I’ve been (rental) house hunting for the last couple of months. I don’t really know anything about real estate investing, but I’ve been trying to read up (John T. Reed’s Best Practices for the Intelligent Real Estate Investor is my favorite so far).

It’s been interesting seeing what aspects of a home (rental or for sale) that I care about are priced in and which aren’t.

Factors which I care about that the market seems to price really efficiently include:

• Square footage
• Neighborhood

Some factors I don’t really care about but get priced into the market efficiently:

• Amenities/”Finishes”
• Nice view

There are also some factors that (in my experience) have very high quality of life implications and basically don’t seem priced in at all.

The big ones I’ve noticed here are:

• Natural light – Fairly clear research that natural light affects mood, but a dark house doesn’t get any discount nor a bright house any premium.

• Intra-neighborhood location – Broadly, neighborhoods seem to have a standard price but location within that neighborhood doesn’t matter much. So, a place that is a 3 minute walk from the pedestrian street with a grocery store and coffee shop is priced the same as a place that is a 15 minute walk.
  
  However, there is an exponential decay function of how often you will use it based on walk time – something that is 3 minutes away will get used 10x something 15 minutes away – and this doesn’t seem priced in at all.

• Design – a house beautifully designed by an architect will be priced the same as a cookie-cutter house thrown up by a developer that is stamping out properties without much thought or consideration.

• Commute Time – It’s not really fair to say this is priced inefficiently because everyone’s commute time is different, but generally people seem to be too willing to take on a longer daily commute for other variables that matter less to overall mood/wellbeing.
  
  If you assume 200 working days per year then the difference between a 10 minute daily commute and 30 minute daily commute is ~140 hours per year. That’s a lot of time to give up.

The process has made me think more about the idea of efficient markets. The strict version of the efficient market hypothesis is obviously wrong and no one outside the halls of academia really considers it (and probably not many within it?)

However, it’s usually a good starting point. If you stumble on what looks like a great opportunity that the market is ignoring, 99 times out of 100, the market as a whole knows something you don’t. So it’s good to start with the assumption that markets are efficient and then work to disprove that on a case-by-case basis.

Even though you’re usually wrong and the market is right, the 1 out of 100 times that you really did identify an inefficiency are worth a lot. They are what Peter Thiel refers to as secrets – things you believe to be true that few others do – and are often the basis for the most profitable “trades” whether that’s an actual trade, starting a business, or positioning yourself in your career.

One interesting place where I think markets are often inefficient is what I call The Illegible Margin. Things that are easy to measure and put into an Excel spreadsheet tend to get priced pretty efficiently. Things that are hard to measure often get ignored.

In the case of residential housing: natural light and design are both very hard to quantify. I think that leads to them largely being ignored. (The lack of pricing good intra-neighborhood seems driven by most people in the U.S. driving instead of walking places so people don’t really care about walking distance. The commute time “mispricing” seems driven by people wanting to live in a “good neighborhood” often driving by school districts).

In the context of careers, new industries tend to be mispriced because the path isn’t very legible. I started learning about Search Engine Optimization (SEO) in 2011 and that was how I got my first job.

At the time, I couldn’t even explain to my parents what SEO was. There certainly weren’t any degrees or formal credentials. Everyone in the field was self-taught.

It wasn’t a particularly bold or savvy bet on my part. By 2011, it was pretty clear that search engines weren’t going anywhere and that more and more businesses would rely on them to acquire customers. It was just illegible and so the competition relative to the demand made it easier to break in and grow quickly.

What opportunities do you see that might be mispriced because of The Illegible Margin? That’s usually where the best investments are.

If you find this idea interesting, see the very related notion of Goodhart’s Law. H/t to Rory Sutherland’s post about inefficient pricing in architecture which got me thinking about this a few years ago.

Last Updated on April 26, 2021 by Taylor Pearson