The question of what is arbitrage reveals far more than the definition itself. We’ll be dealing with the details and significance behind it here.
Table of contents:
- What Is Arbitrage?
- Types of Arbitrage in Real Estate
- The Benefits of Arbitrage in 2022
- How to Get Started in Real Estate Arbitrage
- Final Thoughts
Whether you entered the real estate business years ago, or you’ve just decided to take an interest in expanding your knowledge on the matter, you are bound to come across the term “arbitrage” somewhere in-between the lines.
In the simplest sense, it has to do with buying and selling real estate properties and walking away with a satisfactory profit—hopefully. What real estate investors are interested in when it comes to this type of strategy is the secret of successful arbitrage.
To get the full answer to that question, we will need to break down the topic into meaningful segments—and start by focusing on what is arbitrage, how it works, if it can be applied to any type of real estate property, and more.
To get the full picture of arbitrage in real estate investing—and pick up some useful tips that you can use in your investing career—continue reading.
What Is Arbitrage?
Isolated, the term arbitrage has a financial connotation, and it means “to buy and sell.”
The term heavily relies on the theory of efficiency.
To put it into context, arbitrage is when a trader buys and sells an asset at different locations, at the same time. The anticipated outcome is the price difference from which the trader attains profit.
But, in order to achieve this, the trader must find an efficient market for it. Luckily, today, new and efficient strategies are changing the course of how business is handled—creating new opportunities to increase profits and generate a steady income.
A rule of thumb here would be that arbitrage implies overlooking multiple assets across different markets and building a strategy that involves simultaneously buying and selling them at a more expensive price.
To open up the topic of arbitrage appropriately and make a clear connection with our main focus—real estate investing—let’s start by posing the following question:
What is arbitrage in real estate?
In real estate, an arbitrage involves an investor locating long-term properties. They would then either buy and then sell it for a higher price, or rent the property to rent it out to another party via subletting.
What might be of concern to all parties involved in the arbitrage process (the initial property owner, new host, and renter) is its validity.
With that in mind, is arbitrage legal?
We understand why this may seem like a skeptical idea to most newbie real estate investors. The principle by which this strategy works does not exactly coincide with the traditional types of investing strategies.
Although real estate investors might be baffled by this proposition, it’s 100% legal to rely on this profit-generating opportunity.
In fact, it’s been used for a long time now, and it promises the investor a positive outcome—if you take the right steps, of course.
We’ll get around to mentioning them, as well.
But first, you’ll need to tell the property owner whose real estate caught your eye what you’re planning on doing. That means being completely honest with them and explaining the means of how you plan to develop your strategy and generate income.
Honesty is definitely the best policy—that goes for any real estate business, as well.
Now, to be quite honest, you’ll likely come across property owners that deem your arbitrage strategy incompetent or just unacceptable.
If this happens, you’ve got nothing else to do than just walk away with dignity—however hard it may seem to pass on a project like that.
Avoiding this advice, though, and going through with this by keeping it under the radar is not the best idea. Although this strategy is generally legal, keeping it a secret is bound to get you into trouble.
Types of Arbitrage in Real Estate
Now that we’ve covered the introduction of what is arbitrage in real estate investing, it’s time to discuss the most common types of arbitrage.
And in today’s real estate climate, the four most popular types are wholesaling real estate, flipping houses, master leasing, and Airbnb arbitrage.
Wholesaling Real Estate
The first type of real estate arbitrage is the so-called wholesaling.
Above all, this is a tempting opportunity for “newbie” real estate investors to make their way into the real estate market confidently and at the same time without having to invest a large initial capital.
The goal of investors with this strategy is to find investment properties on the market that are deemed undervalued and sell them for profit.
Now, the selling process is not what you’re thinking of here.
The agreement involves the seller and the wholesaler. The wholesaler is actually more of an intermediary in the story, and they sell the property on behalf of the property owner, which is the seller.
The contract stipulates the date and minimum amount of money that the seller wants to get out of the property. So, the investor’s primary aim is to sell it at a price above the minimum.
Here’s an example situation:
Let’s say that you’re an investor looking for wholesaling opportunities, and you come across a distressed home with its owner ready to sell.
However, the owner doesn’t have the means—or time—to renovate the property.
You can then buy the property for a lower price to compensate for the work that needs to be done—and sell it to someone else who’s also ready to put in some extra work and rehab the property for a higher price.
The flip-and-fix project is the third and probably the most popular choice among modern-day real estate investors.
It’s not exactly leasing the project and renting it out—but it’s another way to make money.
Becoming familiar with the arbitrage definition is the first step; we have that covered by now. The second—and the most crucial—step is connecting that to flipping houses and making a profit.
Here’s what you need to know:
The investor searches for properties—commonly distressed ones. The best way to find them would be through foreclosures and property auctions.
That automatically means that you’ll be buying the property that’s undervalued—so naturally, there’s room for profit.
Here, however, you are expected to renovate the property and pay for the necessary repairs and installments—making it look presentable for the future buyer. Basically, you are restoring the property’s old value and making it even more appealing to potential buyers.
Another arbitrage opportunity involves master leasing. It’s a whole different arbitrage situation than wholesaling and house flipping.
Master leasing doesn’t necessarily involve buying the property. That could end up being the case in the end, sure—but that’s up to your preferences.
In theory, “master leasing” means that you’re acting as the temporary owner of the property you have rented out from the actual property owner. So, with your landlord’s permission, you can rent out the property to other tenants.
And depending on your agreement, you can also modify the property.
Unlike the previous two, this rental arbitrage strategy implies entering into a different agreement with the primary property owner.
With master leasing, there are two types of agreements you should know about:
There’s the “Performance Master Lease,” where you pay the landlord a percentage of your profit once you have received the rent from your tenants, and the “Fixed Master Lease” that obliges you to pay a percentage even if you don’t make any money from sub-tenants.
Here’s how this could play out for the investor—provided that they are familiar with what is arbitrage and understand the specifics of the agreement:
The investor locates a profit-making property—usually a single or multi-family home—and decides to enter into one of the agreements with the homeowner. The investor is granted the authority to rent out the property to sub-tenants and make the necessary adjustments.
You can increase the potential property value here and any extra profit goes directly to you.
You may also offer to buy the property later on.
Once you’ve delved into the topic of “what is rental arbitrage” in more detail, it’s much easier to understand how wholesaling, flipping houses, and master leasing work, and whether this is something you could work around.
We’re down to our last type of arbitrage.
What is Airbnb arbitrage?
In the shortest possible way, it implies renting out an Airbnb home without actually owning the property.
As one of the most popular types of attaining profit, Airbnb arbitrage involves real estate investors renting properties and then subsequently subletting them on short-term rental websites like Airbnb.
As we’ve already mentioned, it’s 100% legal and already known and practiced in the real estate market. Short-term rentals have been present since the 1960s, however, their profitability has spiked special interest among real estate investors in recent years.
This type of arbitrage appears attractive because real estate investors do not have to buy a property. Instead, they can rent one and list it on Airbnb where they could earn more than the rent costs.
The Benefits of Arbitrage in 2022
Using arbitrage in the real estate investing business is a way of attaining profits year-round, and fast. Even in 2022, investors are gladly taking up this strategy. Here are some of the notable benefits that come with it:
For starters, this type of strategy doesn’t involve considerable upfront investments. And that means there is no need for investors to meet up with multiple lenders and negotiate on getting approved for a loan that may lead them into debt rather than profit later in business.
Also, there’s the relief from paperwork.
Although part of the responsibility is now on you, the property owner still has to deal with HOA fees, mortgage payments, etc. You just have to pay your share and put your earnings in your pocket.
Are There Any Risks?
Hearing about it for the first time makes it sound too good to be true. However, learning the risk Arbitrage may have will help you take into account potential obstacles, which are inevitable.
The biggest mistake would be to decide on the wrong real estate market, that is, to opt for arbitrage in a market where the demand is low. This automatically leads to little to no bookings at all.
The two misfortunes combined mean that you’ll be losing money.
Another disadvantage has to do with property damage. Because you’re the main leaseholder, you’ll have to pay for repairs—no matter whether the damage was intentional or accidental.
How to Get Started in Real Estate Arbitrage
We have successfully gone through what is arbitrage in theory and discussed some possible routes you can take as an investor.
Now, it’s time to focus on some realistic aspects, starting with the question:
How to get started?
If you’re unsure where to start, we’re here to get your arbitrage business off the ground:
Step 1: Decide on the Strategy
Now that you’re 100% familiar with what is arbitrage and its main types, you should build up a strong and profit-making strategy.
The absolute first thing you should do is make up your mind whether this should be a fix-and-flip project, master leasing, or Airbnb—whatever suits your preferences.
If you choose either master leasing or Airbnb arbitrage, you should know that the legal side of it is unavoidable, and you’ll be expected to enter into a contract with the property owner. So, our advice would be to proceed with care when examining the property and develop a strategy.
Step 2: Find a Profitable Area
Next, you need to perform thorough market research on profitable locations near you, depending on your strategy.
It would be desirable for the focus to be on locations with 65%+ occupancy rates for Airbnb, or those with a high price to rent ratio.
You should have a few additional factors in mind that can help you easily locate the city that would generate the most profit during your search. For example, an area with at least 2,000 Airbnb listings would be considered travel “hotspots” and can guarantee a steady revenue for your Airbnb arbitrage.
Mashvisor’s most valued asset is that it helps real estate investors locate both short- and long-term properties within minutes. It does so by collecting accurate real estate data and conducting reports that would have taken up a month of your time.
What’s more, interactive filters will help you to pin down the location that fits both your budget and personal preferences.
Step 3: Talk to the Property Owner
Having open and to-the-point communication with the property owner once you’ve reached common ground is essential. You must be completely honest about your intentions—and suggest a fair deal.
What can make or break your investment strategy, though, is the property owner information you have at your disposal.
Mashvisor offers real estate investors a helping hand during their property research. By clicking on the property owner, you’ll be redirected to their page, where you can find all the relevant homeowner’s data you need to reach out to the seller.
If the lead is qualified, a well-developed strategy will ensure profits for both parties.
How to Appeal to Property Owners
Now that we’ve almost wrapped up the topic of what is arbitrage in real estate, let’s switch our focus to a couple of additional tips that you should always keep in mind.
Here’s what you must not forget if you’re considering Airbnb arbitrage.
To show that you’re serious about your intentions and that you’re not looking to deceive the property owner, be sure to suggest profit-sharing. That could work out well if you want to engage in master leasing, where it’s more or less obligatory and expected from the investor.
If your property owner is security-conscious, it would be a good idea to propose an additional layer of security to seal the deal. We’re referring to third-party insurance here.
That ensures protection for almost every possible scenario, and it goes in your favor, too.
Moreover, if your initial arbitrage risk has turned into a successful collaboration and business with the property owner, you should consider taking on additional responsibility. In case your business partner owns more than one property, you can propose an expansion.
Be mindful of these suggestions before you decide to take on an arbitrage strategy.
To get a head start on your strategy, sign up for our 7-day free trial.
We’re ready to conclude the topic of what is arbitrage, the types of strategies that are most commonly applied in the real estate business, and whether this trend will continue to attract real estate investors.
Arbitrage in real estate is a type of investment strategy where real estate investors find new investment properties, rent them, and then sublease them with the consent of the property owner. Another possibility is to buy and sell the property for profit.
The four most popular types of arbitrage are wholesaling real estate, flipping houses, master leasing, and Airbnb arbitrage.
But to get the full idea of each one, you should first be familiar with what is arbitrage—and we’ve dedicated our time to explaining everything that you need to know on the matter.
There’s certainly potential for arbitrage strategies in 2022—and one of the main benefits is that it doesn’t require risky or high upfront investments. With a well-developed plan and legalities taken care of, you can count on high returns.
To choose the Mashvisor plan that best fits your needs as an investor, click here.