Real Estate / Real Estate Investment · February 1, 2022

How To Reduce Liquidity Risk On Real Estate Investments

What is liquidity risk

Liquidity risk is a type of investment risk that arises when there are no desired amount of buyers and sellers in the market.

As an investor, it is critical to consider the liquidity of your assets. As a matter of fact, the liquidity of your investments will have a consistent impact on your cash flow.

When can liquidity risk arise

Imagine you own a plot of land in the neighborhood. Due to some unforeseen circumstances, you want to now sell the plot. You have found out the market value of the plot to be Rs. 10 lakhs. Since you are in an emergency to sell the desired land, you don’t find the right buyer to buy the property from you.

This shows the nature of liquidity of the asset. There is a seller in the market, but there isn’t a counter buyer to close the deal.

In this scenario, even if the asset is worth Rs. 10 lakh, it is still worthless (for temporary) as there is no market participant to close the deal.

Here are some ways to reduce the liquidity risk on real estate investments

Do not pay high price for future benefits

Paying high price for the future benefits simply implies, paying in a hope that one day the property will gain high valuations in the future due to the upcoming development.

How many times have you come across a real estate broker, selling you a property promising you of a new highway, a new railway station or an upcoming airport in the region and shown you the dream that their property will gain tremendous value once it comes in existence?

This unrealistic hype will create a false sense of demand in the market and the rates of the assets are bound to inflate.

In most of these cases, in due course of time, the market price of these assets will fall and people will have no option than to sell the property at loss. There can also be situations the no buyer will be willing to buy the property from you due to bad publicity.

Avoid properties in remote locations

Investing in properties in a remote location only because the property is available for an extremely cheap price may not be a smart investment. When it comes to real estate investment, the value of the property majorly depends on the neighborhood as well.

There is a rare tendency to find the right buyer to give you the fair price for the asset. There can also be certainty that the property will be a dead asset and it will not appreciate with time.

Avoid old real estate property

Real estate properties keep depreciating with time. They also require frequent maintenance in order for it to be habitable.

When one purchases an old real estate, one needs to additionally spend more money in the renovation of the apartment / building. This added cost will increase the price of the real estate for the investor and may not stand at right valuations.

Also, another important reason for not buying old real estate properties is because banks and financial institutions do not provide loans over old buildings. This can be a hard situation for your next buyer to buy the property from you due to lack of financial support.

Avoid real estate that are in court matters

This is by far the most important factor one needs to consider before buying any real estate. The investor needs to ensure proper due diligence is conducted over the asset, the history of the property, check if the property follows the local by-laws and proper NOC (NO Objection Certificate) are readily available before investing.

A real estate property stuck in a court matters can be a nightmare because when the court orders a “stay order”, the investor will not have the right to sell back his property, despite his condition.

On the other hand, one may also have to spend additional cost on hiring lawyers and pay duties, which may further add on the cost of real estate property.

Some alternatives that can ensure healthy liquidity

Invest in properties during construction execution

Investing in properties during the construction execution gives an edge to the investor as the property will be already booked in your name before the project is completed. One may have ample time to study the market and take appropriate decisions by thoroughly gauging the market behavior.

If one feels that the market is not showing a positive sentiment, they may withdraw the invested portion from the real estate developer itself and close his investment.

It is possible for investors to invest in properties during the execution stage, as RERA Act now ensures proper safety and security to the buyers by maintaining proper transparency between the parties.

Also read: What Are The Benefits Of Buying RERA Approved Projects

Switch to REIT investments

REITs (Real Estate Investment Trust) are trust that collect money from the pool of investor and cumulatively invest the sum in real estate properties. The portion of these investments called “Units” are traded on the exchange, just like stocks.

The major advantage of REITs is that they are the highest form of liquid real estate assets. Since the units are traded on the stock exchange on daily basis, there are ample number of buyer and sellers in the market.

One needs to understand that REITs are real estate assets that can only be used as real estate investment alternatives. The investor does not have any rights on the use of physical properties of these assets.

Also read: What Are The 6 Main Advantages of Investing in REIT

Also read: 6 Reasons Why REIT are Better Investment Than Physical Asset

Invest in Real Estate Equity Stocks

Another alternative of taking advantage of the real estate bull run and scare away by lack of liquidity is by investing in real estate equity stocks.

When there will be a demand for real estate properties, these companies will tend to make the most profits. Thus, it is evident that these stocks will perform directly proportional to real estate development.

Conclusion

Summary table

Sr No.Tips to reduce real estate liquidity
1Do not pay high price for future benefits
2Avoid properties in remote locations
3Avoid old real estate property
4Avoid real estate that are in court matters
5Invest in properties during construction execution
6Switch to REIT investments
7Invest in Real Estate Equity Stocks

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