Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 204

Is the property illiquidity premium outdated?

As non-classically trained investment operatives, we have found the basic question ‘Why?’ has served us well. In the past 10 to 15 years, watching market performance, we have constantly questioned why unlisted assets are expected to provide a return premium over their listed peers.

Classical investment theory defines the illiquidity premium as compensation for the loss of control (or liquidity) to exit an investment position at a desired point in time. This is sound logic if markets always trade upon fundamentals. Once behavioural forces come into play, this theory seems to deviate.

Locked funds versus loss of capital

Our research for this article left us thinking that the mortal sin of investing is having investors lose control of their equity in locked funds. While we appreciate the sensitivity of the loss of control, surely losing capital is worse. The distinction between these two will become clearer in a moment.

Historically, unlisted property has provided a return premium of between 100 and 300 basis points (1% to 3%) over listed property as recompense for poor or no liquidity. Property is a good asset class by which to assess the illiquidity premium concept as the listed and unlisted property markets in Australia are deep and generally well researched.

The figure below illustrates the returns from listed property and unlisted (core) property since 2004. This data captures the pre- and post-GFC markets, so represents the impact of the cycle.

Pre-fee cumulative returns, unlisted (core) and listed property (% pa, Jun 2004 = 100)

Source: MSCI

Listed market can suffer from liquidity

Pre-GFC, the listed market was trading at a premium to its unlisted counterpart, clearly at odds with the illiquidity premium, but the listed market was savaged during the GFC.

Herein lies the disconnect: in boom markets, the liquid market appears to trade at a premium to its unlisted counterpart, and then in a market correction, the liquidity sees prices savaged. Peak to trough, listed property lost ~70% of its value whereas unlisted property only declined ~20%.

There is an argument that liquid investors should obtain a premium for the price volatility of their investment. The listed market also took almost 10 years to regain its pre-GFC values whereas the unlisted space took just three years.

Consider our earlier point that losing capital should be the mortal sin of investment, not losing control of the equity. There were a number of unlisted funds that were frozen or locked during the GFC, which saw many investors lose the ability to manage their equity. While this is a less than optimal outcome, freezing these funds may have been the best preservation strategy for the equity at that time. Certainly, these charts indicate that being in an unlisted fund saw ~50% of the equity value preserved in the unlisted sector versus its listed peer. We consider that a reasonable outcome even when factoring in the loss of equity control.

The figure below illustrates year on year returns of listed and unlisted property markets. The listed market shows massive price volatility and ventures into loss territory three times, as opposed to the unlisted sector which has far more stable returns and ventures into loss territory only once.

Pre-Fee rolling annual returns, unlisted (core) and listed property (% pa)

Source: MSCI

If the return expectation for a particular investment is a function of the risk the investor takes on, there is an argument that listed property should provide a return premium to compensate investors for the market risk during irrational periods (both bull and bear markets).

Reconsider the illiquidity premium

We are not pushing one position over the other. Rather we contemplate whether traditional thinking about the illiquidity premium may need to be reconsidered. Periods of exuberance or correction tend to see liquid markets surpassing the fundamental level of the underlying assets, both on the upside and downside.

On this basis, investors need to be clear as to why they are selecting one investment structure over another. Structural differences tied into the same asset class can provide divergent performance and therefore investors need to be clear about their objectives when taking a particular investment position.

Clearly, there are arguments for and against the illiquidity premium. Listed and unlisted markets both have an important role to play in investment portfolios, but the nature of each is shifting. Relying purely on classical investment theory when making asset allocations can be dangerous. As always, drill down into the data and see if the reality matches the theory.

 

Adam Murchie is a Director of Forza Capital Pty Ltd which provides property investments to high net worths, private clients and family offices. This article is general in nature only and does not constitute specific investment advice.

RELATED ARTICLES

Are A-REITs set for a comeback?

Why you can't invest in residential property on the stock exchange

Illiquid assets and long-term investing

banner

Most viewed in recent weeks

Australian house prices close in on world record

Sydney is set to become the world’s most expensive city for housing over the next 12 months, a new report shows. Our other major cities aren’t far behind unless there are major changes to improve housing affordability.

The case for the $3 million super tax

The Government's proposed tax has copped a lot of flack though I think it's a reasonable approach to improve the long-term sustainability of superannuation and the retirement income system. Here’s why.

Tariffs are a smokescreen to Trump's real endgame

Behind market volatility and tariff threats lies a deeper strategy. Trump’s real goal isn’t trade reform but managing America's massive debts, preserving bond market confidence, and preparing for potential QE.

The super tax and the defined benefits scandal

Australia's superannuation inequities date back to poor decisions made by Parliament two decades ago. If super for the wealthy needs resetting, so too does the defined benefits schemes for our public servants.

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

Getting rich vs staying rich

Strategies to get rich versus stay rich are markedly different. Here is a look at the five main ways to get rich, including through work, business, investing and luck, as well as those that preserve wealth.

Latest Updates

SMSF strategies

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

Superannuation

The huge cost of super tax concessions

The current net annual cost of superannuation tax subsidies is around $40 billion, growing to more than $110 billion by 2060. These subsidies have always been bad policy, representing a waste of taxpayers' money.

Planning

How to avoid inheritance fights

Inspired by the papal conclave, this explores how families can avoid post-death drama through honest conversations, better planning, and trial runs - so there are no surprises when it really matters.

Superannuation

Super contribution splitting

Super contribution splitting allows couples to divide before-tax contributions to super between spouses, maximizing savings. It’s not for everyone, but in the right circumstances, it can be a smart strategy worth exploring.

Economy

Trump vs Powell: Who will blink first?

The US economy faces an unprecedented clash in leadership styles, but the President and Fed Chair could both take a lesson from the other. Not least because the fiscal and monetary authorities need to work together.

Gold

Credit cuts, rising risks, and the case for gold

Shares trade at steep valuations despite higher risks of a recession. Amid doubts that a 60/40 portfolio can still provide enough protection through times of market stress, gold's record shines bright.

Investment strategies

Buffett acolyte warns passive investors of mediocre future returns

While Chris Bloomstan doesn't have the track record of his hero, it's impressive nonetheless. And he's recently warned that today has uncanny resemblances to the 1990s tech bubble and US returns are likely to be disappointing.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.