From time to time, current and prospective partners often raise concerns about the illiquid nature of real estate assets.
And while it is nice to be able to push a button and immediately convert an asset to cash, the fact that real estate, and other non-traded assets, are illiquid, is what makes them superior to traded securities IN THE LONG RUN.
It’s a very simple situation, the more liquid an investment is, the less opportunity for mispricing in the marketplace. As value-oriented investors, mispriced and underpriced assets are what we dream about.
More liquidity means more buyers and sellers. If the market place determines a stock is worth $50 per share, it’s not going to be trading long for $45 per share.
In the illiquid world of commercial real estate, there are plenty of “$50 pieces of commercial real estate trading at $45” to use the analogy. In fact, if you look really hard, there are plenty of assets trading below $25 “per share”.
To give a quick example, let’s say a $50mm dollar office building was acquired privately. If you could hypothetically securitize that building and trade it on a public exchange, I can almost guarantee that the asset would be valued much higher than $50mm. This is called a “liquidity premium.”But that is not what this conversation is about.
I am making the case, that because that hypothetical building is privately owned, you have a much greater chance at getting it for say $30mm, than you would be getting that type of discount if it was publicly traded, even at a comparative higher valuation. There is just less focus. There are fewer investors sniffing around for assets like due to the lack of liquidity.
In short, deep value can be found more often in the private market.
More liquidity means more efficient markets. When you are hunting for value, liquidity is not your friend. You can discover situations that the marketplace is mispricing, and acquire them at great discounts, simply because there is significantly less competition in the buyers’ pool.
There are many, many reasons why a piece of real estate may be trading at a discount to its intrinsic value. There are also reasons why a stock might be undervalued, but the sheer amount of people in the buyer’s pool is much, much larger, and the participants are usually much, much smarter in a liquid situation.
This is why private equity traditionally outperforms the public equities market from a risk-adjusted return standpoint. It is fueled with a patient, stable capital.
The downside to private equity is that you need that patient mindset to let a deal play out, but you also need management and deal sourcing expertise to be able to capitalize on these opportunities. Liquid investing is completely passive, while illiquid investing requires significant resources and time as well.
This is what we attempt to bring to our partners. An investment vehicle that allows an investor to take advantage of a completely illiquid, mispriced marketplace, and leverage off of our management and deal sourcing expertise to generate superior risk-adjusted returns, without having to be a full-time operator in the business.
In the end, what appears to be one of the downsides of the real estate business, illiquidity, is actually one of the greatest contributing factors to success if you have the patience to hunt value long and hard, and then be patient enough to be vindicated on the back end of a deal cycle.