Property is an illiquid asset that can't be converted into cash quickly like equities. While yields create revenue and cash flow during ownership, liquidity determines how successful you will be when it comes time to sell.
Liquidity determines whether you will sell your property quickly or slowly and if you’ll achieve above or below market value.
Put simply, property that is easy to sell at market value is liquid. Whereas properties that are harder to sell and require you to discount the price are considered illiquid.
For instance, in Detroit, foreclosed homes sell for $10,000. But these properties are very difficult to sell at market value and are therefore illiquid.
If these properties were advertised for $30,000–40,000, buyers would take years to appear. Any investment asset that can be exchanged for money has a level of liquidity - with cash as the most liquid because it is the most expedient to exchange for other assets.
As a rule of thumb I have listed a few investments by order of liquidity:
- Stocks and bonds
- Precious metals
- Real estate
- Fine wine
Property, as we can see from the list, is one of the most illiquid assets because it requires more capital to buy than securities or precious metals, and takes much longer to sell. Property is also immobile and subject to changes in local and national macro and micro economic conditions.
In general, expensive properties in high end neighbourhoods are less liquid, with very low buyer or seller activity. Whereas properties in less heeled neighbourhoods, tend to sell quickly because the target market of potential buyers is much wider. Both investors and owner occupiers compete for properties in these types of areas.
So how do you determine if a market is liquid? Or not? Well here are a few pointers to help you along:Location
- Close to transportation, places of employment.
- Market purchase and sales activity. More sales, better liquidity
- Affordability. Prime property takes a long time to sell so has poor liquidity.
- Stable prices. Falling prices means sellers are discounting to compete in a shrinking pool of buyers.
- Low transaction expenses. High costs, low liquidity. For instance properties over €200k in Spain incur 14% in transaction costs which cannot be included in the mortgage.
- Timing. Buyer activity is highest between the months of March and September.
- Good solid rental market with high yields and low vacancy rates. Investors are always on the look out for properties that cash flow well.
Liquidity in the property market is very important if you are considering a buy to let investment - much more important than aesthetic considerations like curb appeal or interior decor.
It’s also worth remembering that when prices are over valued, liquidity falls and properties become take longer to sell.
Another rule of thumb to remember is:
- High yields = low liquidity.
- Low yields = high liquidity.
But this is not set in stone. In places like Pittsbugh USA, yields are very high - as much as 17%.
But because the local economy is now undergoing a transformation, prices are rising as buyer activity heats up, and yields are falling rapidly. The market therefore is liquid.
So high yields are okay, providing there is strong reasons to believe that local conditions will increase buyer activity which will force yields lower.
So the next time you are out hunting for that next deal, be sure to give equal consideration to the liquidity of the market in the area you are searching.