Most real estate investors decide on an investment property based on two things: the yield and the liquidity of the property. The projected yield of a property is an easy-to-grasp concept based on the cashflow from the asset. Liquidity in the commercial real estate context, however, is often misunderstood. The most rudimentary definition is “how quickly the property will sell at market value if I list it”. Below we will further define liquidity and discuss its impact on the commercial real estate market.
Liquidity in financial markets affects whether assets like real estate properties can be sold quickly or slowly. Liquidity also has an influence on whether the price of an asset will vary significantly from its market value when it’s sold. When a market is liquid, assets sell quickly and at close to market value. On the other hand, when a market is illiquid, assets sell less rapidly and at a price that may diverge from the market value (either higher or lower).
In commercial real estate, highly-specialized properties and “trophy properties” tend to operate in especially illiquid markets. There is a very finite pool of buyers for such properties, which makes them more difficult to sell. In certain cases, the owner of the asset may have to list the asset at a heavy discount in order to get a sale done.
Determining Property Liquidity
For many reasons, commercial real estate assets are more illiquid than stocks or bonds. Buying a piece of real estate requires more capital than buying other assets, thus reducing the number of potential buyers. Debt financing is almost always included, and deal-specific structures are created. CRE properties, unlike non-physical assets, are also immobile which further reduces the potential buyer pool. Furthermore, the methodology for estimating commercial real estate value is not as standardized as valuation methodologies for other assets. All of these factors contribute toward the relative illiquidity of CRE.
There are several questions that can be asked to help determine the liquidity of a piece of real estate. Things like the location, transaction costs, the condition, zoning, and the state of the local market all work to affect the liquidity of a particular property.
Liquidity and the Real Estate Market
There are generally two adjectives used to describe the real estate market at any given period of time—hot and cold. A hot market is a market where the prices are rising, and people are buying. A cold market is where the prices are falling, and people are slower to purchase. Liquidity is higher in a hot and lower in a cold market.
While it would always be preferable to sell into a hot market, the CRE market cycle is long enough that sellers often have trouble timing the sale of their particular asset. Thus, professionals need to be equipped to buy or sell in any market, utilizing the best tools available. Lucro aims to improve liquidity in the CRE market by standardizing valuation, automating data ingestion, and creating a singular platform for all parties of a deal to conduct business upon.