As an investor, it's important to think about liquidity. After all, the liquidity of your investments will directly impact your cash flow on a regular basis. With that in mind, we've provided a guide to real estate liquidity below. Read it over to learn more about what liquidity is, why it matters, and which real estate investment strategies have the right level of liquidity risk for you.
What is real estate liquidity?
First and foremost, liquidity refers to how quickly an asset can be bought or sold on the market for a price that reflects its current value. Investors should know each asset class comes with a unique level of liquidity risk. In particular, real estate assets as a whole are traditionally thought of as notoriously illiquid investments, while stocks are often known as the quintessential liquid investment.
However, an experienced investor knows that only certain types of property assets come with the infamous real estate liquidity risk. In truth, real estate investing can be very diverse and includes many different investment strategies. With that in mind, each real estate investment strategy comes with its own level of liquidity risk.
Liquidity vs. illiquidity: How liquid is each real estate investment strategy?
If you're interested in real estate investing but also concerned about how quickly you can increase your cash flow, keep reading. We've ranked the different real estate investment strategies by their liquidity risk.
Liquidity level: Illiquid asset
To start, a buy-and-hold investment strategy is what most people think about when they consider property investment. This strategy involves buying a rental property, finding a tenant to rent it, and collecting rental income. Typically, this strategy has one of the highest levels of real estate liquidity risk because you need to wait for the property to appreciate before you can sell it for profit.
Whether you are interested in investing in residential or commercial real estate, this type of investment strategy is best for investors who have a long-term outlook. If you think you can wait out building equity in the property over time -- and for the real estate market to turn in your favor -- this might be the right strategy for you.
While long- and short-term rentals are generally considered two different investment strategies, in this case, they follow a similar trajectory and can be considered two sides of the same coin.
Liquidity level: Moderately illiquid asset
For its part, a fix-and-flip investment strategy involves buying an investment property for below market value, fixing it up, and then selling it to interested buyers for profit. In this scenario, investors hope to increase the market value of the property through added sweat equity.
While fix-and-flip real estate transactions tend to happen much sooner than with traditional rental properties, sometimes there can still be a liquidity crunch. For example, suppose potential buyers don't like the work that has been done to the real estate property in question. In that case, it may be hard to offload and end up staying in your portfolio for a long period of time or eventually be sold at a loss.
Real estate wholesaling
Liquidity level: Moderately illiquid asset
Also known as micro flipping, real estate wholesaling involves buying a property that is undervalued for the current market and quickly selling it to end buyers for a profit. With this strategy, investors often count on an established network of end buyers to help them sell quickly and a transactional funding lender who can provide them with short-term financing.
Here, the liquidity risk is pretty much the same as with fix-and-flip investing. If you know of potential buyers interested in the property, these real estate transactions can occur quickly. However, if you're not tapped into the right network, these properties can suffer from having fairly low liquidity.
Liquidity level: Moderately liquid asset
Real estate crowdfunding is a financing method used by real estate developers who don't have the capital to finance projects on their own. Typically, these developers will use a digital platform to pool money from individual investors to fund their projects. Eventually, if the project goes well, the investors will see dividends.
While it is possible to sell your shares in a crowdfunding investment, you need to be conscious of something known as a "lock-up period." In real estate investing, a lock-up period is a time frame during which investors are prohibited from selling their shares. Typically, this period can last for a few months to a few years. It's up to you to do your homework and make sure your investment horizon matches the crowdfunding platform's rules.
Real estate investment trusts (REITs) and property funds
Liquidity level: Liquid asset
A real estate investment trust (REIT) is a publicly traded company that either owns or finances income-producing properties. Investors have the opportunity to buy shares in these companies, and in exchange, they receive dividends. Meanwhile, a real estate fund is a managed fund that primarily invests in listed real estate companies.
If you're hoping for stock-market-like levels of liquidity, investing in a REIT may be your best bet. In particular, shares of a listed REIT anytime the market is open.
The Millionacres bottom line
While real estate assets may cause more of a liquidity crunch than some other assets, it's important to realize that liquidity levels do vary depending on your investment strategy. Given that, feel free to use the information in the guide to help you pick an investment strategy that works for you. Armed with this knowledge, you should be able to start building a portfolio that provides the right liquidity mix.