There’s a popular saying in investment circles that “cash is king.” For many, this means that an investment’s liquidity is of paramount importance, and it may be. But, it also implies that a lack of liquidity in real estate is a bad thing, which isn’t always the case. We call this implication the “commercial real estate liquidity myth,” and we choose to look at it a bit differently.
It is common for commercial real estate transactions to require multi-year financial commitments from their investors, which means that they aren’t suitable for everyone. Our view is that illiquidity presents an opportunity to discover and acquire assets below market value and to manage them in a way that delivers elevated returns to our shareholders over the long term.
In this article, we will define what liquidity is in commercial real estate, why illiquidity is an overlooked benefit for CRE investors, explain the downsides to illiquidity, and explain the benefits of working with a private equity real estate firm.
What is Liquidity in Commercial Real Estate?
Liquidity is a word that describes how easy it is to convert an asset to cash. Or, looked at another way, liquidity could be defined as a measure of how robust the market is for a given asset. For example, a share of Apple stock is highly liquid because it is relatively affordable and there is a large market of buyers willing to step in and purchase any shares that are for sale. This level of liquidity also means that the share price on the open market is fairly well established through hundreds or thousands of sales on a given day.
Applying this definition of liquidity to commercial real estate reveals why CRE is not a liquid asset. Commercial real estate is not converted to cash very easily because market participants are limited by high price points, lengthy due diligence periods, financing contingencies, and high transaction fees. Where a share of Apple is converted to cash in a matter of seconds with hundreds or thousands of available buyers, a commercial property may take weeks or months with just a handful of potential buyers.
For many investors, this is a turnoff. We think it is an opportunity.
Why Illiquidity is an Overlooked CRE Benefit
Cash IS king in the sense that the person with it has a superior negotiating position to the person that needs it. This is where the combination of commercial real estate’s illiquidity and the private market can be a good thing. It drives pricing power for investors with cash to deploy.
Much of the commercial real estate market is private, meaning that properties change hands between buyers and sellers privately, not on publicly traded exchanges. Where public markets offer liquidity and efficiency, private markets offer pricing asymmetry for well capitalized investors that know where to look. The asymmetry is driven by the bargaining power of well funded investors who can leverage their cash, scale, experience, and closing ability to acquire a property at a favorable price.
To illustrate this point, consider the example of a publicly-traded REIT vs. a privately-held property. An investment in either will provide exposure to the real estate asset class. The REIT is publicly traded, which means it has a high degree of liquidity. But, it also means that its share price is based on the whims of market participants, which can lead to volatile movements on a day to day basis. Conversely, the privately held property isn’t very liquid, but the price doesn’t change from day to day. It only changes when a market participant buys or sells it, which may happen infrequently.
It is this very lack of liquidity that can be leveraged by those with the ability to identify undervalued properties and the cash to buy them. Purchasing investments at a discount to intrinsic value creates an excellent starting point in the effort to deliver positive long term returns to shareholders.
Downsides to Illiquidity in Commercial Real Estate
While illiquidity can be leveraged to acquire a property at a favorable price, it also means that a private commercial real estate investment is not suitable for all investors. Income and profits from real estate are delivered over the long term and any effort to quickly convert a property to cash will likely result in having to accept a price below market value. These types of “liquidation” sales may result in a loss and represent the primary downside risk to holding an illiquid investment. To mitigate this risk, the best firms are conscious of the amount of debt placed on a property because it allows them some room for negotiation in the event of a liquidation scenario.
Because commercial real estate investments can be illiquid, investors should carefully consider their risk tolerance and time horizon before committing to one. If the invested funds are going to be needed in less than five years, they probably shouldn’t be used.
The Importance of Partnership in CRE Investments
Commercial real estate investment is a team sport. Even the largest firms have teams of professionals dedicated to finding, sourcing, analyzing, valuing, and acquiring properties at a favorable price. The best ones do it with a rigid set of return criteria, a commitment to discipline, and a long term time horizon, which mitigates the impact of any liquidity issues.
First National Realty Partners is one such firm. We are one of the country’s leading private equity commercial real estate investment firms. We leverage our decades of expertise and our available liquidity to find world-class, multi-tenanted assets below intrinsic value. In doing so, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in. We understand that illiquidity may be an impediment for many investors, but we see it as an opportunity to acquire assets at attractive prices, which gives us a head start on the effort to deliver strong returns.
Whether you are just getting started or searching for ways to diversify your portfolio through commercial real estate, we are here to help. If you would like to learn more about our investment opportunities, contact us at (800) 605-4966 or email@example.com for more information.