Liquidity is an important concept when investing in anything. From stocks to bonds all the way to real estate, understanding what a ‘liquid asset’ represents can give you a financial advantage over others.
What is liquidity?Liquidity is a measure of how easily someone can buy or sell something without affecting the price of that thing. The mysterious ‘thing’ referred to here is known as an asset.
What are assets?A few examples of common assets would be your house, gold, shares of a stock, your phone, your laptop, cash, or any ‘thing’ that could be traded or sold for another ‘thing’ if necessary.
What is market liquidity?This really involves the question: how likely is someone to trade an asset for a different asset without affecting the price of similar assets? One example of a liquid market is the food for cash market, or if you will, the supermarket. Since so many people purchase bread, no one person will be able to pay less for bread, and if a single person paid more, nothing would change. This is because the bread for cash market has high liquidity.
On the opposite end of this, imagine there was a market that traded solely in rare bongos and bazookas. Since there are so few people trading in these assets, each trade would result in a new market norm for the number of bongos exchanged per one bazooka. If you were interested in entering this market and had three bongos and wanted one bazooka, but one of the few other people involved in the market just traded 15 bongos for a bazooka, that would be the market price. This is illiquidity.
How does this relate to real estate?
Pro tip: Always contact a local real estate agent before you buy or list your house.
The real estate market is somewhere in between these extremes but leans toward illiquidity. If you want to buy a house, but the property is appreciating in value, sellers are going to demand more dollars per house than you will want to pay. This is especially true if someone in the neighborhood just sold their home for much higher than your ideal price. This is known as a seller’s market.
On the flip side, if you owned a home and wanted to sell, but people in your neighborhood recently sold their homes for much less than you want to sell yours, the value of your home will go down. This is known as a buyer’s market. Either way, it is illiquid because the price is easily influenced by a single person selling a single asset — their home.
Look at real estate listings to use this to your advantage whether you are buying a house or selling a house. Also, consult with a real estate agency about market trends. A good way to know how much your house will sell for is by browsing the real estate listings in your neighborhood. If you have any doubts or questions, 78% of recent home buyers found their real estate agent to have helpful information.