Is Real Estate A Liquid Investment?

Is Real Estate A Liquid Investment?

Posted by on Oct 23, 2020

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As a quick answer, no. Direct real estate is not a liquid investment and is among the least liquid investments you can make due to the amount of time it takes to convert this asset into cash without affecting the price. 

The process of selling a property is extensive: you need to find a qualified buyer, negotiate and agree upon a price, wait out the due diligence period, property inspections, and closing at escrow. It can be months or even years to convert into cash. 

Liquid vs. Illiquid

Would you rather lend $50 to a friend who will pay you back $75 upon request, or would you rather lend $50 to a friend who will pay you back $150 in three years? Many investors choose the former, but both situations have their benefits. When it comes to investing, this example can be compared to liquid and illiquid assets. 

Liquid assets are those that can be converted into cash at fair prices within a short amount of time. Assets that are liquid are also described as “cash-like,” which can include cash alternatives that carry little risk of loss no matter how long they’re held such as CDs, money market accounts/funds, and Treasury bills. Liquidity offers investors flexibility and less potential risk with the possibility of generating a return while still having access to cash when needed. 

Contrarily, illiquid assets cannot be converted into cash in a short period of time without loss in value. These include private equity and venture capital, infrastructure finance, private placement loan issuances, and real estate. Selling illiquid assets is a time-intensive process but there’s a potential for higher returns over time and opportunities for diversification. 

Liquidity Premium 

While the benefit of flexibility in liquid investments sounds attractive, real estate investments can potentially generate higher returns over long periods of time. Because illiquid investments carry additional risks such as market volatility, economic downturns, interest rate fluctuations, and potential default, investors seek higher returns. These return expectations are referred to as liquidity premiums. 

A liquidity premium is additional value expected by investors when an asset cannot be easily sold for cash at fair market value. The liquidity premium is high with illiquid investments, and investors can potentially profit from long-term, illiquid investments because of liquidity premiums. 

Determining Liquidity in Real Estate

For higher levels of liquidity, there needs to be both high supply and demand for an asset. Some factors determine the level of liquidity in real estate such as location, transaction costs, local market dynamics, condition, capital availability, and zoning. 

Real estate investments require more capital than other assets with smaller pools of qualified buyers. Investors need to evaluate a transaction by determining how fast a deal can be made and all contracts finalized, how much it will cost to close the deal, and whether or not the market in that specific location is hot or cold. 

Illiquidity shouldn’t stop you from considering an investment in real estate. While there are risks, there’s potential to generate profit through rental income and appreciation and other possible benefits such as tax advantages and diversification. 

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete, and is not intended to be used as a primary basis for investment decisions.

 


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