There are a lot of ways to make money through real estate investing, but few can be done as quickly as real estate arbitrage. Real estate arbitrage is when an investor purchases a property and quickly sells the property for more than it was purchased for. It's identifying a price difference in the market and turning the arbitrage opportunity into cash. Whether you are an active or aspiring real estate investor, learn how real estate arbitrage works and how you can profit from this investment strategy.
How real estate arbitration works
Real estate arbitrage refers to the act of quickly selling a property or piece of real estate for more than it was purchased for. This could be done in a matter of hours, days, or weeks, but generally speaking, the profit should be earned quickly. Arbitrage is a strategy that can be used with a short-term rental, such as a vacation rental, long-term rental property (referred to as rental arbitrage), raw land, commercial real estate, or residential real estate. However, it's most commonly used with residential properties, particularly ones that are distressed and being sold below market price.
Examples of arbitrage in real estate
Arbitrage is made possible when there is a pricing gap in the market. This could be because the property is distressed and needs repairs in order to sell at market value, a buyer who simply needs cash now is willing to sell at a discount, or a property is located in a quickly appreciating real estate market.
Just prior to the Great Recession, property prices were appreciating at alarming rates. Investors and regular home buyers were able to purchase a property, and just a month or two later, the property would be worth more than it was purchased for. Some took advantage of the quickly appreciating market, selling the properties using arbitrage. However, this type of arbitrage doesn't happen commonly in real estate. We now know home prices were being driven in an unsustainable and backed by shady practices.
Wholesaling is the most common example of arbitrage in real estate. When a wholesaler puts a real estate property under contract at a lower price, such as $100,000, then assigns the contract to another real estate investor for a higher price, say $110,000, they are using arbitrage to make money. The wholesaler did not do anything to add value to the property; rather, they identified that the property was undervalued.
House flipping is another example of arbitrage because value can be added quickly to an investment. With this strategy, an investor purchases a property below market, makes improvements, and sells the property for more than they invested into it.
Why use arbitrage to invest in real estate
Real estate arbitrage can be an appealing investment strategy because an investor can create profit without having to put any of their own money forth, or they can recoup their investment back rather quickly. Making it fairly easy to create a real estate business around these strategies.
However, it's important to understand the risks involved. An investment that hinges on a specific valuation doesn't take into account natural market corrections. Investors who utilized short-term gains just prior to the Great Recession in 2007 and 2008 were hit hard and likely stuck with properties with far less than what they were purchased for. Rental property is often viewed as a much safer real estate investment in the long term that can provide passive income and cash flow, with the potential to utilize arbitrage in unique situations. There isn't one perfect way of investing, it's a matter of finding the right strategy for your risk tolerance and business goals.