The Liquid Future of Real Estate

Entering real estate transactions often implies an uncountable amount of time spent on research, analysis, discussions, evaluations, and decisions. Both sophisticated institutional and retail private investors willing to buy properties experience the feeling of facing a fight with an acquisition process that is, in most cases, uncertain and exhausting. People can argue differently, but real estate asset deals are not a liquid market yet. A liquid market can be clearly defined as a financial market in which it is easy to buy and sell, and in which a lot of buying and selling takes place (Cambridge Dictionary); basically, a market where players can easily and quickly cash in, without worrying too much. Globally speaking, and taking, again, a high-level standpoint of analysis, real estate is still a victim of major business blockers and delayers. This brief analytical article, which is intended to be just the starting point of a set of studies on real estate investments, will try to offer the reader a view and few basic inputs of how investors, sellers, and advisors should consider recent developments, market trends, and alternative mindsets to (i) accelerate the closing of the deals, (ii) secure a successful outcome, and (iii) counterbalance the major risks associated to this market. However, before jumping into the topic, it is worth clarifying that this high-level analysis will only examine buyer-seller dynamics, therefore focusing on direct asset acquisitions. Any consideration and opinion should not implicitly apply to the purchase and negotiation of structured financial instruments underlined and/or backed by real assets, nor to listed products.

So, what are the main obstacles, burdens, and threats that a real estate transaction naturally brings with itself? There are, in our opinion, five main critical points to consider that might affect the good outcome of a deal of this kind and, as a consequence, the liquidity of the entire market.

First, the buyer’s appetite. It is often the case that investors approach the target asset or the seller shyly. There is no clear and strong determination since day one to close the deal; there is no sufficient entrepreneurial arrogance. It can be noticed that buyers seem to put their fear of purchasing at disadvantageous terms in front of the original need to purchase that specific and selected target. This approach, which should be better classified as a commercial mistake, turns the table in favor of the seller who will inevitably take advantage of the situation by becoming the strong negotiator at the table. Such a circumstance can be considered a negative impact on the transaction since rapidity, efficiency, certainty, and – ultimately – the successful outcome might be heavily affected by the weakness of the buyer.

Second, lack of knowledge. This second point is interconnected with the first threat above and involves all the parties of the deal. During the preliminary and non-binding phases, the investors know just the minimum necessary on the assets, the sellers are rarely aware of which are the intentions or the investment strategy of their counterparties, and, ultimately, the advisors (unless they are co-investors in the deal) are generally more focused on their fee structure rather than on the quality of the property. An ecosystem like the one mentioned might inevitably generate an acquisition process governed by random patterns and misaligned decisions.

Third, information asymmetries. Not only specific market and transaction knowledge is missing, but each party is in possession of crucial information that is barely and rarely shared with others. There is this general misbelief that all data - unless expressly required by law - shall be secretly kept and treated to one’s advantage only, to gain a stronger negotiating position. If it is certainly commercially smart to take proper advantage of the informational set every single party has, in real estate, the lack of communication or even worse, transparency, can just produce the failure of the deal, and a tremendous waste of time and economic resources for all.

Fourth, high fixed costs. Obvious but massive obstacle. Real estate involves important transaction costs compared to other asset classes: advisory, brokerage, technical and legal fees, due diligence costs, taxes, capex, and financial leverage (if necessary). It is a set of inevitable economic burdens that, with due distinctions and exceptions, affect all these transactions, from the purchase of a flat by a single individual to the acquisition by a global asset manager of a portfolio of logistic warehouses spread around multiple countries.

Fifth, old-style procedures. On the last point, a tiny provocation may be allowed. Real estate is not highly sophisticated compared to the main sub-fields of corporate finance and investments, and this is evidently and daily proved by the chaotic and old-fashioned processes that govern these (commercial) transactions. The development of the characters, their education, and technological evolution is much slower than elsewhere in business. Just think of how personal relationships and local connections are still a pivotal methodology for the scouting and origination of investment opportunities.

However, in conclusion, some preliminary remedies and different business developments can be proposed in this article with the ultimate aim of fighting the five threats above and starting to, slowly, build a more liquid market.

Information asymmetries and old-style procedures could be counterbalanced by the constant consultation and advanced study of market intelligence platforms and digital databases, which nowadays can quickly provide investors with a technical and ready-to-use set of tools. Such resources should not substitute the role of advisors and brokers but offer them and their clients a more solid business proposition and market awareness.

On the side of the scarcity of technical knowledge, the challenge is bigger. Real estate acquisitions cannot be hostile, but is always a common walk that all, buyer, advisors, brokers, and seller, take together for the economic benefit of all. Here, there is no one-stop solution to this blocking point, other than a higher level of recognition and respect of each role, equally essential for the success of the deal.

High fixed costs are an ever-ending story, a tunnel with no exit. From the investor perspective, this economic exposure could be offset by, once again, a more accurate identification of the target assets. Analysts and portfolio managers, therefore, should adopt a new paradigm where the allocation of time and resources to the origination and scouting phases should be preferred to the transactional activities. This tendency might probably produce fewer non-binding offers but, most likely, in the end, a higher number of successfully closed deals and, directly, less expenditure on unnecessary due diligence and advisory services. Similarly, buyer’s appetite could be cured in this same way; by increasing the amount of data, in-depth analysis, and relevant advisory services produced in advance of any non-binding or binding offer, the investor will gain - once all the necessary green lights and preliminary approvals are obtained - a non-comparable level of awareness and willingness on the quality of the target, duly studied and identified. Doing this, the transactional timeline will be inevitably compressed, for the benefit of all parties, and the buyer will finally recover its lost negotiating power.