Traditionally, commercial real estate (CRE) is not thought of as a liquid asset. But, there can occasionally be some confusion about what, exactly, liquidity means. This post aims to clear it up.
In this article, we will define what liquidity is, why it matters, what affects it, and how this concept applies to commercial real estate assets. By the end, readers will be able to use this information to determine whether or not an investment is truly liquid.
At First National Realty Partners, we always consider the liquidity of a property as part of our pre-purchase due diligence process. In doing so, we maximize the chances for a profitable outcome. To learn more about our current investment opportunities, click here.
Real Estate Liquidity Explained
The term “liquidity” refers to the ease (and speed) with which an asset can be converted to cash. For example, a share of Apple stock is considered to be very liquid because there is a large pool of buyers waiting to snap up any shares that an individual wishes to sell. Often, a share can be sold and converted to cash in a matter of seconds. At the other end of the spectrum, something like a large art collection may be very valuable, but it might not be liquid because it is very unique and the potential pool of buyers for it is likely much smaller than a share of Apple stock.
This same liquidity concept can be applied to a commercial real estate property and there are certain factors that make a property more or less liquid in the commercial real estate market.
Determining a Property’s Liquidity
As the example above suggests, liquidity is a function of demand. If there is high demand for something, it tends to be more liquid than an asset class for which there is low or no demand. As it relates specifically to commercial real estate investment, there are certain characteristics of a deal that may make a property more or less liquid. They include (but aren’t limited to):
- Location: High traffic, high visibility, and high growth locations (like New York) are much more attractive to potential buyers than properties with low visibility or low traffic in low growth markets.
- Tenants: Commercial properties with strong, financially secure tenants tend to be more liquid than those with financially insecure tenants. This is because stronger tenants provide real estate investors with more confidence that the rent will be paid in full, on time, each month.
- Lease Length: Properties with tenants who have long term leases tend to be more liquid than those with tenants on short term leases. This is because the longer term leases provide cash flow stability and reduce the risk that a tenant decides not to renew their lease or renews it at a lower rental rate.
- Market Value: Properties with smaller valuations, say $1MM – $5MM, tend to be more liquid than those with larger values, say $10MM+. This is simply due to the fact that there are fewer market participants at higher price points.
- Unique Features: Properties built for a general purpose or those that can easily be reconfigured for a new purpose tend to be more liquid than those that have unique features. For example, a grocery store is really just a big “box” that could be repurposed for some other use with relative ease. At the other end of the spectrum, something like a movie theater requires very specific construction. They need sloping floors, high ceilings, space for large screens, and specific wiring for sound and video. It would be much more difficult (and costly) to convert a movie theater to some other use than a grocery store.
- Economic Conditions: While not specifically related to a property, general economic conditions can also have an impact on liquidity. When interest rates are low and/or the economy is in an expansion cycle, properties tend to be more liquid than in a high interest rate/economic contraction scenario. This is simply because there is more money being borrowed in capital markets when rates are low and borrowers need to put it to work earning a return.
- Property Type: There is simply more demand for some types of properties than others. For example, multifamily properties tend to have higher levels of liquidity than other property types like land or restaurants, which tend to be less liquid.
These are not hard and fast rules. Any investor could buy any property, at any time if it is a good fit for their real estate investment objectives. But, the general rule of thumb is that lower priced, lower risk, properties in high demand locations tend to be more liquid than higher risk properties in locations where the market is contracting.
It is important to note that the above liquidity factors relate to the characteristics of a property. Liquidity is also heavily influenced by the type of investment.
Liquid Investment Types vs. Illiquid Investment Types
For the purposes of this article, commercial real estate investments can be grouped into two types, public and private.
Publicly Traded Real Estate Liquidity
Publicly traded real estate investment trusts – REITs for short – are a very liquid commercial real estate investment type. This is because their shares are listed on public exchanges and can be bought and sold by any investor with a brokerage account. Their relatively low share price, high dividend yield, low transaction costs, and inherent tax benefits are popular with income investors. However, their share prices can be subject to high levels of volatility during times of economic distress and the shareholder has no say in capital allocation decisions.
Private Real Estate Liquidity
Private real estate investments come with slightly more liquidity risk. This is because they are bought and sold in private real estate markets, which have lower real estate transaction volumes, higher transaction costs, and generally fewer market participants looking to purchase investment properties. But, there is an upside to this scenario.
Private real estate owners are not subject to the pressures of public market sentiment so they have the space and time horizon to fully implement a property’s business plan. Often, this investment methodology may include renovations, lease renewals, new tenants, or the sale of outparcels. These strategies take time to implement, but can often maximize value of the long term.
Summary of Real Estate Liquidity
The term liquidity refers to the ease with which an asset, of any type, can be converted to cash. For example, stocks and bonds are generally considered to have more liquidity than commercial real estate assets.
Within the commercial real estate category, there are several factors that determine how liquid a property is. They include property type, tenants, location, lease length, market value, and whether or not the property has any unique features that may make it difficult to repurpose for another use.
In addition, the type of commercial real estate investment can impact its liquidity. Publicly traded investment vehicles like REITs tend to be liquid because they are traded on public exchanges and their shares can be bought or sold by anyone with a brokerage account. But, they can also have significant price deviations in times of economic distress.
Private real estate investments tend to be less liquid because there are fewer market participants, lower transaction volume, and higher transaction costs. But, there is also an upside to this. Free from public market pressures, private real estate investors have the freedom to implement strategies that maximize long term value.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Real Estate Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.