  Because of this, it becomes difficult for buyers and sellers to find each other and the opportunity for good deals occurs.

I had a personal experience with this when I bought my condo.  As I’ve related in the past, the place was quite “rough around the edges” when I got it and I got a good price on it because of that.  Most buyers weren’t interested in doing (or supervising) the necessary renovations to make it habitable, so I was only competing with other buyers willing to renovate (which was a smaller group).  This is the whole basis of the flipping strategy, which ironically has become a hard way to make money as more people are pursuing it, increasing competition on available properties, and decreasing the profit.

There are arbitrage opportunities to make money (or a living) by moving goods between inefficient and efficient markets (beyond the property flipping example).  In my home town a used book dealer would visit all the garage sales on weekends and buy cheap books they had for sale.  The sellers didn’t know if they’d be able to sell them in the rest of the day,  ultimately just wanted to get rid of junk more than anything, and would give him a very good price.  He’d then put them on the shelves of his store where they could sit until they found the right person who was eager to read it and willing to pay a premium for the book.  Even in this case, he’s really moved the book from a very inefficient market to an inefficient market.  The efficient market would be the book store that has everything new, and will order whatever you want that they don’t have on the shelf (and charge you top dollar for this convenience).

As an aside, Mike told me recently that he thinks our book reviews are some of our least popular posts and that we’ll do fewer of them in the future.  I’ve since thought that MAYBE people like them, but just tend not to have any comments about them.  If you’ve liked (or disliked) our reviews in the past, please comment below and it’ll probably influence how likely similar posts are to appear on the site.

Be Sociable, Share!

{ 10 comments… read them below or add one }

1 Mike P

I’m a big fan of the book reviews. I read ravenously, so I’m always looking for more ideas of books.

2 Dividend Growth Investor

To me an efficient market is one that brings all the buyers and sellers on one place, all the information is out there and that’s it. This doesn’t mean that one cannot make a ton/or lose a ton just because the market is efficient. Just because you bought a condo for a discount doesn’t mean that your total investment ( price + renovations) wasn’t close to what a newer condo would cost.

3 R I

I like the book reviews. I wish I had the time to read all the books that some bloggers do – so reading the review gives me a condensed version of it. Plus, if there’s a book you’ve reviewed that I really like, I’ll go out and read it.

4 Jasper

Contrary to Mike P, I’m rarely have the time to read. These book reviews allow me to get the essence out of books I likely would never read. On occasion I request a book mentioned in a review at the library and have a closer look. Keep the reviews coming!

I like how you broadened the concepts from this book and applied it to the larger market: those who think outside the box can get some great deals.

5 nobleea

i’ve bought quite a few gift certificates for home depot off ebay. if they’re in the right category, you can get them for 80-85% of face value. sometimes sellers put them in the wrong category. in such cases, i’ve been able to get them for 60-70% of face value.
(despite the horror stories, i’ve never had a problem with over $4000 spent in home depot GCs)

6 Mr. GoTo

Definitely like the book reviews. There is so much to read, it helps to have guidance to separate out the bad reads from the good reads.

7 Aolis

I had heard about the book before and was curious. It was nice to get your perspective.

8 Deb

I vote that you continue to do book reviews – they help me to determine what’s worth my time and what’s not.
Regarding e-bay, I got a great deal on some re-sale window blinds. They were over-sized so very few people could use them (limited market) but they were just right for me.

9 Dillon

I’m a fan of the book reviews.

10 Ray

To be honest, since you asked, I skip all feeds in the RSS reader that say BOOK or Book Review in them. People are addicted to the latest dynamic blog postings and I believe lesser so to the reviews of some static content book.

Leave a Comment

Current ye@r *

Previous post:

Next post: