Real estate has long been categorized as an illiquid asset, lumped somewhat together with interests in private companies, alternative investment strategies, sports teams etc., in contrast to liquid assets such as stocks, bonds, and currencies.
But this view has become outdated, at least for certain real estate asset classes. The markets for workforce multifamily, student housing and particularly triple-net lease assets have changed and matured to a degree that has reduced their illiquidity. As a result, family offices are viewing real estate as not only a staple, at close to 17.5% of portfolio allocations, but also more closely on the spectrum to liquid assets.
A handful of characteristics make a market illiquid, including difficulty executing a trade quickly, lack of transparent market pricing, depth of the market, and differing investment time horizons. Examining some of these common factors in the context of certain real estate asset classes, few, if any, are absolutes.
Difficulty in Selling Quickly
In addition to the overabundance of ready and willing investors, the time to close on commercial real estate assets has been shrinking for years. Currently, thanks to advancements in technology (including real estate research firms such as CoStar), due diligence periods on deals involving workforce or student housing and triple-net lease assets have generally fallen to 30 days.
Everything, except in-market due diligence can be done remotely. Market participants are provided with a hyperlink to a “virtual data room” in the cloud, housing underwriting documentation that has become markedly more standardized. Due diligence reports, third parties, and contracts, have all become more standardized as well.
Lack of Real-Time, Transparent Valuations
Illiquid assets in private markets are generally priced on an “as-needed” basis, creating an inherent lack of transparency. That no longer holds true for commoditized real estate assets.
In contrast to the inherent challenges of valuing and marketing fractional interests in a private company, the analysis required to value a piece of real estate is simpler and more contained. A business needs to tell a story. A “retail box” leased to a CVS? Much less so. Triple net leases, workforce housing, and student housing are all relatively easy to comp these days. There are thousands of other assets like them which trade frequently, with transparent pricing – and all of this relevant information is easily accessible online.
Pricing of artwork, a vineyard, tech startups, etc. are significantly more difficult to handicap. For evidence one must simply look at Sotheby’s, where an item may be valued, but the bid-ask reflects wide ranges, which may be attributed at least partially to the emotions often driving these types of investments.
Depth of Market; Inability to Sell Without Substantial Loss of Value
With interest rates as low as they have been, there continues to exist a flood of capital – both foreign and domestic – seeking to park itself, with the goal of wealth preservation, value accretion, less volatility, and some coupon, on a tax sheltered basis. However, with the amount of capital chasing both safety and growth, asset pricing remains generally high, by historical metrics.
For example, when partnering in the development of a 200-unit workforce housing project, it is common to routinely entertain between 10 and as many as 60 expressions of interest from institutions by the time the property is listed. This is a direct reflection of the current deep pool of buyers in what has become a liquid, transparent, institutionalized and commoditized market.
It’s a truism that certain buyers of buildings may hold them for years, even generationally, while owners of publicly traded equities and corporate and government debt may hold properties for much shorter time periods. In reality, hold duration in real estate has gotten shorter, but more importantly, the optionality to hold real estate for shorter durations has increased.
Based on our observations and experience, the development horizon for a triple net lease asset can be 12 to 18 months, at which point the asset may have been pre-sold subject to tenant occupancy and a first lease payment.
Alternately, as an investor, it’s conceivable to buy a “triple net box” and sell it, subject to this reduced and standardized due diligence period within as little as 60 to 90 days. Thousands of these “boxes” trade every year. In fact, brokerages like CBRE, Cushman & Wakefield, JLL and Newmark Knight Frank (NKF) all have teams in place to advise clients who trade just this type of asset.
To be sure, there remain aspects of the real estate industry that make it different, and somewhat less liquid than classic liquid assets like corporate bonds. Investing in real estate still requires a certain degree of credibility. Before entering into deal negotiations with a prospective buyer or seller, other parties will look at their reputation. Are they a “good” buyer? Have they closed? Do they “re-trade” or renegotiate the purchase price after initially agreeing to purchase at a higher price? Lack of reputation, or a bad reputation, remains a significant barrier to entry. We consider this the last hurdle to liquidity of real estate as an asset class.
The truth is, although many investors still harbor dated conceptions about real estate, the trend towards greater liquidity, standardization and commoditization in real estate is not new. The industry has been undergoing changes to this process for 100 years, and the technological advances – combined with favorable market conditions and deep liquid transparent markets – have accelerated this trend significantly. As investors continue to become more educated, real estate has become viewed less of an alternative portfolio investment type, and more as a staple for a well-rounded investment portfolio.
February 21st, 2020|News