“It takes money to make money.” If you’re familiar with the corporate world and fundamental investment tactics, you’ve definitely heard that statement. It’s also incredibly useful and valid in the real estate market. Why? Because acquiring rental property, whether it’s a single-family house, modest multifamily, or a 300-unit apartment complex, will almost certainly need a down payment and some cash.
As a result, it costs money to make money. With money locked up to buy property, the question of “Is real estate liquid?” arises. Investors select investment property based on two criteria: yield and liquidity. While yields provide income and cash flow during ownership, liquidity affects the investor’s performance after departing the business.
For many years, real estate has been a profitable investment destination for many investors. This is because land and property as an asset tend to appreciate over time generating high returns. While investing in real estate, investors often look at two main factors- yields and liquidity. Yields or return on investment (ROI) determine the revenue and the cash flow that is generated during ownership, while liquidity decides the investor’s profit (takeaway) when the property is sold. When it comes to real estate investing, liquidity should always be a factor to consider. Crowdfunded real estate investing offers the potential for large profits, but you must recognize that you will be in it for the long haul. Publicly traded REITs, on the other hand, have slightly lower projected returns, but they are readily sold.
Liquid real estate property is the type of property that is easy to sell and buy at market value. Illiquid properties, on the other hand, are those that are difficult to sell and transact at a discount.
When liquidity is such a big concern, how do we ascertain the liquidity of our real estate investments? In this article, we discuss liquidity in real estate and factors to look for in a property to determine its liquidity.
What exactly is Liquidity in Real Estate?
Liquidity refers to the ease with which an asset can be traded for money. Money is the most liquid asset since it can be traded for other assets the quickest. As compared to other forms of investments (stocks, bonds, etc.), real estate is certainly less liquid. This is because it requires a higher capital to invest in (in case of purchasing property) and in some cases entails a lengthy procedure to find buyers, perform legal obligations and complete the sale.
Moreover, property assets are often restricted to their current position (immobile) and are subject to market fluctuations. However, a certain level of illiquidity offered by real estate ensures that the investors stay patient and earn highly lucrative returns as the property appreciates over the years. Real estate is the form of investment that offers long-term asset appreciation.
Liquidity in real estate also depends on the type of asset class. This means that different types of properties have different liquidity. For example, residential properties are more liquid than commercial real estate as they require comparatively less due diligence, fewer transaction fees, and are comparatively more immune to unfavorable market situations. On the other hand, some commercial properties may have greater liquidity as compared to certain high-value luxury assets. Thus, the liquidity risk associated is different for each asset class.
Why is real estate an illiquid asset?
Real estate is considered an illiquid form of an asset when compared to other types of assets due to reasons that are specific to this particular sector and market. The following are two major reasons explaining why real estate is comparatively illiquid.
- Prevalence of Private Markets in Real Estate: Many real estate deals, unlike most shares, take place in private markets whereas, shares are publicly traded on online platforms. Private markets are priced on an “as-needed” basis and lack transparency, on the other hand, public markets offer regular pricing and comprehensive customer awareness. Private markets are often more difficult to access since many need a certain level of reputation or ranking. This means that buyers and investors often have to conduct a proper market survey, conduct due diligence, inspect the property in person, find and get in touch with brokers and real estate agents before investing. This can be quite time-consuming.
- Complex Transaction Procedure & Funding: As you might be aware, real estate deals entail a variety of parties and a large amount of paperwork. The process of structuring a bid, organizing funding, and performing the required due diligence could take weeks, adding to the inability to convert real estate into cash quickly. Also, there is no denying that real estate is costly and requires a significant amount of capital while investing. Transactions generally take longer to complete when a large sum of capital is involved.
What are the Factors That Determine Real Estate Liquidity?
Liquidity is often affected by the place, condition, and dynamics of the local market. However, due to the variety of types of properties on the market and different factors governing each type, it is difficult to evaluate liquidity in terms of price. Each property’s price in the market is determined by the location that it is set in, the amenities that it comes with, ease of transaction, market condition, and time of sale. Therefore, it is difficult to generalize and state a standard method of evaluation however, here are some points to consider when assessing a potential investment.
- Easy Transactions: The time taken to process the transaction is an important factor to consider before finalizing the deal on your potential investment. Determine the amount of paperwork, legal obligations, and how much value does the deal hold for you as an investor. The simpler the process, the quicker the transaction and the more liquid your investment becomes as potential buyers would look for hassle-free transactions.
- Assess Overhead Costs: Before finalizing your deal assess the costs involved in the completion of the transaction (for example- taxes, registration fees, broker’s fee, etc.) and overhead costs involved in the maintenance of the property. When you understand the various costs involved, you will be able to explain and list the same to potential buyers in the future and this will save considerable time. Moreover, the simpler the steps involved in the transaction, the quicker it is, hence, look for properties with less overhead costs.
- Stay Up-to-date With The Market Trend: It is important to buy and sell your property during favorable market conditions. Market trends are cyclical and while trying to sell your property you must consider these trends to ascertain the best time to sell. Conduct due diligence while analyzing the real estate market trend to determine whether the property that you are considering is in high demand. If the property you are planning to invest in now, is highly in demand then it is likely that it will attract the same level of demand when you try to sell it. This is because of the more the sales, the better the liquidity.
- Look for Convenient Location: Location of the property is an extremely important factor. Finding a property in a prime location with all necessary facilities such as schools, offices, hospitals,, and retail centers, in its proximity makes it an attractive option for potential bidders. Moreover, a safe locality with a good builder reputation and neighborhood are factors that would give an advantage to the owner while trying to sell the property.
- Purchase Quality Property: Physical aspects of the individual property itself in addition to its location also determine its marketability and value to potential bidders. Hence as an investor, you must look for affordability, proper amenities, a good view, convenient design in a property. Amongst all factors, affordability is an important point to consider, as potential buyers are more interested in buying properties that provide state-of-the-art facilities at an affordable rate. Understanding the factors that affect the liquidity of your property and where it stands in the market can help you foresee an appropriate exit strategy. Hence it is important to understand and better yet, estimate the liquidity of a potential real estate property before you purchase it. Investing in the right property based on these factors will not only ensure steady returns but also make it easier for you to sell the property in the future, should you decide to do so.
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Liquidity in real estate FAQ’s:
The ease with which an asset, or safe, can be transformed into ready cash without affecting its market price is referred to as liquidity.
Liquidity risk in real estate refers to the risk that is associated with selling your real estate investment. A high liquidity risk implies that it is difficult to sell an investment when needed, or that it must be sold for less than its fair value, or that transaction costs are heavy. This makes the asset an illiquid investment for the owner.
REITs or Real estate investment trusts are more liquid as compared to other forms of real estate investments. Most REITs are publicly traded and can be bought and sold just like stocks. This makes it easier for investors to sell their shares and realize their profits.