Insider Trading: The Secret Weapon of the World's Most Successful Real Estate Investors
In the world of investing, insider trading is often thought of as a taboo, if not illegal, activity. However, for the most successful private market real estate investors, insider trading is a secret weapon that can give investors an edge over their competition. Of course, in the public markets, whether real estate or otherwise, insider trading is illegal.
In the private (i.e. non publicly traded markets) market, the key is to obtain this information before it becomes public knowledge. Once it's out there, competition to buy a property or make an investment will typically increase, driving up the price and thus reducing profit margins.
So, how does an investor get his or her hands on this valuable insider information? Please keep reading to learn the answer to this question and much more.
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What Is Insider Information?
What is insider trading in commercial real estate? It's simply taking advantage of valuable information about a particular asset before it is available to the general public or broader real estate investment community. It can come from various sources, including brokers, property managers, lawyers, accountants, financial advisors, industry insiders, government officials, and any other persons who might have some inside knowledge about a particular property, seller or transaction.
The key to capitalizing on such insider information is to act on it quickly and efficiently. Here are a few examples of how a real estate investor could profit from insider information when buying a property:
- Learning that a property will be coming to market before it is widely marketed.
- Accessing key financial data about a property before it is provided to others.
- Understanding the particular motivations of a seller.
- Getting wind of an upcoming zoning change that might affect a property's value.
- Having first-hand knowledge of actual rent and sales comparables, which data are often manipulated or distorted in published reports.
Why Insider Trading Is Legal in Commercial Real Estate
In the world of investing, there are a lot of different strategies and tactics that can be used to make money. For example, some investors are contrarians (they buy when others are selling and sell when others are buying), while others focus on finding undervalued properties and holding onto them for the long term. And then there are those who utilize insider information to their advantage.
Insider trading is illegal in the stock market because it gives an unfair advantage to those with access to material, non-public information. This type of information is not available to the retail investor and would give insiders an unfair advantage when making investment decisions.
However, trading on insider information is perfectly legal in private market real estate. This is because most private market real estate deals are assumed to be between sophisticated parties, each of whom are typically represented or advised by attorneys and licensed real estate brokers who have a duty to disclose all material information in their possession to the parties.
So, the key takeaway here isn’t whether or not insider information is ultimately disclosed to all serious buyers - it usually is. The main value for successful CRE investors is having early access to such insider information – in other words, having a head start on the competition and thereby potentially gaining an early advantage to close an attractive investment.
How Top RE Professionals Use Insider Information to Gain a Competitive Advantage
Privatel real estate investors who have an inside track on proprietary information about a property, a seller, an off-market listing, advance notice of an upcoming sale offering, and other key elements of a transaction, can gain a significant competitive advantage. Here are three ways that savvy insiders use such information to their advantage:
Identifying prime locations: Insider information can provide an investor with unique insights into local market conditions, trends and other key market data that may not be readily apparent to outsiders or the broader universe of buyers. Such information can then be used to buy property in these neighborhoods before prices respond.
Anticipating changes in demand: By tracking the expansion plans of local businesses and planned nearby commercial development activity, private real estate investors can anticipate potential changes in demand for different submarkets and property types. For example, if a major employer is planning to significantly expand its workforce in a particular submarket, that could potentially increase demand for a range of real estate product types in that submarket, including office, retail, industrial, lodging and residential.
Getting early access to “pocket” listings and other off-market acquisition opportunities: This is perhaps the most valuable form of insider information for commercial real estate investors. The marketing and sale of Southern California apartments is dominated by a large and fragmented pool of local brokers who tend to specialize in particular neighborhoods and property types (e.g., larger Class A assets in the peripheral submarkets or smaller infill Class B/C properties). Paladin has earned a reputation among the brokerage community as a strong, highly credible buyer that does not re-trade transactions once placed under contract. As importantly, we are also widely known for protecting our broker relationships (e.g., among other things, we typically allow the listing broker to represent us in a purchase, thereby allowing them to “double end” the transaction and receive a full sales commission – more on this below). As a result, brokers frequently give us a first look at any new deal before formally bringing the offering to market. This, in turn, gives us a few weeks head start in underwriting a potential acquisition opportunity, with the goal of allowing us to place the property under contract before it is broadly marketed to other buyers. This allows us to avoid auction-type buying scenarios that can bid up the purchase price beyond our comfort zone.
How Do You Know if You Have Reliable Insider Information?
Saying that information comes from the "inside" is one thing, but how do you know if that information is truly reliable? For example, what's to keep a listing agent from telling you - and 100 other people - about an off-market property for sale?
As described above, the Southern California apartment market is broker controlled and highly fragmented. So, it is essential to have strong relationships in the brokerage community that are firmly grounded on prior experience, mutual trust and integrity. In a market dominated mostly by “mom and pop” investors, many sellers and most brokers are motivated by certainty of closing with credible and strong buyers like Paladin. And yet, trust and integrity are two-way streets. If a broker has a reputation for misrepresenting information about properties or market comps, larger sophisticated investors like Paladin won’t waste time on their offerings and, as a result, they will lose access to an active, repeat regional buyer relationship that otherwise could have been quite profitable.
Paladin Realty is an institutional-quality real estate investment firm with a proven track record of closing dozens transactions in Southern California since 1995 and the capital to close deals quickly. This gives the listing broker and their clients the peace of mind that their investment is in good hands with Paladin and the transaction will be completed as agreed upon. Most sellers actually accept the most credible offer, even if it may be at lower offering price, because of this certainty. Closing these transactions can often take months, and if a seller accepts an offer that ultimately doesn’t close, the seller must start the process all over again. Certainty is important to most sellers, oftentimes, more important than price.
When it comes to buying properties, we generally avoid taking part in auctions or widely marketed listings. If an opportunity we are underwriting turns into an auction, we will bow out and tell the broker or seller the price we would be willing to pay, which may not be the highest offer they receive. For example, there are many 1031 tax-deferred exchange buyers in the Southern California market who are not nearly as sensitive to purchase price as we are. Frequently, transactions with such exchange buyers fall through and brokers will bring the deals back to Paladin. If market conditions haven’t changed and we aren’t focused on other higher priority transactions, we will usually stand behind the price we originally quoted.
As a private equity real estate sponsor who has been through the process of buying and selling numerous off-market listings, Paladin knows that, in addition to certainty of closing, a second and important motivational factor for brokers is what they can earn on a transaction.
The fact is that off-market listings and first-look opportunities come from listing brokers in a broker-controlled market like Southern California. Many times, smaller buyers and exchange buyers are represented by a broker other than the listing broker. The listing broker will be obligated to share, typically, 50% of the commission with the broker who brings the buyer to the transaction. Paladin will typically allow the listing broker to also represent us, as the buyer in the transaction. By doing so, the listing broker earns 100% of the commission rather than the more typical 50% (known as “double ending”). Plus, when the time comes for us to sell the property in three to five years, we will typically list the property with the same broker, so long as such broker remains an expert in that local market. So, the broker can potentially earn three commissions over a few years with Paladin, versus only one commission from the initial transaction if sold to another buyer.
To be clear, brokers have a fiduciary duty to put their client’s interests first and must disclose any dual agency relationships to sellers when presenting offers, and the seller makes the ultimate decision. However, certainty of closing with a strong and reputable buyer like Paladin is paramount for brokers and is an important consideration for sellers too, especially given the number of undercapitalized and “flaky” buyers in the market. Having said that, knowing that their commission will likely be greater by closing with Paladin, does tend to motivate brokers to give us a first look ahead of other potential buyers.
Where To Get Access to Insider Trading Information for Private Real Estate
Paladin Realty is an excellent option for family offices, high-net-worth investors and institutional capital seeking to invest in private real estate in the large Southern California apartment market. The firm is a U.S. SEC Registered Investment Advisor with a nearly 30-year track record making value-added real estate investments in the United States and select markets in Latin America, with a particular focus on workforce housing.
In the U.S., we renovate and reposition older “Class B” and “Class C” rental apartment properties that are under-performing their market potential. Since 1995, we’ve acquired over 90 properties totaling more than 15,000 units and $800 million of cost, half of which were located in Southern California. In Latin America, the firm has developed nearly 40,000 for-sale housing units in seven countries, as well as select commercial properties.