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. Conversely, it also implies that a lack of liquidity is a bad thing, but we choose to look at it a bit differently.

It’s common for commercial real estate deals to require multi-year financial commitments, which means that they aren’t suitable for all investors, but we think 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.

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What is Liquidity?

Before we get to the evidence supporting our argument, let’s first define exactly what we’re talking about. Liquidity is a word that describes how easy it is to convert an investment to cash. Or, looked at another way, it could be defined as a measure of how robust the market is for an investment. For example, a share of Apple stock is incredibly liquid because it’s relatively affordable and there’s a robust market of buyers willing to step in and purchase the share if it’s for sale.

Applying this definition of liquidity to a commercial real estate property implies that it isn’t very liquid because market participants are limited by comparatively 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. But, we think it’s an opportunity.

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Why Illiquidity is an Overlooked CRE Benefit

Cash IS king in the sense that the person with it usually has a superior negotiating position to the person that needs it. Here’s where a commercial property’s illiquidity, combined with the private market, can be a good thing. It drives pricing power.

Much of the commercial real estate market is private, meaning that properties change hands between private buyers and sellers, not publicly traded exchanges. Where public markets offer liquidity and efficiency, private markets offer pricing asymmetry for those that know where to look. Often, the asymmetry is the result of a seller who needs cash and is willing to accept a discount to market value to get it. Because the pool of potential buyers is relatively small, buyers with available cash can land a good deal.

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 that it’s got a higher 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. On the other hand, the privately held property isn’t as 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.

That same lack of liquidity means that good deals can be found for 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.

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That same lack of liquidity means that good deals can be found for 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

While illiquidity can be positive in the right situations, it also means that a private commercial real estate investment isn’t for everyone. Income and profits from real estate are optimized 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 will be conscious of the amount of debt placed on a property. This will allow them some room for negotiation in the event of a liquidation scenario. Because real estate can be illiquid, investors should carefully consider their risk tolerance and time horizon before deciding to deploy their funds. If the invested funds are going to be needed in less than five years, they probably shouldn’t be used.

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The Importance of Partnership

Commercial real estate investing is a team sport. Even the largest investment firms have teams of professionals dedicated to finding, sourcing, analyzing, valuing, and acquiring properties. 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 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.

Whether you’re just getting started or searching for ways to protect your diversify your portfolio through real estate, we’re here to help. If you’d like to learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.