Liquidity Vs. Illiquidity in Commercial Real Estate

May 5, 2022

Many investors believe that an asset’s best quality is its liquidity. After all, we all grow up learning that ”cash is king.” Although, this is not the case in regards to every investment, especially in real estate. This might leave you questioning—”Is real estate a liquid investment?

Traditionally, real estate has been labeled as an illiquid asset, or an investment that cannot be sold easily. Real estate is lumped up together with other similar assets, including: art, alternative investment strategies, and equity in private companies. However, a lack of liquidity in real estate isn’t always as bad as it seems. With commercial real estate, you get to acquire assets below the real estate market price and manage them effectively to guarantee steady returns as an investor. It is, therefore, time to debunk the commercial real estate liquidity myth. 

If you are ready to invest in real estate to earn some money on the side, continue reading to take a comprehensive look at liquidity and illiquidity in commercial real estate in order to ensure you make an informed decision before investing in any real estate venture.

Is Real Estate a Liquid Investment?

A liquid asset is an investment that can be quickly converted into money in a short time period. Some investors define it as a measure of how vigorous the market is to acquire a particular asset. For example, Apple stock is considered to be a highly liquid asset that consumers want. Many people are ready to purchase shares as soon as they hit the market.

However, trying to sell commercial real estate is not as simple as selling you Apple stock. Selling your Apples shares won’t take long thanks to the thousands of potential buyers, while your commercial property could take weeks or months to sell with less buyers showing interest. Its liquidity is limited by prolonged diligence periods, high real estate market prices, and financing contingencies, and it takes longer to see a return investment on.

Illiquidity in Commercial Real Estate

Every commercial real estate asset is unique, which makes it illiquid. You will need to give yourself some time to sell the property if you want to make any profit from it. This means that preparing a property for sale will take a lot of time and effort on your part as the asset’s owner. As an investor, you have to advertise the property, conduct tours, negotiate contracts, and wait for financing. Each step has a process that must be followed and has a waiting period, which can be frustrating for investors.

Illiquidity in commercial real estate means that your asset comes with risks for the sellers. For example, let’s say a piece of property will sell within nine months after listing. A lot can happen within this period, including a recession, floods, and more. Damage to your property means significantly lower returns, if not losses.However, it is important to remember that illiquidity constraints aren’t always a bad thing. Commercial real estate market prices are protected thanks to their illiquidity. They will never plummet like the liquid stocks that most investors often go for because of their quick return on investment. The real estate market is not known for panic-driven fire sales and volatility, like the traditional stock market is.

Workaround Commercial Real Estate Illiquidity

Have you heard of real estate investment trusts, commonly known as REITs? Well, these companies own commercial real estate property and sell shares to potential investors. Publicly-traded REITs offer extreme liquidity for anyone interested in the commercial real estate industry

As the investor, you can purchase and sell commercial real estate shares with the click of a button. This means you can invest in a commercial real estate at noon and sell it by dinner. Fidgety investors get the opportunity to acquire commercial real estate without liquidity limitations. However, the illiquidity in real estate means that the REIT also facesissues of illiquidity. These companies have to buy and sell these pieces of real estate like everyone else, but the only difference is that investors don’t have to ask, “Is real estate a liquid investment?” This is why investors pay a premium when investing in REITs, which is the cost on top of the asset’s market value for the benefit of liquidity.

Examples of Illiquidity in Commercial Real Estate

All commercial real estate property is by definition illiquid. However, there are a few of these properties that are relatively more liquid than others. A well-maintained grocery shopping center will sell faster than a quarter-leased rental apartment. However, a department store, where major merchants have pulled away, will probably take more time to sell and only have a few bids. In such cases, the investor’s only option is to repurpose the property, but that also takes a lot of time and money.

What makes some commercial real estate more liquid is their occupancy and the number of interested buyers they have. It is also important to remember that troubled properties will require a lengthy due diligence process. Illiquidity in real estate means that buyers will also need to tour the property and research profitability.

Causes of Illiquidity in Commercial Real Estate 

All investors want to buy commercial real estate that is in pristine conditions and great locations. Although, no location is the same as the next. For example, two identical buildings in the same block will have differences that may affect their property values. Maybe one is a bit more accessible or visible from the street than the other, or perhaps one of the two buildings includes a larger parking lot. 

Illiquidity in real estate means that perceptive buyers tend to conduct thorough inspections when looking for commercial real estate, which means you also need an appraiser to help you figure out your property’s worth. Savvy real estate investors go a step further and research the local ordinance of municipal codes in order to ensure the property is in working condition.  

How to Mitigate Risks in Commercial Real Estate Illiquidity

Now that you have answered the question, “Is real estate a liquid investment?”, it is time to understand how you can mitigate the risks that come with commercial real estate illiquidity. Let’s take a quick look at some of these ways:

Commercial Property Flipping

You can always renovate or reinvent commercial property as you would with residential real estate. However, ensure your buyers will like the renovations before closing on a sale. Otherwise, you end up spending a lot of money without increasing your property’s liquidity.

Commercial Property Wholesaling

With this strategy, investors buy undervalued commercial property to sell at a standard real estate market price. The flip happens quickly which increases your chances of making money. However, it is important to make sure you have buyers lined up before buying the piece of commercial property. It will also help to research real estate market prices.

Real Estate Investment Trusts (REITs)

As stated earlier, Stocks are liquid assets. With REITs, you transform commercial real estate into stocks. You can purchase the stocks and sell them at any time for a profit. You can’t go wrong with a REIT.

The Bottom Line

It is absolutely essential to answer the question ”Is real estate a liquid investment?”, and is the first step toward making informed investment decisions. Commercial real estate investors need to understand that illiquidity isn’t always a bad thing. What you need is a partner that understands the value of portfolio diversification. 
Contact us today to learn more about EXtrance.