Liquidity is one of the most important - but often under-appreciated - features that sophisticated investors (and that includes you) should take into account when developing their investment strategies.
What is Liquidity?
Liquidity is defined as the ease by which an asset can be bought or sold, without cost, and without affecting the market price. A fully liquid market is completely transparent to all parties, making it easy to enter and exit investment positions. Cash is the most liquid of all assets.
If we compare residential property to this, it doesn’t actually meet any of the criteria for a liquid market. So, in order to be useful, we will look at what liquidity really means in the context of your property investments, why it’s important, and how you can go about determining the liquidity that you have.
The first thing to consider is that with property, we are discussing relative liquidity, I.e. how one property compares to another. A more liquid property investment will have the following key factors:
Easier to value;
Faster to sell;
No significant discounts required to sell.
Let’s look at these in turn.
Easy to value
Properties for which there are lots of comparables are easier to value. Note this means comparables within the same market. As we will discuss in another blog, property markets vary significantly from location to location, even within the same city.
As an example, apartments in popular city centre markets such as Manchester and London tend to be relatively liquid.
Fast to sell
While we see above that ease of sale is helped by there being lots of similar properties, the downside of this is that if a market is oversupplied, this can conversely make it more difficult to sell, especially if many similar or identical properties are being sold at the same time. This would happen at completion of a large-scale new-build development – a reason why we are extremely cautious when advising clients whose strategy is to buy off-plan and sell at completion or within 2 years.
The amount of time to sell a property will vary, but is something we at BellPepper pay attention to. The chart below indicates the times to sell for a 2-bedroom flat in 3 major markets. Note that this was mainly during 2020, where the UK went into repeated lockdowns as a result of the Covid pandemic.
No significant discounts
If a large discount has to be offered to secure a sale, then your investment returns will be severely impacted. For illiquid properties, the relationship between discount offered and time to sell means that it’s possible to be in a lose-lose situation – holding at a higher price meaning potentially no sale for several months or longer.
The table below gives an illustration for Crouch End, in London N8. It shows that there can be a large variation of the discount required, with 1 bedroom flats on average needing to offer almost 11% discount to sell, meaning that the effective profitability is much lower than the gross yield figures would indicate.
Data provided by REalyse
Why is this important?
As property is generally illiquid, an investor needs to firstly be aware that the funds that they invest may not be available upon demand. Unlike investment in the most liquid assets such as listed equities and bonds, to exit a property investment can take a long time, so this is vitally important when planning how much to invest.
Even if investing for the long-term, care must be taken to ensure that the property is capable of being converted into cash at the appropriate time – especially in case something unforeseen happens.
How to determine liquidity
There are a number of indicators that an investor should look at in order to determine the liquidity level of their investments.
1. Typical time to sell;
2. Overall transaction volumes;
3. Popularity of a location.
Time to sell
People unfamiliar with UK property investing are often surprised to learn just how long it takes to complete the sale on a property – even after a sale has been agreed. This can easily be 3-6 months, depending on a number of factors including the existence of a chain, the state of the property market (e.g., at the time of writing, there is a huge amount of activity due to the stamp duty holiday, which is leading to most solicitors, surveyors and lenders having large backlogs, further exacerbated in many cases by restrictions in light of Covid-19).
However, in addition to this, the time to actually agree on a sale of a property must be added. This can be days, months or years, depending to a large extent on the type of property. If a property is a standard 1- or 2-bedroom apartment, in many markets this will sell very quickly if the price is set at the correct level. However, note the following:
- This will vary from location to location;
- Unusual features will often result in longer time to sell;
- If looking to sell an off-plan, the likely existence of a large number of other sellers;
o Developments with high % of BTL investors will be particularly impacted by this.
Data provided by REalyse
Transaction volumes
Another simple indicator of liquidity is the number of transactions. We would consider looking at a comparable area in terms of housing stock and population. In the chart below, again for Crouch End, we have compared to the number of properties coming onto the market. The number of listings has risen during 2020, while the number of transactions has fallen over the same period.
Data provided by REalyse
Popularity of location
Finally, the desirability of a location will have an impact upon activity levels. There are a number of indicators of popularity. Some of these are already covered in the preceding section, but a general picture can be gained by the amount of general buzz there is about an area. A more tangible measure is the population growth, e.g. Manchester centre has experienced a population growth of 149% between 2002 and 2015.
Conclusion
To build a diversified investment portfolio, relative liquidity should be taken into account. This means having a portion of the portfolio with more liquid properties than others, in addition to the other typical diversification markers such as property type, gearing and so on. We will discuss this further in a future blog.