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Investment Real Estate vs. The Stock Market... Which Offers Greater Returns For The Average Investor?

Why do I love investment real estate? Two words... inefficient markets.

Conversely, why is it so difficult to "beat" the stock market? Efficient markets.

For the past 15 years, I have built my real estate investing business on the belief that some markets for investment properties are inefficient, and therefore, it is possible to earn extraordinary returns. (By the way, inefficient real estate markets make for the best real estate markets.) Have I been right?

Well, my first investment in commercial real estate earned me a profit of over $2 million dollars. And much of this profit was, in my opinion, due to my ability to recognize and exploit inefficiencies in certain investment real estate markets.

Does one example prove my theory? Of course not. But for the past 14 years I have been developing and executing a strategy for investing in real estate that has consistently earned my extraordinary returns.

What Are Efficient/Inefficient Markets?

The "Efficient Market Hypothesis" was first put forth by Professor Eugene Fama of the University of Chicago Business School. The basic theory is that prices of assets in an efficient market will always fully reflect the available information, and therefore, earning extraordinary returns is not possible.

For the most part this theory has been attributed to stock markets, or more precisely, individual publicly traded stocks. But it can (and is) applied to other asset classes such as bonds and investment real estate.

The bottom line? No market is 100% efficient. And on the flip side, no market is 100% inefficient. But the reality is that some asset markets are less efficient than others. For example, real estate markets, and certainly the market for more specialized investment properties, are certainly more inefficient than say the market for government bonds.

Why is this?

There are a number of reasons, but here is the main one. The active participants in investment real estate markets do not all posses the same amount and/or quality of information. And as I alluded to above, the more specialized a market is, the more this is likely to be the case.

For example, the market for a basic single family home in a large city will be more efficient than say the market for a large distribution warehouse, in a small community. The information required in order to analyze the warehouse investment is simply much more specialized and difficult to quantify than that of the single family home in this example.

Aside: If you are interested learning more about commercial real estate cash flows and how to capitalize on "inefficient markets", here is an "e-course" I recommend that will get you started in that direction.

What Is Considered An Extraordinary Return In Investment Real Estate?

In general, an extraordinary return is defined as a return greater than the market average. In the stock market for example, if your stock portfolio were to outperform the return of the S&P 500 for example, those returns would be considered extraordinary. With real estate however, it is a little more difficult to determine what the average return is, and hence determine what "extraordinary" returns might be.

So how do I know that my investment real estate returns are extraordinary? I'll let you decide...

Ten years ago I purchased an apartment property which I still own to this day. Without going into too much detail, here is a summary of my returns from this investment property.

  • I purchased the property for $625,000 (which I knew was below market value)
  • I originally assumed the existing financing and refinanced another property in order to come up with the down payment
  • Before purchasing the apartment complex, and using the investment real estate system I had developed, I identified opportunities to immediately add value to the property once I owned it
  • Within 8 months of the purchase, the property was appraised at $850,000
  • At that point in time, I refinanced the property (which was my original plan) and "took out" close to 100% of the money I had originally invested. For this discussion we'll assume it was 100%, although I believe it was in the 98-99% range.
  • For the past ten years I have earned, on average, $35-$45,000 per in net income from the property. And that is completely passive income as I have professional managers in place who handle all of the day to day operations of the revenue property.
  • The value of the property itself has double over the past ten years to approximately $1,250,000
Let's recap.

1. After refinancing the mortgage ten years ago I have none of my own money invested in this property.

2. Over those ten years I have earned a total of over $1 million from that one property alone. This works out to approximately $100,000 per year for the life of this investment.

3. To calculate my average annual return on his piece of investment real estate I would divide $100,000 by the amount that I have invested in the property.

ie. $100,000 / $0 = AN INFINITE RETURN

Knowing this, do I need to know (or even care) what the average return in the real estate market has been over the past ten years to know whether or not I have in fact earned an extraordinary return? Of course not.

How Did An Inefficient Market Play A Role In This?

This property is located in a smaller city for starters. Therefore there will typically be less market participants. Secondly, the property was woefully marketed, which exacerbated the inefficiency in the market for this property.

Investment real estate can be a great way to create wealth and passive income. However, it can also be wrought with pitfalls. My advice to you, if you are interested in real estate as a possible investment, is to educate yourself thoroughly. This includes studying both your geographical market(s), along with investment real estate theory in general. And to do this you do not need to spend $1,000's of dollars on a seminar. There are good courses available online for under $100. Start with this one.

You may also wish to sign up for my free investment real estate newsletter. I am constantly adding information to this site that covers many aspects of the real estate investment business, but with a focus on revenue/apartment properties. You can sign up here if you wish.

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