Many investors will put a value on an investment’s liquidity. Including liquid or illiquid assets can alter how investors handle their portfolios.
Explore how real estate is assessed as a liquid investment to see how investment properties may affect your portfolio.
What Is Liquidity?
Liquidity measures the ease with which an asset can be turned into cash or liquidated. The liquidity of an asset can have a profound impact on the financial decisions an investor can make; turning an asset into liquid cash opens up many opportunities.
High liquidity assets make for higher financial maneuverability in future investments. Securities are an excellent example of a high-liquidity asset. Investors can acquire and liquidate stocks traded on the exchange within a day.
The ability to quickly liquidate held assets means that investors can turn a quick profit, then immediately use that liquid cash for new investments.
Alternatively, high liquidity provides a better exit strategy for investors. If an asset’s value starts to tank, you can quickly liquidate high-liquidity assets.
Suppose the value of shares held by an investor begins a sharp plummet. Investors can act fast and may have the opportunity to avoid steep losses if they can liquidate their shares quickly.
Is Liquidity Good or Bad?
Liquidity is generally considered to be a strength for a given investment. The maneuverability of an asset affords investors a wider range of investment opportunities; they can always liquidate that asset and move on to the next one.
With the exit strategies high liquidity creates, investors can utilize the strengths of increased liquidity for a better-performing portfolio.
However, nothing is ever all good or all wrong. High liquidity asset classes can result in less-than-ideal circumstances because of the ease with which they can be bought and sold. For instance, the stock market can present great investment opportunities.
However, the more investors emphasize high liquidity in their investment strategy, the more volatile their portfolio may become. Day traders might be able to turn a quick profit, but the ultra-high liquidity strategy of day trading does not have the stability to produce reliably strong returns.
The strengths and weaknesses of liquidity and a liquidity-focused investment strategy depend on the goals investors strive for. Liquidity is only a strength if investors play to its strengths.
Is Real Estate a Liquid Asset?
Real estate is a well-known asset class for producing stable returns. That is due in large part to the fact that real estate is a relatively illiquid investment.
High liquidity means an asset can be liquidated into cash very quickly. High illiquidity means that it may take a protracted period to turn that asset into cash. Real estate moves slowly through the liquidation process.
Anyone familiar with homeownership knows the many stages of the property acquisition process; selling real estate can become a drawn-out affair. In 2021, a house’s average time on the market was about 22 days.
Between listing the property, finding a buyer, going through appraisal and inspection, negotiating the price, and then drawing up the final offer, the time it takes to sell a property for liquid cash can range widely.
Moreover, selling the home and receiving the actual capital can add even more time to the liquidation process.
Selling property is a deeply involved process. Compared to buying and selling stocks, real estate moves very slowly. Because of the many considerations that must be considered during their sale, real estate assets are inherently grounded as illiquid assets.
Is Illiquidity Always a Drawback?
Illiquid assets like real estate are difficult to get rid of. There can be loads of red tape between first listing a property on the market until closing is officially completed.
These necessary parts of the property sale mean that it takes longer for property owners to see the liquidation of their sale in their bank account.
Illiquid assets like real estate don’t lend themselves to fast-paced approaches to investing like day trading. Speeding through property sales can result in negligent practices that could cost the property owner more time and money. Failure to properly inspect and appraise a property could come back to haunt investors.
Illiquidity means that investors may be stuck with their assets for extended periods. Whereas day traders can dump their tanking stocks, real estate investors don’t have the same luxury regarding failing properties. Real estate’s high liquidity means it’s suited for long-term holding periods—which isn’t always a disadvantage.
Benefits of Illiquidity
Just as liquidity isn’t always good, illiquidity isn’t always bad. There are a few hidden benefits found in illiquid assets. Realizing these benefits depends on how investors approach their real estate investment strategy.
- Long-term benefits
- Stable market
- Committed investors
Long-Term Benefits
Real estate isn’t suited for short-term trading. The most popular means of short-term real estate trading is house flipping, which can take months or over a full year to complete. While the illiquidity of real estate may mean it isn’t suited for short-term gains, its long-term potential is extraordinary.
Real estate has a remarkable appreciation rate. Since the 1960s, real estate has increased in value year after year, almost without fail.
Investing in real estate in the long term is almost guaranteed to increase the value of your portfolio; when real estate is such a solid long-term asset anyway, it doesn’t matter as much as it is illiquid.
Stable Market
Real estate’s illiquidity makes for a more stable market that investors can rely on. Illiquidity means that real estate assets move slowly. While that may hinder investors from letting go of an asset fast, it also means the market moves slowly.
The real estate market is well-known for its stability. Because assets move so slowly, there aren’t the kinds of volatile market shifts that disrupt more liquid markets, like the stock exchange. When investors connect with real estate assets, they can count on their assets being in a safe, stable market.
Committed Investors
When investing in real estate, investors need to be committed; pulling out your investment is a process due to the illiquidity. Because of that illiquidity, real estate investment projects necessarily attract investors committed to their investment projects.
Getting involved with real estate investment funds often requires a commitment of at least a year in the fund. That level of commitment means that you can have a certain level of trust in your investment; when everyone else is locked in, you can be confident in the stability of your investment.
REITs: Liquid Real Estate
REITs are a compelling real estate investment option with far more liquidity. Real estate investment trusts function like publicly traded securities on the exchange. However, instead of generating revenue through goods and services sold, REITs increase their value through income-earning investment properties.
Investors can buy and sell shares of REITs with relative ease. With REITs, investors don’t own the properties but rather the income they generate.
While returns may not be as substantial as getting involved directly in property, REITs offer investors the opportunity to get involved in real estate investments without the high financial thresholds or the red tape.
The Bottom Line: Know the Advantages & Disadvantages of Illiquid Real Estate
Illiquidity has its disadvantages, but depending on how you plan to utilize real estate in your investment strategy, those disadvantages can be negated and even turned into a strength.
Every financial opportunity has its benefits and drawbacks; a firm grasp on your investment helps you make better decisions.
