Dave Sather’s Money Matters
Lately, we’ve had numerous conversations with clients, as well as others, who have found themselves “asset rich and cash flow poor”.
They have put themselves in this predicament by owning illiquid real estate assets.
Often, these illiquid assets are from privately formed real estate partnerships which come with a slick sales pitch offering attractive cash flows at a time when traditional interest income continues to be pathetically low. With money markets and C/D’s offering less than 1% interest the thought of earning 8% or more sounds too good to be true—and it usually is.
More than likely, the assets appeared sound and the buyer relied on the advice they received at the time. However, often that “advice” is motivated by a large commission that the selling broker stands to receive if you bite.
Furthermore, many investors in these partnerships later realize that the big “cash flow” they received was not “interest” income but rather a combination of interest and return of principal. Given this, the check you receive may be very deceptive in terms of its actual rate of return.
Although the majority of the concerns we currently hear about involve private real estate partnerships put together by brokers, there are many other examples of assets with similar issues. Whether it is a private business, acreage, or even your house there are many issues to evaluate and consider.
For instance, many illiquid assets are hard to value and even harder to find a buyer for–especially when time is of the essence.
Think for a moment just how different shares of Coca-Cola stock are when compared with any illiquid asset. This past Friday there were 8.1 million shares of Coca-Cola that traded hands. As such, an owner of Coke stock can rest assured that if they need to sell their shares there will be many willing people vying to buy their asset. The same is not true for the illiquid assets. Sales may take months to complete and even then, due to a lack of competing offers, you may be forced to sell for a fraction of what an asset should be worth. As such, in a pinch which would you rather own?
Buying illiquid assets can compound the liquidity trap that many retirees are now facing. Their single biggest asset is a house that cannot be used for cash flow and is illiquid. Consider an individual homeowner who allocates a significant portion of their remaining savings to other illiquid assets—and then something unforeseen occurs. They have very little room to maneuver and their financial picture can quickly become a house of cards.
Obviously, the fact that an asset is not publicly traded does not mean you should run for the hills. However, some common sense is warranted. Don’t fall for something just because of a good sales pitch and don’t fall in love with an asset. If someone is actively selling you a product of this nature ask many questions and get the responses in writing. Furthermore, recognize that if you invest in a non-publicly traded asset you need to be very confident that you have a very long time frame to hold that asset.
Finally, remember that the world’s greatest investment ideas may never be profitably completed if you don’t have the necessary cash flow in the meantime or if you don’t have other financial resources that allow you to be sufficiently patient.
President, Sather Financial Group