Real estate has traditionally been considered an illiquid asset. It has been lumped somewhat together with similar asset classes like equity in private companies, alternative investment strategies, and art.
In contrast, more liquid assets such as stocks, bonds, and currencies can be more readily bought and sold with fast settlement times. There are a few specific things that create market illiquidity including a lack of transparent market pricing, depth of the market, difficulty executing a trade quickly, and differing investment time horizons.
Illiquidity discount is the reduction in price that gets applied to an asset because of a shallow market. It exists because it is not always easy to move in and out of a cash position.
Commonly used in the context of risk, illiquidity is defined as “the state of a security or other asset that cannot easily be sold or exchanged for cash without a substantial loss in value.”
While liquidity has historically been less of an issue for public equity markets, in private real estate markets, liquidity has always been a key factor significantly affecting asset valuation — or more specifically, pricing. In fact, illiquidity discounts can often reach up to 30%-50% of the estimated fundamental value! These types of “liquidation” sales may result in a loss and represent the primary downside risk to holding an illiquid investment.
Illiquid assets priced “as needed”
Illiquid assets in private markets are generally priced on an “as-needed” basis, creating an inherent lack of transparency. Price discovery can be difficult, especially complicated in an economic climate that further clouds valuation.
Most of the commercial real estate market consists of private buyers and sellers, as opposed to publicly traded exchanges. Where public markets offer liquidity and efficiency, private markets create pricing asymmetry resulting from a seller who needs cash and is willing to accept a significant discount to market value to get it. Because the pool of potential commercial real estate buyers has traditionally been relatively small, sellers are limited in their liquidity options.
Traditional Real Estate Has Limitations
Illiquidity also means that a private commercial real estate investment isn’t for everyone. Aside from the size of investments being outside the range of a lot of investors, income and profits from real estate are optimized over a longer term horizon and any effort to quickly convert a property to cash will likely result in having to accept a price below market value.
Even after finding a buyer, the speed of the transaction to sell real estate can be 60 to 90 days, but can be much longer depending on the size and complexity of the property itself. Brokerages like CBRE, Cushman & Wakefield, JLL and Newmark Knight Frank will also pull transaction costs, further reducing the net on a sale in an already compressed market.
XDEX Global Financial Records Network
XDEX, the global financial record network, creates an opportunity to transform illiquid real estate properties into an asset class that can behave more closely to liquid assets.
Through a process known as asset tokenization, XDEX creates digital representations of shares as well as ownership rights in real estate properties and investment vehicles.
This allows asset owners or managers to fractionalize the ownership and simplify the process of reselling those assets to a larger pool of buyers. Now the property can be marketed across a robust and liquid dual-sided market.
By encrypting and storing all of a property’s related documents, accounting, reports, and agreements on the XDEX network, real estate owners may simplify the effort to managing a highly-distributed fractional ownership while automating real-time access all of the necessary due diligence and record-keeping. XDEX can even automate fractional distribution of operating cash flow or coupon payments.
To learn more about these exciting new opportunities for the real estate market, contact 10XTS to discuss how we can help you transform your real estate assets and achieve better liquidity over time.
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