by Greg Brown, Head of Real Estate

Investopedia defines illiquid as such, “the state of a security or other asset that cannot easily be sold or exchanged for cash without a substantial loss in value”.

Please understand, before investing in private real estate deals, that they are indeed illiquid. Let’s talk about how this fundamental characteristic of private real estate equity investments should impact your decision making process.

First–be able to do without the money you’re considering investing for AT LEAST the duration of the projected hold period. In most offerings, the deal sponsor will project a hold period for the asset. That could be as short as a projected 18 months for a turnaround or flip deal. Or it could be as long as ten years. You need to assume the investment cannot be liquidated into cash in a timely manner during your investment period. Caveat: some well capitalized deal sponsors will include provisions for them to buy back your investment should you need to liquidate. However, that buyback is usually at a very significant discount and not an obligation on the sponsor.

Deal sponsors are well aware they are asking investors to commit their capital with the inability to get it back. And for that, investors are usually able to command higher returns.

Second–read the offering documentation thoroughly to ensure you understand any restrictions on resale of your investment. Some deal sponsors restrict your ability to transfer your ownership interests to a third party. Most deal sponsors will allow for you to transfer your interests but withhold the right to approve to whom you are selling to. This protects deal sponsors and the other investors from your selling to bad actors like terrorists or money launderers.

Third–illiquid is not all bad. There is almost always a risk premium in total return projected for illiquid assets. Deal sponsors are well aware they are asking investors to commit their capital with the inability to get it back. And for that, investors are usually able to command higher returns. This premium is a big factor in why private real estate deals offer higher projected returns than publicly traded equities, even publicly traded REITs.  But, of course, the risk premium is a projected higher rate of return, not a guarantee of such results.

Lastly, I will say there are platforms out there chasing the goal of being efficient exchanges or marketplaces for private securities, many focusing on real estate. This is a noble goal. But we are YEARS away from there being the depth and breadth of both product and capital necessary to create highly liquid auction marketplaces for “alternative” investments like real estate.