Can Increasing Liquidity Add Value to Real Estate as an Asset Class?

Eli Randel, director of business development at CREXi.

MIAMI—If illiquidity can negatively impact value, can increasing liquidity add value to real estate as an asset class? In the exclusive commentary below, Eli Randal , business development manager in Miami for CREXi , discusses that question and talks about the risks associated with the lack of liquidity in commercial real estate transactions and the role technology can play to minimize that risk. The views expressed below are the author’s own. LIQUID DIET Liquidity (or lack of) is one of the most important risks associated with commercial real estate. Because commercial real estate lacks the liquidity of say the equity or bond markets, investors will demand a greater return (or a premium) to offset risks associated with the general inability to quickly sell an asset to capture value, free up capital, realize gains, stop losses, pay a loan maturity, or any other reason that might necessitate a quick sale. In order to capture “market” value, or the amount the property is worth in a non-distressed, marketed transaction, a disposition from contemplation to close will typically take about four to six months. During that time period the market, tenancy, financing environment, and other factors could change affecting the value of the property negligibly or significantly and nearly always negatively (a buyer under contract will not decide to pay more because sale conditions improved). Property specific or market specific events which can force a sale might create distress which can damage the sellers position or they can create an oversupply diluting value and/or liquidity as properties compete for buyers. Because of the added risks associated with illiquidity, investors demand a return premium to balance the risk-reward scale and to provide more room for error. For instance, a 200bps yield premium from a single tenant net lease deal vs. a corporate bond from that same corporate entity could decrease the net present investment value by 10% (assuming the same reversion value) despite the many upsides and shelters associated with owning structure vs. paper. So if illiquidity can negatively impact value, can increasing liquidity add value to real estate as an asset class? INEFFICIENCIES Currently the commercial real estate disposition process is a lengthy dance where over the period of a 180-day sale only a fraction of that time has a sense of urgency. Once, when disseminating information was slow and offering memorandums were mailed (yes mailed) to buyers, these time periods might have been necessary. Yet now even with the ability to send important documents in real time with the click of a mouse, lengthy sale periods remain the norm. While there are several important reasons why such a large transaction can’t happen overnight, the process is loaded with down time and is overly cumbersome despite new technologies allowing for a quicker process. The traditional sale process typically calls for a decision to sell and internal approvals (2 weeks); broker selection, negotiation of listing agreement, and creation of offering materials (4 weeks); marketing period (6 weeks); selection of buyer and negotiation of Purchase and Sale Agreement (2 weeks); due diligence period (4 weeks); closing period (4 weeks). This hypothetical 22-week process assumes a successful deal with minimal hiccups (a rarity) and as most deal makers know: no transaction is easy. During that 22-week period (close to half of a year) sale conditions can change which can and do often derail transactions forcing a seller to either accept a lower price or start the process over. The changing conditions could be as relevant to the property as a major tenant filing for bankruptcy, or as seemingly distant as the value of a foreign currency affecting the lending environment. With recent chatter and speculation around interest rate increases, and the corresponding increase in borrower cost of capital, six months can be a long time to have your fingers crossed when wanting to close a sale. Failing to execute on a disposition can result in opportunity costs when capital needs to be freed to pursue other opportunities, increased losses if the property is losing value or has negative income, or distressed situations if maturities are approaching and debt can no longer be paid or serviced. TECHNOLOGY’S ROLE With technology there is an opportunity to solve for these inefficiencies and speed up the transaction process. What if property management analytics quickly allow for a sell decision based on projected returns? What if brokers could be quickly selected based on a transparent rating system? What if offering memorandums and web-pages could be more quickly created and disseminated using web platforms and applications? What if brokers could drive buyers to an automated best and final process to quickly select the winning buyer? What if underwriting tools and analytics were available in real time from a buyer’s desktop? What if due diligence was made available up front with a PSA which could be red-lined, negotiated, and submitted on a shared document as part of the buyer’s offer? What if third party reports were quicker and easier to obtain and financing was easier to source and close? Many inefficiencies can be eliminated and the industry is (slowly) entering a chapter where companies like CREXi will deploy technology not to redesign the sale process but to enhance, modernize, and increase fluidity and liquidity to the industry. By increasing liquidity and enhancing the transaction process we can add-value to real estate as an asset class by reducing risk premiums while also reducing friction costs (not increasing them with our services) and indirectly improving other industries as well. As the speed and efficiency of transactions increase, the lending industry has no choice but to catch up and companies like Raisal.com are building the technology platforms to help lenders keep pace and give buyers instant access to debt capital. “Lenders of all shapes and sizes, from banks and credit unions to institutional CMBS conduit lenders, are embracing technology solutions like ours to gain access to deal flow. They realize that if they are not willing to commit and fund quickly, they will lose lending opportunities to lenders who are,” noted Joshua E. Young, Esq., Founder and CEO of Raisal.com. With lender underwriting and loan commitments made more quickly transactions can be closed sooner and more time can be spent adding value to the real estate through the buyer’s business plan or new found reductions in required premiums as investors become more comfortable with the idea that sale volatility is reduced and capital can be accessed more quickly. We believe disruption can be subtle and nuanced and that process reform benefits every party in the transaction: sellers and brokers like certainty of sale and buyers, who historically have enjoyed the added time to contemplate their transaction and structure their capital stack, also benefit from smoother ownership transitions, less deployment of human capital, and access to more deals as the transaction environment becomes more fluid and open. Transactions will always have a tempo and therefore a dance, but the industry has been slow waltzing for too long and with new tools and a fast changing environment, perhaps it’s time to boogie.