Definition of "Arbitrage"

Linda Clifton real estate agent
Linda Clifton, Real Estate Agent Berkshire Hathaway HomeServices

Through real estate properties, many individuals of varying degrees of expertise find ways to make money. The real estate industry allows these practices as real estate properties are durable and can be reused. Because of property appreciation, even a homeowner who lived in a home for years during which they renovated parts of the structure can make a significant profit on their resale price.

One of these money-making practices in real estate is arbitrage. When you want to comprehend what is the definition of the word arbitrage, your mind instantly goes towards a referee or arbiter. While the term arbitrage is similar in form to “arbiter”, it has nothing to do with sports. The practice of real estate arbitrage is one of the quickest and easiest ways to make a profit through real estate. Many investors venture down this path as it doesn’t even require their own funds.

What does Arbitrage Mean?

To put it simply, when an investor purchases a property and sells it almost instantly, they’re doing an arbitrage. A real estate arbitrage is all about identifying a property that is listed at a lower price than its fair market price, purchasing it, and selling it at its fair market value. Like this, an investor can turn the arbitrage into an easy cash opportunity.

How Arbitrage Works?

As mentioned above, arbitrage is all about buying and selling a property in the shortest amount of time possible. Sometimes it can take even hours, but the process can be lengthened to days or even weeks. The main principle of the practice is to earn potential profit as quickly as possible.

The arbitrage strategy can be applied to any type of real estate: rental (long or short term), lots, commercial or residential real estate. However, the most common types of properties for which the arbitrage is applied are residential properties that might not be in the best of shapes and are sold below their market price.

Types of Arbitrage

The one thing required for arbitrage to be possible is a pricing gap in the market. The reasons may vary, but a distressed property, a buyer who needs fast cash, or a quickly appreciating neighborhood can result in homes sold for a lower price than their market value. The most significant period for this scenario was just before the Great Recession. Homebuyers and investors could afford homes at low prices, and in a couple of months, the property appreciation increased the value of those homes at an alarming rate. People took advantage of this situation and would buy homes only to sell them a couple of months later at the increased price through arbitrage. However, this type of arbitrage is leaning too much on economic trends and can dramatically impact the industry. The following types are more sustainable and easier to accomplish without affecting the real estate market as a whole.

Wholesaling

As the most common example of arbitrage, a wholesaler puts the property under contract for a lower listing price than its market value, after which they assign the contract to someone else for a higher price. The property did not undergo any alterations or renovations as the wholesaler identified that the property was undervalued.

House Flipping

House flipping is the best-known practice of arbitrage in the real estate industry through which value is added to the property before the resale. The investor purchases the property below its market value, improves and resells it for more than they spent on it.

 

From this analysis, we can see that real estate arbitrage can work as a profitable investment strategy as the investor can make a profit without actually spending money, or they can recover it quickly. It’s up to you if you want to venture on this path, but there are risks involved as in any other investment strategy.

 

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