Point of View Mature and Yet Imperfect: Real Estate Capital Market Arbitrage

Executive Summary. The familiar boom-and-bust pattern of the real estate market has been tempered recently by an increased amount of discipline administered by the capital markets, and by the debt markets in particular. Additionally, due to the emergence of the public REIT and CMBS markets in the 1990s, and the accompanying proliferation of data concerning not only property market conditions but also capital flows and broader industry trends, the industry's ability to detect property and capital market imbalances has greatly improved. While this is generally a positive for the industry, this informational efficiency has created an environment in which it has become increasingly difficult for real estate investors to obtain excess returns.However, while real estate capital markets are much more competitive than they were a decade ago, they are still exceptionally fragmented due to the unique supply and demand characteristics of real estate properties, markets and real estate-related securities. This fragmentation or “market segmentation” leads to inefficiencies than can be exploited by investors desiring excess returns.In this article, we examine the overall characteristics and trends of the real estate capital markets that have led to increases in efficiency. Subsequently, we explore the inefficiencies and segmentations that still remain in the market, and demonstrate how a general real estate investment strategy can be enhanced by capitalizing on opportunities to arbitrage valuation discontinuities and inefficiencies between and within these segments.