The liquidity premium and the non-liquidity discount: research into the history and future of Ill-liquid assets.

Let’s agree on the general terminology.

Illiquidity discount: it is the discount that an owner of an asset needs to take below valuation to liquefy his asset.

A liquidity premium is a premium an owner of an asset can get on top of the valuation.

So the bottom line is valuation, although valuation metrics differ from one asset to another and sometimes within the same asset class. Yet the premium or discount applies to any valuation regardless of the dynamics.

I will start today with the most common phenomenon: “they usually sell illiquid assets at a discount to valuation.”

If you own land in the peripherals of a city or a village and have attempted to sell it before, you would know exactly what I mean.

Why did I start with one of the most illiquid types of property? I did so, as it is easier to show the idea when the gap is enormous. It is like a caricature artist wanting to highlight a politician’s enormous nose; they usually sketch it much larger than it is.

My company, Arms & McGregor International, and I purchase and sell similar assets, making serious money doing so. Why and how?

When someone who owns such an illiquid asset wants to liquidate his asset and get some cash-out, they rarely find a buyer waiting and ready to take forward the purchase, as those assets are not in high demand and get some specific interest now and then. To seduce buyers to come through, what sellers do here is drop the price below valuation.

This discount, if big enough, usually makes buyers interested. Alternatively, the seller would have needed to wait a long time to get someone interested in his plot.

We purchase the asset and usually either arrange a subdivision if big enough and sell it in parcels at higher prices. There are other ways we typically follow similar assets that put us in a privileged position to get profit from it.

This same occurs at different ratios when assets are illiquid at different levels.

Liquid assets usually benefit from being liquid and get affected by multiple market dynamics that allow them a premium to the state of no liquidity until this new value plus premium becomes the new valuation. How and why?

Some liquid assets have a non-liquid state. For example, companies like Google are not liquid if they have no publicly traded shares.

This allows Google and similar assets a few characteristics. This makes the asset more accessible, thus allowing a much bigger group of investors access to it. What is noticed is that the valuation multiples increase once that occurs. More investors having access means more demand and a greater variety of investment strategies and expectations, all of which create a different dynamic in buying, holding, and selling the asset and allow a liquidity premium to develop.

In summary, this premium is in two parts. The first part avoids the discount, and the second is the valuation expansion.

If you are a holder, seller, or buyer, what assets would you like to hold, the conventional real estate you know today or the evolved real estate 6.0?

Tokenization has a growing impact on all asset classes, yet the biggest will be on the asset class that would benefit most; “Real Estate.”

Article by Makram Hani