In real estate, when you wholesale or sell a property, you are actually participating in a type of real estate arbitration. However, this is not the type of arbitration that I am referring to here. The type of arbitrage I’m referring to takes place in the rental market.

So how does the real estate arbitrage strategy work in the rental market?

With this strategy, you buy a property for a certain amount. However, instead of renting the entire property to one tenant, you rent different parts of the property to different tenants. This allows you to generate higher monthly cash flow due to savings at scale.

In any rental market, the smaller the unit size, the more money you earn per square unit compared to similarly larger units. A tenant who rents a 1-bedroom apartment will generally pay more per square unit than a tenant who rents a 2-bedroom apartment in the same market.

Here’s an example of how this works.

Suppose you are looking to buy property in Forest Hills, New York, a good upper-middle-class neighborhood in New York City. Here are the average rents for apartments in this area:

1BR – $1300 to $1400/mo

2BR – $1400 to $1600/mo

3 BR – $2000 to $2500 a month

House 3 BR $3000 to $3500 a month

The average 3-bedroom, 2-bathroom home costs $700,000. Just the mortgage based on 6.25% interest rate and 20% down payment will be over $3400 per month. If you rent this house to a tenant, even if you can get $3500 a month, you will still have a negative cash flow property.

On the surface, this doesn’t look good for you as an investor. If the homeowner is unable to sell the home, you as an investor must pay the lien before you buy the property. Depending on the terms of the deal, this may not be feasible.

However, before you make the decision to back out of the deal, there are certain things to know about trial bonds that could have a big impact on your decision.

If you come across a property that has a judgment lien filed against it, your first step should be to find out how much all the liens on the property are. Then consider the amount you are buying the property for, as well as the full market value of the property. Depending on the With the Real Estate arbitration, what you would do is rent the rooms to three different tenants. Each tenant would have exclusive use of the bedroom and shared use of the rest of the house.

Suppose you charge $1,300 per month to each tenant. Multiply that by 3 tenants and the monthly income for this property is now $3900 per month. Whereas in the first scenario, this property would have produced a negative cash flow, in the second scenario, this property would have produced a positive cash flow.

Is a house out of your budget? No problem! You can buy an apartment and implement this same strategy. You can buy a 3-bedroom condo for $500,000. With a 20% down payment and an interest rate of 6.25%, her mortgage is just over $2,400 a month.

Just like the house scenario, trying to get cash flow positive by renting out the entire apartment to one person will be difficult at best. Even if you charge $2500 per month, you’ll still experience negative cash flow when you factor in taxes and insurance.

Once again, the arbitrage strategy also works in this scenario. Using the arbitrage strategy and renting the apartment to 3 separate tenants, even if you only charge $1000 per month, you would still have positive cash flow from the unit overall.

There are some investors who take this strategy to the extreme. For example, I have seen some investors put up to 2 beds in each bedroom, plus 2 additional beds in the living room. The investor rents it for $500 per month per bed to 8 different tenants. With the apartment scenario, even if his expenses were $3,000 per month, in this scenario the investor would still have a positive cash flow of $1,000 per month.

Personally, I don’t recommend that strategy, as it may be illegal in many areas of the country. You will need to check the laws in your area. Also, a strategy like that would only work if it targets specific communities that don’t care about shared housing. Two examples are college students and immigrants who have just moved to the country or are temporarily in the country on a student or work visa.

In addition to the added cash flow, another advantage of using the real estate arbitrage strategy is the lower vacancy costs. If you rent an apartment from a tenant and that tenant moves out, that apartment does not produce any cash flow while the property is vacant.

With the arbitrage strategy, if one of your tenants moves out, instead of having an empty apartment that produces zero cash flow, you have an apartment that still has other tenants paying rent. While you won’t receive the full cash flow during this period, the good news is that you will at least receive some cash flow instead of none at all.

There are also some drawbacks to this strategy. For example, if there is property damage, there is really no way to know who is responsible for the damage unless the damage is to one of the specific rooms. Trying to prove that in court or penalize all the tenants can be difficult depending on the laws and regulations in the area you want to invest in.

Finally, you should keep in mind that the arbitrage strategy works in other ways as well. For example, if you have commercial space, you can rent some of the space to another company. I’ve seen some homeowners even set up a single desk and phone line and rent the desk out to a business owner who wants an office but really only needs a desk. Get creative and you will find many ways to use this strategy to profit from your real estate investments.