Real Estate and Stock Markets are Different – One is Liquid and Efficient. The Other isn’t.

January 26, 2007 –  Buy 10,000 shares of Microsoft for $30.25 per share, and it’s reflected instantly on trading boards around the world. Contract to buy an existing home for the same $302,500 and the result is not made public until long after the contract is signed. Imagine investing that much money in a stock knowing only its selling price of two months ago.

 

In Economics, The efficient market hypothesis says that the price of a financial asset reflects all the known information.  In the housing sector, critical information is delayed by the time span between the selling agreement and the closing date. Regulations and statutes prohibit disseminating the actual selling price earlier. If you’re not plugged into MLS data, as I am, you might have to wait a few more weeks until the sale is reflected on the public information website. Sellers set their asking price based on comparable sales in the area. In a fast moving market, in either direction, this information is dated. It’s hard to set a selling price when you don’t really know what a comparable home is selling for today. Buyers are as much in the dark as sellers.

 

The stock market is liquid. The housing market is not. Try asking your real estate agent to sell your house at the "market price"  tomorrow morning. First, you must do the listing agreement dance to select an agent and set the asking price, followed by days, weeks, or months of showings with, perhaps, a price change or two thrown in. Next are the negotiation and contract followed by the weeks of uncertainty over the appraisal, mortgage commitment, inspection, and repairs. Once you decide to sell a house, the proceeds may be unavailable for months.

 

While the housing market is less volatile than the stock market, regulations limit the amount of leverage available in the stock market. You cannot, for instance, buy stock using a no-down payment, interest only loan with an artificially low front end rate. The potential price decline in real estate is much less than with stocks, but the combination of illiquidity with the exotic loans favored by many real estate investors creates an enormous exposure. And don’t forget to add the higher transaction cost of a real estate sale, plus the additional carrying costs of taxes, insurance and Association fees. Do not invest in real estate if you think it’s a short term investment.