Liquidity Is Always The Real Estate Investor’s Best Friend
08 Sep 2016
Liquidity is ALWAYS the real estate investor’s best friend.
When real estate markets are hot, cash differentiates a buyer by enabling it to offer faster closing times and a more certain close than buyers who are dependent on obtaining financing. When markets are cold, investors need liquid assets to take advantage of sinking prices while those without liquid assets are left in the dust.
At Hager Pacific, we have built a strong business by self-funding the great majority of our deals. As all-cash buyers, we can make investments in turbulent real-estate markets that other firms simply cannot. For example, during the Great Recession from 2008-2010—as developers drowned in their own debts, property valuations plummeted, and access to capital was cut off—we were able to acquire assets at a significant mark down, in large part because we didn’t have to worry about securing outside financing. As many investors fled real estate, we became one of the most active buyers of industrial real estate in Southern California. In 2009 alone, we invested approximately $50 million.
Maintaining access to capital reserves is an important way to hedge against the uncertainty of fluctuating interest rates as lenders find themselves either under or overwhelmed with requests. In a difficult real estate market—when interest rates can soar out of control make capital for transactions challenging to access—cash is king. One simply cannot overstate the importance of maintaining significant liquidity when markets become turbulent. Access to cash gives you the flexibility to seize opportunity during a market crisis, as Hager Pacific did in the mid 90’s, after the Dot Com bubble in 2001, and after the crisis of 2008.
Cash is not only essential for taking your firm to the top of the real estate world, but also for staying there. It serves as a buffer between your profit margins and the unexpected. Smart investors also understand that market indicators do not move linearly. Major fluctuations can happen very quickly as a result of changing governmental monetary policy, an investor panic, or an unforeseen international crisis. You have to factor in the potential for these fluctuations. For example, in January 1978, the federal funds rate was 7.96%. Four years later, as the Federal Reserve sought to bring rising inflation under control, it had skyrocketed to 14.59%. Many investors were completely wiped out.
So how do you limit your risks where the only certainty is uncertainty? The short answer is an abundance of caution. Hot real estate markets—with low interest rates and rising prices—are the environments where major mistakes are made. Before buying or investing in property, carefully consider the worst-case scenario. Sinking the bulk of your capital into an illiquid asset like property could leave you powerless should a sudden market shift occur. Make sure that you can live with the consequences of a change in interest rates or a decline in valuations.
Long-term success in real estate requires steady access to capital and a keen understanding of market forces. If access to capital becomes more expensive during an upturn, incentives to invest in and buy real estate weaken, lowering property valuations. The result? Relatively small fluctuations in interest rates can have an outsized impact on the real estate market. Maintaining spreads on deals above risk-adjusted rates is the formula for success. Yet, this is not always easy – it requires careful analysis, patience, and a focus on the long-term.
In the end, success in real estate, like so much in life, depends on timing. Never rush into an investment: understand the booms and busts of the business cycle, manage your assets accordingly, and you’ll find that even in a climate of uncertainty, opportunities abound.