Liquidity is the probability that an asset can be converted into an expected amount of value within an expected amount of time. If you know that you can sell your wristwatch for $100 within an hour, you could claim that your wristwatch is a liquid asset. If you are uncertain how much your watch is worth, or how long it might take to sell, where and to whom, then it is rather "illiquid."
Why is this important?
Because in today's market, questions abound. Where is the real estate market going? Is now a good time to buy? A bad time to sell? Is real estate even worthy of investment consideration? There are many people saying that it is over for real estate and one should invest in liquid assets, such as gold.
I put real estate and gold in the same class of investing, in that they are both hard assets and reflective of value. In 1980 gold went to $850 per ounce. Then it dropped to $260 an ounce. Now it is close to $900 per ounce. Will it stay there? I really don't know. What I do know is that if you purchased gold at $850, you lost a lot of money if you held it until today. While you can sell it for $900, that figure does not take into account the inflation of the last 28 years. If that is considered, then the gold would be selling in the $6,000 plus range. If, on the other hand you purchased real estate for $100,000 in 1980, with a 20% down payment, you could have a property worth about $850,000 to $1,000,000 in the SF Bay Area. And your $20,000 would have made you a tidy $830,000 to $980,000in profit. That is the magic of leverage and the benefit of using borrowed money with tax deductible interest.
I am not in any way suggesting that one ignores gold, nor blindly buys real estate.
As I have stated in previous articles, real estate is location specific. Gold is not. Another benefit of gold is the absolute pure liquidity. Decide to sell at 9:00 AM and it can be sold at 9:15 AM. A ready market is there to buy the gold.
So, should you buy real estate instead of gold? That depends on you and your situation. You can buy any gold, as it is completely fungible (interchangeable). Such is not true of real estate. One piece of real estate is not like any other piece of real estate, therefore fungible is out the window. Buying real estate takes time and effort and ongoing management. It is not totally liquid, in that some period of time is often required to achieve the full value for the property in a sale.
Today's Market:
The price declines for single family homes have been dramatic. Too many were bought with no money down, 100% financing, no doc loans (the borrower did not have to document their income or asset balance sheet) and the financial reality of the adjustable rate mortgages was ignored. The purchase was based on what is called the "greater fool theory." That simply says that "no matter what I paid, there is a greater fool who will pay more." And for a while that was true, as it is in any bubbling economy. This phenomenon, however, was particular to the residential real estate market.
When dealing with commercial properties and investment properties with more than four units, lenders were a lot more careful. These properties required a down payment of at least 20% and both the property and the borrower had to qualify. In addition, the theory, long substantiated by past performance, tells us that an investor will rarely walk away from the amount of money involved in real estate investment property. And, even if the investor does walk, there is sufficient cushion to protect the lenders position.
What does all this mean? Well, it means that the foreclosure rates on commercial properties are far lower than residential properties. Not that they are immune, just that the loan criteria were more stringent, and therefore fewer shaky purchases were made.
So what, you say?
Well, there is money to be made in real estate, as in the stock market, or most any other market, when it is at the bottom of the curve. We are approaching that point now. The only way we ever know the top or bottom of any market is after it has happened. The unusually prescient may know it at the time, but I am not one of those and, I suspect, neither are most of you.
There is plenty of money available for loans on commercial product, but the loans are both market and product specific. Interest rates are still low, in the 6.5% to 7.5% range. Cap rates have not jumped, but are climbing.
What this tells me is that now is the time to start looking and deciding what portion of your investment dollar will go into real estate or into gold. Just remember that only real estate has the magic wand of LEVERAGE.
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