04 Jan 2023Yousra Badra

Understanding Liquidity Risk is Paramount to Building a Profitable Real Estate Portfolio

Liquidity is often referred to in terms of the sale of equities such as stocks or bonds, or other hard assets in exchange for cash.

The value of liquidity is measured in terms of how quickly an asset can be turned into cash at the current market rate or price. An asset that cannot be sold relatively quickly by industry standards for current market value would be deemed “illiquid.”

Liquidity is an important measure for real estate since market values are subjected to numerous forces and conditions and may not remain constant or increase. Over the last two years, liquidity has become indispensable in determining the true value of real estate assets for portfolio managers.

How does this impact Portfolio owners? 

Most recently, in a post pandemic era, companies are opting for remote and hybrid work models, and that has drastically reduced occupancy rates leaving portfolio owners on sinking sand. Even buildings that once held ’trophy’ property status have been turned upside down in many cases.  Otherwise, real estate investments are considered illiquid, where assets come with varying levels of liquidity risk. Assessing liquidity then is fundamental to ensure that outcomes for property investment portfolios and ownership income are maximized.

Frequent Market Changes Result in Uncertainty – Liquidity Risk Exists Across a Spectrum

Because liquidity is subject to numerous factors, liquidity risks exist across a spectrum. In real estate, for example, a building that was appraised at a high value to market price and able to attract long term tenants based on location may lose status if the demographics or other external environmental factors change. This building would then become more illiquid, and potential investors should be aware of the changing intrinsic value and liquidity status.

The reality is that successful real estate investing is highly diversified, encompassing a wide range of investment options. Real estate investors and property owners then must be able to deeply assess and understand their liquidity risk across a wide range of assets.

Overall, understanding the risk involved with illiquid assets such as real estate can help investors to shape their portfolios. For example, an investor who might need cash in three years’ time will likely have enough liquid assets in the portfolio to cover that short-term obligation. Knowing this ahead of time can help ensure sufficient allocation of assets ready to monetise. By the same token, liquidity provides investors with the knowledge that certain properties will not be monetised quickly, and that the capital needed may have to be raised through other sources.
Real Estate Illiquid, but Long-Term Value Appreciation Can Create a Strong Liquidity Position for Those That Understand the Market 

Today, market fluctuations and varying asset types all combine to create a wide spectrum of liquidity risk for investors. In today’s perfect storm, investors that ascertain their risk most accurately with credible data will be at an advantage. In a post pandemic and volatile economy, portfolio managers need a strategy that includes access to accurate and timely data to enable the creation of diverse portfolios that are able to be monetized.