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What Are Illiquid Investments?
June 5 | 2014

Illiquid Investments

If you have ever invested with RealtyMogul.com or in real estate in general, you have invested in what are called illiquid investments. Illiquid Investments are securities or assets that cannot be easily sold or exchanged for cash without a substantial loss in value. Illiquid investments cannot be sold quickly, because of a lack of ready and willing investors to purchase the assets or securities. In other words, these assets and securities cannot be readily converted into cash. 

How Do Illiquid Investments Work?

You may now be curious how illiquid investments work? Some examples of illiquid investments include real estate, cars, antiques, private company interests and some types of debt instruments. Real estate investments at Realty Mogul are generally considered illiquid investments for several reasons.

First, the transferability of the securities being purchased (whether those securities are membership interests in a limited liability company (LLC), or debt securities tied to the performance of a particular loan) are restricted by both Realty Mogul (or the applicable LLC) and by United States federal and state securities laws. In general, investors will be able to sell or transfer their interests in the securities offered through Realty Mogul only in very limited circumstances.

Additionally, there is no public market for these types of securities, and none is expected to be available anytime soon. The lack of a public market means that, even in those circumstances where a sale of securities might be permitted, the lack of ready buyers could adversely affect the price of those securities, at least as compared to situations where there is a market with daily trading activity.

Finally, investments in securities offered through Realty Mogul are “passive” in nature, meaning that the control decisions applicable to such investments are in the hands of third parties. In the case of equity opportunities, for example, it is generally the sponsor real estate company that decides when the underlying property should be sold and investors’ capital contributions (and any gain thereon) returned to them. Investors can gain from the expertise of such companies, but investing with them also means control of the underlying property, largely rests with those operators.

Why Do People Utilize Illiquid Investments?

Despite the disadvantage of illiquidity, there can be advantages to situations where someone is willing to “sit on” their investment. Cash flow-focused real estate investments, for example, can largely remove speculative price movements from the equation and be relatively stable if the property performs as expected. Investments in common stocks, for example, generally are not focused on cash flow, and have great uncertainty associated with them. Debt securities that are related to secured real estate loans have a degree of stability associated with them, and equity real estate investments can also involve potential appreciation and tax-deferral features related to depreciation deductions. These latter situations can potentially involve investment return rates that might even exceed those available with riskier investments like common stocks.

Passive cash flow investing through Realty Mogul is a more specific approach that makes cash flow investing easy and accessible. These opportunities are managed by experienced operators who earn fees that largely align their interests with those of investors. This approach is like “hiring experienced operators” on your behalf. If the investment performs as expected, it can result in investor’s simply collecting cash flow from the opportunity without any additional effort.

Passive cash flow investments are typically much less liquid than stocks and bonds, as an investor’s shares cannot be easily sold. Passive cash flow investing also involves handing over control to the operator, which makes the investment even more illiquid. If you are careful when choosing your investments (conducting due diligence for each opportunity and diversifying across many operators and investments) then passive cash flow investing can prove to be a sound strategy despite the illiquidity that is inherent in such investments.

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