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.

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