The One Thing Most Property Investors Ignore

There is an endless variety of metrics used to explain the property market. Vacancy rates, building approvals, population growth, annual price growth – the list goes on.

All with varying popularity, each of these measures help to describe supply and demand in different ways, which in turn helps us to forecast the direction of a market.

Of course, prices are created by that intersection of supply and demand (the fancy term for this mechanism is ‘price discovery’):

Greater supply = downwards pressure on prices

Greater demand = upwards pressure on prices

(And vice versa)

Hopefully, this isn’t news to you – all pretty simple stuff!

But it isn’t just prices that are created by supply and demand.

Liquidity

Liquidity is another crucial product of the supply-demand interaction, and it’s something that property investors tend not to pay much attention to.

Liquidity is defined as the ease by which an asset can be converted into cash – i.e. ‘liquidated’ – without affecting its market price.

Of course, property is an inherently slow-moving market, and the role of liquidity here might be less obvious. But, when it is time to sell, liquidity – or the ease with which you can sell your property for a fair price – becomes very important.

Compared to other assets or investments, real estate is typically considered extremely ‘illiquid’, making this even more of an important consideration.

Of course, property is an inherently slow-moving market, where the role of liquidity may be less obvious. But when it comes time to sell, liquidity – the ease with which you can sell your property for a fair price – suddenly becomes very important.

What does real estate liquidity look like?

For an individual property to be considered ‘highly liquid’, it must have enough demand for a sale to be completed rapidly, without the seller having to compromise on asking price.

On that level, liquidity is simply a question of sufficient demand – i.e. could I sell this property tomorrow without compromising on price?

At the market level, things become more difficult to gauge, and there are a few ways to measure the liquidity of a property market.

For example, you might consider the average time it takes for a sale to complete (e.g. days on market), or you might consider the average volume of sales within a given period (e.g. number of sales per month).

Therefore, on a market level, time and volume-based measures of liquidity are both the result of supply and demand in tandem – not demand alone, as with an individual house.

Back in 2015, an organisation called the IPF (Investment Property Forum) published a comprehensive literature review on liquidity in real estate markets, and produced some fascinating insights.

To be more precise, IPF identified five key characteristics that make up liquidity:

Each of these five characteristics can create different inefficiencies, and

make it harder for a market to settle on the fair price for an asset. This is the ‘price-discovery’ process we mentioned earlier.

Often, this is also referred to as a widening of the bid-ask spread:

If you were unfortunate enough to invest in a highly illiquid property market, the risk is that you may be forced to accept bids well below your asking price, or even the ‘fair’ value of the property.

In this situation, your only other option would be to wait and see if things improve down the track, or if the market liquidity begins to improve.

It’s entirely possible for a property to experience stellar underlying growth, only for illiquidity to eat away at those returns, as well as impact your flexibility in decision-making.

In a future article, we’ll look at some strategies for navigating liquidity within property investment research.

Stay tuned!

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