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Kraaaa-POW!! The front door swings open, and you look up, startled. You see your mom rush in, eyes wide and out of breath, panting. “I can’t believe it!” she exclaims. “Start packing clothes, I’ll explain as you pack.”
She takes out a gleaming blue rock, and your eyes light up! Everyone in your desert town knows about the recent sapphire discovery, and since there are likely other deposits nearby, it has spurred townspeople to go search for them and mining companies to bring in helicopters to cover more ground. She tells you that your best friend Tobais just returned from one of these two week trips and found a big sapphire deposit! He needs your help rowing a big canoe upriver, digging them out, and returning with generational wealth for both families. You both are off on the river in an hour, desperate to beat the mining companies that will take it all for themselves. You both row with all your might.
You arrive a week later, and the sapphire deposit is huge! You & Tobais spend so many days digging them up and loading the canoe up to the max that you’re running low on food. Exhausted but ecstatic, you agree to head back home and on to a new life. Should be smooth sailing down river; you’re almost there!
Halfway back, you hit a sandbar. And then another. And then another. You realize that the canoe is too heavy for the dry season and the river’s levels have decreased. You and Tobias are stranded too far to paddle or walk, out of food, and have no options to get you & your sapphires back home. You’re afraid this might be it.
Whamp-whamp-whamp! You look up and see a helicopter that can take you home! You can’t hide the sapphires, but you and Tobias are more than happy to split with him. You flag it down and explain the situation, and the pilot gives a menacing smile. “That all sounds great to me, but only one difference: I will take 90%, and you two can split the other 10%.”
You’re furious, and say it’s completely unfair! But the pilot responds, “the way I see it, you can either die here with your riches and I come pick them up over your corpses, or you can live and have some. What’s funny is that you all think we fly these helicopters to look for the sapphires…but in reality we were looking for people like you. I’ll give you 5 minutes to make a decision.” Livid, you and Tobias discuss privately. What do you do?
Welcome to the world of illiquid assets.
In the story above, you can see the advantage the river gave you and Tobias. The water (liquidity) allowed you to move faster further and with less effort than when on land, and then made it much easier for you to move the sapphires (your assets) down the river. In a world where the river stayed full, the story would be easy and you would be home celebrating with your family.
However, we know that rivers are not always full and that dry seasons come, and illiquidity is when the water goes so low that you can’t move anymore.
In the finance world, liquidity and illiquidity basically translates into: “How many potential buyers are out there that will let me sell this asset at a fair price?” If you have a lot more people willing to buy your asset (demand) than the asset you hold (supply), then you generally can feel pretty confident that you can sell it whenever you want. On the other hand, if you have an asset that is big, expensive, and/or unique and there are only a few people willing to buy (demand), then you might be stuck having to negotiate a lot more than you want or have more trouble selling at the value you determined.
In today’s world, you might hear many people referring to certain assets as being liquid such as stocks because there is a large market for them. But in reality, a share of a company like Amazon or Tesla is only liquid because of the markets they trade on and the systems in place to keep those markets moving in addition to the number of people who are willing to buy or sell them at a given price. For example, the stock market exchanges hire “market makers” who pay fees to accept trades from investors looking to buy or sell. However, when you consider assets like real estate these types of markets are non-existent.
Historically, real estate is often considered to be one of the most illiquid assets, literally and figuratively some of the heaviest things to move down the river. For instance the high purchase costs that most people and families do not have access to and the longer time to build or adapt a real estate project to make increased returns and realize the business plan of having higher rents can make real estate heavy. Additionally, the time-consuming procedures and middlemen involved in buying or selling a property, such as document signing, inspections, appraisals, legal and loan approval, can further exacerbate illiquidity in the real estate market. These factors can make it challenging for property owners to access funds quickly or for investors to take advantage of new investment opportunities.
This is the opposite of how stocks work. You can open up a Fidelity, E-Trade, or Robinhood account, buy a share of a large capitalization stock like Apple, and be nearly certain that you can sell that stock whenever you want. This works because stocks like Apple trade on a marketplace (called an exchange) that matches buyers and sellers instantly. Because there are so many buyers and sellers for something like Apple stock, you can feel confident that you can buy Apple anytime and sell Apple anytime. With all those buyers and sellers, Apple stock enjoys movement on a very powerful river.
Real estate has lacked this, until now.
So if illiquidity is so terrible, why would anyone be willing to invest in assets with them? The answer is the same reason you initially went on the quest for the sapphires - if you and Tobias were able to make it back to the town, you could have made much more wealth, which in finance is known as a higher return on your money invested.
Because the likelihood of you getting back to the town is uncertain, you will demand more of a benefit (return) on your sapphires because you want to balance that higher return with not making it back. In the investment world, that higher return you would want on illiquidity is called an illiquidity premium. If measured well, such a premium can help grow your wealth significantly.
The downside of illiquid assets is represented in the helicopter pilot extorting you and Tobias when there weren’t many options. Unfortunately, this is when illiquidity can lead to very scary results.
The problem is when you are stuck there is a lack of liquidity there are only a few options. In this case you only have one helicopter who is willing to give you a ride but at a significant cost, which the finance world calls distressed investors, who specialize in paying rock bottom prices for your asset for much less than it’s worth (called buying at a discount). At that point, beggars can’t be choosers. And just like the helicopter pilot, when dealing with distressed investors, you know that you may lose all the money you thought you were going to make - and maybe even some of the initial money you put in - just to get back home.
So what’s the best option then? Is it not worth investing in illiquid assets at all? Do you just assume that any journey with Tobias is doomed from the beginning since you’ll always get stranded? Not so fast! Like most things in life, there do not need to be extremes, and you probably fall somewhere in the middle.
The first thing to think about is: what caused you to be in such a dire position? The main factors that caused you to be stuck were:
You and Tobias likely could have handled any one of those factors, but the combination of two or three turned out to be potentially deadly.
When thinking of it that way, what things could you do that would have increased your chances of getting home and not getting stranded? If you spent less time gathering sapphires and exhausting your food, you may have had enough food to walk back home if the river dried up. If you collected fewer sapphires on the trip and your canoe wasn’t so heavy, maybe you could have gone further down the low flow river that you could’ve made it home.
Both of these would mean that you and Tobias wouldn’t have as many sapphires (assets) when you made it home, but it would decrease the chance of falling prey to the patrolling helicopters. But then, on the other hand, if you planned to go back, you could use some of your wealth to buy food, horses, and carts, round up your friends, and head back with a plan for how to bring it back and not get stranded.
A final option could be that you have spent time studying the river. If you knew the shallowest parts of the river, when every year the river gets to its lowest point, and indications for when river level is about to decrease a lot, you could’ve monitored the river for signs of it drying up and decided to leave when you saw there would be more water or brought more food given the likelihood of of the need.
At the end of the day, the amount and how you think about how much illiquidity you have in your investments is how much of the different factors are you comfortable with? Some people are ready to risk it all and will take their chance with the helicopter pilots. Others will feel comfortable collecting sapphires 1, 2 or 3 days and having more of a cushion to get back home. And some will enjoy studying the river (or markets) to determine when it makes sense to focus on each option.
At the end of the day, there are an infinite number of options, and the answer will depend on your family’s and your individual circumstances.
We hope you have enjoyed understanding some of the nuances of illiquid assets and some of the factors to look out for that will determine whether and how they make sense for you.
We are also excited to introduce a new concept in the illiquid world of real estate investing that will change how it is traded. Kopa will be creating the equivalent of an everlasting snowpack that feeds and expands the river so that it remains deep enough for you to bring your sapphires home. This has not existed before, but if you want to learn more about how it works or have other questions, please send us your question, reach out or follow us on Instagram, Discord, Twitter, TikTok, Facebook, to Join the Movement to Own Your World!
Once upon a time, there was an ant and a grasshopper who lived in a beautiful meadow. The ant was a hardworking creature, always busy collecting food and storing it for the winter. The grasshopper, on the other hand, was carefree and loved to sing and dance all day long.
Rhea was scared stiff, her heart beating fast. Even though she was a mythical Greek Titan, she was terrified of what might happen if her husband found out she’d left their baby on the isle of Crete. Still, she stepped closer and held it together as much as she could.
Our platform provides a solution that empowers everyone everywhere with equal opportunities to create impact and cultivate wealth through ownership.
Amount of real estate transactions shared by the Kopa's senior leadership of $12 billion
The amount of funding that startups have gotten from professional investors previously
A testament to our technical proficiency, making investment easy for everyone