Friday, 4 October 2013

Reits' Better Liquidity than Direct Property Ownership is a Risk?

Unlike direct property ownership, REITs offers liquidity and daily price quotations. Many investors mistake this for increased riskAfter the average real estate investor has acquired a house, apartment building or storage unit, he becomes primarily interested in the future rental income prospects, not the potential sale value of the asset if he put it back on the market. Indeed, if the investor holds the property for twenty years, he is likely to have lived through significant boom and busts in the real estate cycle. In most cases, it is safe to assume that because of the lack of daily quoted resale value, the investor has not actively considered that his real estate fluctuates as he would for common stock, In this case, the lack of quoted price is mistaken for stability. 

As Benjamin Graham said in his The Intelligent Investor :
There was then [during the Great Depression] a psychological advantage in owning business interests that had no quoted market. For example, people who owned first mortgages on real estate that continued to pay interest were able to tell themselves that their investments had kept their full value, there being no market quotations to indicate otherwise. On the other hand, many listed corporation bonds of even better quality and greater underlying strength suffered severe shrinkages in their market quotations, thus making their owners believe they were growing distinctly poorer. In reality the owners were better off with the listed securities, despite the low prices of these. For if they had wanted to, or were compelled to, they could at least have sold the issues – possibly to exchange them for even better bargains. Or they could just as logically have ignored the market’s action as temporary and basically meaningless. But it is self-deception to tell yourself that you have suffered no shrinkage in value merely because your securities have no quoted market at all. In other words, despite the fact that the quoted price of the REIT may fluctuate on a daily basis, the economic reality of direct real estate investing is no different. In essence, it is as if the owner of a REIT simply didn’t pick up the paper and examine the price offered to him by Mr. Market. Taking it one step further, this perceived disadvantage is actually one of the perks of owning REITs. Unlike direct real estate holdings, they are a liquid asset that can be sold fairly quickly to raise cash or take advantage of other investment opportunities.

REITs' liquidity can be an double edged sword. The ready-to-trade price can serve investors with many benefits that are not possible with direct property ownership, but it can also seduce investors to react to their greed and fear and make regrettable decisions. 

In this game, we have to dance and pay attention to the music, while we also must always remind ourselves not to dance to the tone of the frenzy Mr. Market.

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