The Underperformance Paradox: Why Individual Investors Fall Behind Despite Buying Low

These differences form part of the conventional wisdom within real estate investing. However, a historical shortage of data (and data analysis) in the sector allowed such mental models to continue unconstrained by the burden of proof. With a recent positive shift in data availability and scientific rigor, we can fact check these statements and expose them to sunlight, the results of which can inform a more robust investment process for individuals and firms alike.

In the interest of informing this process, this article provides an analysis of 22 years of multifamily transaction records (and an apples-to-apples transaction comparison), suggesting that individual investors materially underperform corporate investors . As we will show, the underperformance cannot be attributed to geography, property vintage, hold period, market timing, property size, or pricing (per square foot)—because all of these variables have been controlled for. Finally, we delve into the possible causes of this underperformance by individual investors and explore the implications of these findings.

METHODOLOGY

Our goal in this analysis is to generate a statistically significant volume of comparable transactions: each individual investor transaction paired with one corporate investor transaction. We control for various factors that may influence investment returns (e.g., property vintage, market timing, transaction year, price per square foot, portfolio transactions, location, and household income) so we attempt to arrive at a true apples-to-apples comparison.

A transactor is classified as an “individual” if the name in the grantor/grantee fields of a transaction record is that of a person or a company registered at a residential address. A transactor is considered “corporate” if it is a company registered at an address of a commercial property (an office or another commercial building). Our research shows that about 20% of all multifamily properties in the US are owned by individuals.

ACQUISITION PRICE EXPERIMENT

Our first question was: do individual and corporate investors acquire multifamily properties at the same price per square foot?

To answer this question, we constructed a parallel dataset of multifamily purchases made by individuals and by corporations (while controlling for key variables), and analyzed the difference in purchasing prices between the two groups. We ensured a robust and fair comparison by checking for potential selection biases.

We started with a dataset of all acquisition transactions on multifamily properties performed nationwide. We excluded small transactions (those with a price of less than $1 million) and removed transactions in non-disclosure states.¹ We also removed transactions with price tags differing significantly (5x or more) from the property’s market value; those that differ might be non-market transactions which we do not want to consider. We then removed all bundle transactions that we managed to detect. We ended up with 42,300 transactions.

From these 42,300 acquisition transactions, we selected only those with populated (and sensible) values of the property size (at least 10,000 square feet), year built (which should be prior to the year of the transaction), and county where the property is located. For each census tract where the transacted property was located, we extracted the median household income value from the National Historical Geographic Information System (NHGIS) and associated the income value with the transaction. We split the resulting transactions to the 3,366 performed by individuals and 13,318 performed by corporations.

For each transaction made by an individual, we looked for a similar transaction made by a corporation, while controlling for:

1. Acquisition year (the two transactions should be made in the same year, or at a one-year difference from each other);
2. Location (the two transacted properties should be located in the same county);
3. Year built (the two properties are built within 10 years from each other);
4. Property size (up to two times larger or smaller from each other);
5. Household income level in the neighborhood (up to two times greater or lesser from each other);
6. Sensible price per square foot (prices per square foot for both properties should be in the range between $10 and $1000, to exclude overly cheap properties, extra luxury properties, and unreasonable cases or data issues).

Once we applied this matching mechanism, we discovered that, on average, corporate acquisitions involved larger properties than those acquired by individuals. To accommodate for that, we randomly excluded some cases when the matching corporate acquisition was larger than the individual acquisition. We ended up with 1,635 acquisitions made by individuals and 1,635 matching acquisitions made by corporations. We then compared prices per square foot in both datasets (Exhibit 1).

We found out that, on average, individuals acquired multifamily properties at $118 per square foot (with standard error of the mean of $2.8), while corporations acquired properties at $128.4 per square foot (with standard error of the mean of $3.1). Median prices are $80.6 and $87.0 respectively. This implies that individuals tend to acquire cheaper properties, as compared to corporations.

We checked for possible selection biases and found none, noting that:

1. Both individual and corporate acquisitions involved properties that were built around the same time (with an average year of 1979 and a median year of 1976, for both individual and corporate acquisitions).
2. Both individual and corporate acquisitions are done over properties of roughly the same size. For individuals, the average size is 77,000 square feet, with the standard error of the mean of 2,000 square feet, and the median of 45,500 square feet. For corporations, the average size is 76,500 square feet, with the standard error of the mean of 2,000 square feet, and the median of 47,000 square feet.
3. Both individuals and corporations made acquisitions in neighborhoods with similar household income (between $64,000 and $65,000 on average, with the standard error of the mean of $600, and between $60,000 and $61,000 as the median).
4. In terms of location, the US state distribution of acquisitions made by individuals correlates well (r=0.76) with the overall US state distribution of multifamily properties (excluding non-disclosure states). By design, the US state distribution of acquisitions made by corporations is identical to that made by individuals (each property in one dataset is matched with a property of the same county in the other dataset).

REPEATED TRANSACTION EXPERIMENT

In the second experiment, our focus shifted to repeated transactions. Specifically, we analyzed properties that were both acquired and subsequently sold by individual and corporate investors.

We recorded acquisition and sale prices for both transactions and asked the question of whether investment returns of individuals are different from the investment returns of corporations. As previously, for each acquisition/sale pair of transactions done by an individual, we match an acquisition/sale pair of transactions done by a corporation.

We started with the same dataset of 3,366 transactions performed by individuals and 13,318  performed by corporations. The design of this experiment was almost identical to the design of the previous experiment, with an adjustment to the first control:.

acquisition year (the two properties should be acquired within 10 years from each other) and sale year (the two sale transactions should be made in the same year, or at a one-year difference from each other).

We discounted larger properties on the corporate side exactly in the same way as in the previous experiment. We ended up with 280 acquisition/sale pairs of transactions made by individuals and 280 matching pairs of transactions made by corporations. We then compared appreciation returns in both datasets (the sale price minus the acquisition price, divided by the acquisition price and multiplied by 100, to come up with percentages).

As shown in Exhibit 2, on average, individual investors had appreciation returns of 62.6%, with a standard error of the mean of 4.6% and a median of 38.8%, while corporate investors had appreciation returns of 79.1%, with a standard error of the mean of 5.3% and a median of 52.9%. Our results indicate that individuals generally earn significantly lower appreciation returns than corporations.