Real estate, regrets and the lessons of liquidity

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One thing I can safely predict for 2018 is that most of us are going to make at least one investment mistake. That begs the question of whether we are going to live to regret it. Naturally, the successful investor will be aiming to sing a line from the Frank Sinatra hit, My Way: “Regrets, I’ve had a few. But then again, too few to mention.” Whether investors will eventually need to own up to their ‘regrets’ will depend on how easily they can reverse a decision, if and when they recognise things are not working.

Real-estate investing is no exception in this respect. Moreover, an investment in a building locks up large sums of capital in a single asset and such decisions (and their unwinding) as a rule involve substantial preparation work and transaction costs. Investors typically hold property for many years to realise their returns. Clearly, timing a purchase (or a sale) can be as much an art as a science, given the illiquid nature of the asset class.

It is worth weighing up the liquidity risks

Consequently, when contemplating investing in real estate, you could benefit from weighing up the liquidity risks. Surprisingly, experienced, professional real-estate investors sometimes ignore the value of liquidity when investing in the asset class. That leaves them to rue the decision all the more so when they want (or need) to sell buildings or non-listed funds.

Recent European fund closures were an inauspicious example of the constraints of owning property directly. In the aftermath of the Global Financial Crisis, property fund managers were closing their non-listed investment vehicles to redeeming investors as transactions in direct markets dried up. In 2008, 11 German property funds worth nearly EUR 30 billion froze client withdrawals as investors tried to withdraw money. More recently, there were similar problems after the UK’s June 2016 vote to leave the EU, as property funds closed their doors to investors wanting to withdraw money because the funds had insufficient liquidity.

Daily liquidity, cheaper transactions and a modest starting point

In contrast to all of that, listed real estate enjoys a considerable liquidity premium over direct property investments, while still providing true real-estate exposure. Real-estate stocks have daily liquidity, transactions are cheaper and initial investments can be modest. Comparing the time it takes to sell EUR 1 billion of buildings and a similarly sized portfolio of real-estate securities, our research has found it can take more than a year to offload all the buildings compared to just 10 days for the real-estate shares.

Average number of days to liquidate 50%, 90% and 100% of a EUR 1 billion global portfolio of listed and direct real estate in similar market conditions as those that prevailed on 30 November 2015. Local currency terms, monthly data 2015

Source: The Case for Listed Real Estate, BNP Paribas Asset Management 2016

Reassurance ahead of unwanted surprises

At the start of 2018, the real-estate cycle is at an advanced stage. Can you assume that global financial markets will remain this buoyant without a spike in volatility? Against such a backdrop, real-estate equities surely look more attractive for investors seeking diversified exposure to global property markets.

After all, for those of us that will by the end of this year be acknowledging that we bet on at least one wrong horse, owning a liquid investment such as listed real estate may provide some reassurance ahead of any major surprises over the next 12 months.


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Written on 08/01/2018

Shaun Stevens

Real Estate Strategist

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