Do Short-Term Real Estate Investors Outperform the Market?

Abstract

Some real estate investors engage in short-term trading in spite of the high transaction costs that this involves. While previous studies have identified various incentives that encourage short-term investors to engage in these practices, there has, to date, been little investigation into the influence of different market conditions over their performance. Based on real estate transaction data from Hong Kong, this study finds that buying and reselling within three months produces, on average, a gross return of 6% above the market. Three economic conditions are shown to be favorable to their performance: 1) comparable transactions are scant; 2) prices are more dispersed; and 3) market prices go down. Further analysis reveals that these short-term investors make a greater profit from purchases than from resales. While it is beyond the scope of this study to pin down the strategy adopted by each investor, the results are consistent with a “search” explanation, according to which, short-term investors behave as if they were arbitrageurs capable of exploiting the valuation spread between buyers and sellers.

Keywords:

• Trading strategy
• search
• information asymmetry
• real estate

JEL Codes:

• G14
• D83
• R30

Notes

1 The round-trip transaction cost in Hong Kong is about 4.5%. More details will be given in the Data section.

2 Real estate short-term trading is not arbitrage as defined for the securities market in a strict sense, as it is not risk free. Instead, short-term investors have to take the risk that the equilibrium market price may shift during the short period between buy and sell.

3 A possible way for arbitrageurs to hedge the price risk is to become real estate agents, who do not hold the property but earn a fee by matching buyers and sellers. In reality, some agents also engage in short-term trading.

4 Cosmetic repairs (for example, cleaning, removal of old furniture, and minor repairs to ceilings, walls, and floors) are usually made to improve the marketability of a property. This, however, does not necessarily provide extra return to short-term investors because most other sellers would do the same.

5 Depken et al. (2009) show that the average excess return of flipping real estate is time variant and highly correlated with market conditions, though they do not explain why.

6 We did not specifically characterize owner-occupiers in this market, as they are unlikely to be better informed. In terms of search effectiveness, owner-occupiers do not typically differ from ordinary investors; hence, they are considered as being part of the category of ordinary investors.

7 Refer to Chau (2006) for the index values and for details about the construction of the index.

8 See Depken et al. (2009), Bayer et al. (2020), and Fu and Qian (2014).

9 The Hong Kong government implemented the Special Stamp Duty (SSD) policy, which was aimed at suppressing speculation. If a property was acquired between November 20, 2010, and October 26, 2012, the SSD chargeable is 15%, 10%, and 5% for properties held for 0–6 months, 6–12 months, and 12–24 months, respectively. The rates were increased to 20%, 15%, and 10% on October 27, 2012.

Inland Revenue Department, The Government of Hong Kong SAR, 2017.

10 Similar to the filters of the excess returns, observations in which the purchase discount or the resale premium were larger than 1 or smaller than –0.5 were discarded.

11 The large standard deviations of the purchase discount and resale premium seemed to make both statistically insignificant. This, however, was due to the “noise” introduced by our repeat sales approach of estimation. In an unreported analysis, we ran a hedonic model with dummy variables that indicates the purchase and resale of short-term trading, respectively, based on the overall transaction records. The hedonic estimation of the purchase discount was 6.2% and the resale premium 2.5%, both significant at the 1% level. The purchase discount and resale premium estimated by the hedonic approach added up to 8.8%, close to our repeat sales estimation of the gross excess returns.

Additional information

Funding

This project was financially supported by the General Research Fund (Project Reference: 17204419) and Shanghai Pujiang Talent Plan (CN) (Project Reference: 2019PJC043).