The importance of liquidity in your investment portfolio

Liquidity, why does it matters in property crowdfunding?

In a nutshell

Liquidity is the ability you have to convert any asset into cash quickly, for little or no loss in value. Some examples of liquid assets are cash, listed stocks and government bonds, whilst illiquid assets may be things like property, antiques or fine art.

While it may be a good idea to have some illiquid assets depending on your investment goals and risk appetite, it's vital that you have some of your wealth in assets that you can sell quickly if needed.

For example, if you were to need funds rapidly and your wealth is all tied up in your home, it might not be very easy to access any money without a lengthy process and a willing buyer. Trying to offload illiquid assets quickly can be highly costly and lose you a great deal of money as sellers will have to accept vastly depreciated prices, especially in economic downturns.

Illiquid assets like property have the potential for long-term gains, but you have to be in a situation where you don't need to sell them quickly. It's preferable to hold onto them until the opportune moment when they have appreciated in value, and there's someone keen to buy them for the desired price.

What is property liquidity?

As we've established, liquid assets are all the assets you own which can readily be spent or converted to cash.

Whether you stuff your £5 notes under the sofa cushions or drop a £1 coin into the kitchen swear jar every time the Wi-Fi connection fails, these constitute assets that you can immediately spend should you need to.

However, the flip side of that £1 coin is that it is not the safest type of asset as liquid assets can be destroyed by fire, lost, or as with your £5 notes, stolen.

So, this brings us to property - its apparent illiquidity as well as its potential for having some liquidity. Yes, it can take months or even years to convert into cash, but it's more nuanced than that.

Property can be seen as a liquid asset based on numerous factors.

Its liquidity is determined by whether the property can be sold rapidly or whether it will struggle to sell, and as a result, if it falls below market value. Property with a high demand that's easy to sell and purchased at market value could, therefore, be considered to be liquid.

Key factors that can give property more liquidity

Although property is largely considered an illiquid asset, certain factors can increase its liquidity.

Firstly, if there's a high demand for the property in question, the chances are that this will result in a quicker sale. Logically, if more buyers are vying for the asset, they'll be more willing to pay slightly over market value to secure it. Then, the less time it spends on the market, the more liquid it is.

This liquidity factor directly relates to property type. Evidently, some types of property will be more liquid than others as there's either more demand for them or they're more affordable. To dissect this further, the location of the property will affect the variable of property type. In a low-income inner-city area, affordable flats and apartments will clearly be more liquid than detached mansions.

Conversely, in an affluent country village within commuter distance from London or any other city, there'll be more demand for larger homes and detached residences. Investigating these market variables is important when researching investment opportunities on Property Crowdfunding platforms as the exit will directly impact whether you receive your returns on time or not.

It's well publicised that there's a national shortage of affordable homes being built around the UK at the moment and as the rental market is increasing year upon year, property types with greater liquidity in 2020 are typically predicted to be flats, Right-to-Buys or Buy-to-Lets.

"Overall, 20% of UK households were renting privately by 2017, compared to 28% who own a house with a mortgage, according to the Family Resources Survey by the Department for Work and Pensions (DWP). Of the rest, 34% own their home outright and 17% are in the social renting sector." - Office For National Statistics 2019

What are DOMs and how do they affect liquidity?

Moving away from Property Crowdfunding very briefly, but staying with property liquidity, "Days on Market" (DOM) refers to the number of days that a property is on the active market, which is an important measurement of market liquidity regarding property.

DOM is a useful indicator for potential buyers to evaluate the popularity of a house. For example, if you see a home you love and you want to make an offer, there are several factors to consider before getting your wallet out. These factors will include demand, location, property type and condition, as well as the value of all the market comparables. All these categories will impact the property's liquidity and should be taken into account.

The DOM is significant for a number of reasons. If a property stays on the market for a long time, the seller may have to lower the asking price or accept an offer for a lower price. Many potential buyers will associate a home sitting on the market for months and months with the home being undesirable or having issues that will be expensive to fix. However, this can be a positive sign for the buyer as you can offer less than the asking price as the seller is more likely to be open to negotiations.

As a buyer, seeing a home that you like that has been on the market for a long time can be an ideal situation. After being on the market for an extended period, the buyer might be more motivated to sell. Most people who are selling a home are doing so because they are ready to move on and may even have a new home they want to get moved into as quickly as possible.

In short, the longer the DOM of the property, the less liquid it will be and the lower the selling or renting price generally is.

Liquidity in Property Crowdfunding

Investors typically choose to invest in property based on two factors: yields and liquidity. While yields create revenue and cash flow during ownership, it's the property's liquidity that determines how successful the investor will be upon exiting the project.

Therefore, if you're an investor on a Property Crowdfunding platform, considering the liquidity of the investment opportunity is of paramount importance as it will affect the money in your pocket upon project completion.

To summarise, when carrying out your personal due diligence on different investment opportunities, it's worth bearing in mind the following liquidity factors;

Location:

• Proximity to transportation hubs, places of employment, health / education / retail centres and infrastructure.

• Low crime rate and reputation for being safe.

• Good employment opportunities.

• Areas of beauty (greenery / parks / woods).

Property:

• Recent construction (new-builds and renovated properties tend to sell better than old, decrepit buildings).

• Design and location (good view, convenient design, high ceilings, second floor or higher).

• Amenities (parking spaces, playgrounds, etc.).

Market:

• Excess demand.

• Good market capacity and activity (more sales, better liquidity).

• Affordability (prime property is harder to sell).

• Stable value (falling prices decrease liquidity).

So, as you put together a property investment portfolio, don't forget to consider liquidity. Really consider your long-term financial goals and think about your financial situation, always considering what you would do in an emergency.

Would the investment tie up your assets to the point that you couldn't easily access your wealth if you needed it quickly? Plan your investments and your finances so that you have enough liquidity to meet your needs and goals.

Liquidity matters. Liquidity is important, and definitely worth considering if investing in a generally illiquid property market.