Illiquid investments: what it means when your assets are tied up

Illiquid investments are investments that cannot be converted into cash quickly and without a loss in value. Examples include direct real estate, private companies, and participation in real estate projects with a fixed term. In return, illiquid investments can offer returns that listed investments do not always provide. The question, therefore, is not whether illiquidity is good or bad. The question is how much tied-up capital suits your situation, and how you ensure that you never need to rely on it before the term has expired.

In short

• Illiquid investments trade flexibility for a potentially higher return, known as the illiquidity premium.
• Real estate is not equally illiquid in every form: the difference between a listed fund and a project participation is significant.
• Those who invest in illiquid assets plan their liquidity in advance, including a scenario in which the term is extended.

What are illiquid investments?

Liquidity describes how quickly you can convert an investment into cash at a price that reflects its value. Savings are fully liquid. Listed stocks and bonds can be sold on any trading day, although the price is fixed at the current market rate. At the other end of the spectrum are investments for which there is no daily market. For these investments, you must find a buyer or wait until the end of an agreed-upon term. These are illiquid investments.

Illiquidity is therefore not a property of a product alone, but of the agreement surrounding it. Two investments in the same type of real estate can have very different liquidity, depending on the structure. Always look at how you enter and exit, not just at what underlies the investment.

Is real estate an illiquid investment?

That depends on the form in which you invest. Listed real estate is tradable daily, but as a result, it also fluctuates with market sentiment. With some non-listed real estate funds, you can only enter and exit at fixed times, and the manager may limit redemptions if many investors want to exit at once. Direct ownership of a property is illiquid in the sense that a sale takes months and involves costs. Participation in a real estate project is the most pronounced example, because the capital is tied to one project and one term.

At Dutch Value, the investment is project-bound and cannot be withdrawn early, unless contractually stipulated otherwise. A project typically lasts 6 to 18 months. The fixed-interest model has a term of 12 to 36 months. These terms are clear, but the capital is tied up during that period. You can read about how the three models relate to each other in our article on profit sharing, fixed interest, or hybrid.

The illiquidity premium: why tied-up capital can yield more

Investors who commit their capital for a longer period generally demand compensation for doing so. This additional compensation is called the illiquidity premium. The idea is simple: those who give up flexibility want to see a return in exchange. Large institutional investors with a long-term horizon, such as pension funds, invest a portion of their assets in illiquid categories like real estate and private companies for this reason.

However, the premium is not a given. An illiquid investment with a modest expected return asks you to give up flexibility without sufficient compensation. Therefore, always assess whether the expected return outweighs the period during which you cannot access your money. Preferably do this using an annual return, so you can fairly compare it with liquid alternatives.

Illiquidity is a price you pay. The return must be worth that price.

No daily price does not mean lower risk

An illiquid investment has no daily market price. As a result, the value appears more stable than that of a stock portfolio. This is a consequence of the valuation method, not of lower risk. The actual result of a real estate project only becomes visible upon sale. A sensitivity analysis and a detailed exit scenario provide the best picture in advance of the range within which that result may fall.

What illiquid investing requires of you in practice

Illiquid investing primarily requires planning on the part of the investor. The project determines when the capital becomes available, but you determine whether you can wait for that moment. Four points deserve attention. They apply to every illiquid investment, not just real estate.

A liquidity buffer that is separate from the investment

In addition to the illiquid investment, maintain a buffer that covers your fixed expenses and unforeseen costs for a substantial period. How large that buffer should be depends on your income, your obligations, and your other assets. A buffer that is only sufficient if everything goes according to plan is, in fact, not a buffer. For entrepreneurs, the liquidity of the company also applies, which we discuss in our article on real estate from your holding company.

Alignment with planned expenditures

Compare the investment term with the major expenses you anticipate in the coming years. Consider things like purchasing a home, gifting to children, business succession, or investing in your own company. If such an expense falls in the middle of the investment term, it should be payable from other assets. An illiquid investment is suitable for capital for which you have no planned use during that period.

Accounting for delays

An investment term is a plan, not a fixed date. For real estate projects, the sale may occur later than estimated, for example, due to a slower market or renovation delays. Therefore, include a scenario in your own planning where the capital becomes available six to twelve months later. You can read about common agreements regarding delays and extensions in our article on exit scenarios for a Spanish renovation project.

Paying taxes from other assets

An illiquid investment often generates little or no cash flow during the term, while tax obligations may continue. For private participation in the Netherlands, the value is generally included in Box 3, even in years when the project has not yet made any distributions. You would then pay that tax from other assets. You can read about how this works in our article on Spanish real estate and Box 3. Have your own tax advisor calculate the consequences for your specific situation.

A calculation example: illiquid investments in a wealth plan

The example below is fictional and intended to illustrate the decision-making process. It is not advice on how to allocate your assets and does not reflect any existing or future project.

Suppose you have €3,000,000 in investable assets. Your fixed expenses are €120,000 per year, and in two years, you expect to make a gift of €300,000 to your children. You divide your assets into three tiers, based on when you might need them.

• Immediately available: two years of fixed expenses plus the planned gift, totaling €540,000 in savings and deposit accounts.
• Liquid investments: €1,960,000 in a diversified portfolio of publicly traded stocks and bonds.
• Illiquid investments: €500,000 in two project participations of €250,000 each, with different terms.

In this example, approximately one-sixth of the assets are illiquid. If one of the projects concludes a year later than planned, the fixed expenses and the gift remain fully covered by the first tier. The second tier also provides a buffer if something unexpected occurs. By staggering the two participations over time, not all illiquid capital is released at once, and your planning does not depend on a single sale. You should determine which portion is appropriate for your situation together with your own financial advisor.

Common mistakes with illiquid investments

Investors who are making a significant illiquid investment for the first time often fall into a few common traps. These have little to do with the investment itself and much to do with the planning surrounding it.

• Assuming the planned term without accounting for potential delays.
• Maintaining a buffer that is only sufficient if everything goes according to plan.
• Comparing the total return over the term with the annual return of a liquid investment.
• Having all illiquid investments mature at the same time, which increases the risk of exposure to a single poor market.
• Forgetting that taxes may be levied on the investment even while no distributions have been made.
• Assuming that exiting early is always possible without checking the agreement.

The last point is the easiest to avoid. Read the agreement to see what it says about the term, renewal, and the possibility of transferring your position. We explain which provisions matter in our article on the investment agreement for a Spanish real estate project.

Frequently asked questions

What is the difference between liquid and illiquid investments?

A liquid investment can be sold quickly at a price that reflects its value, such as publicly traded stocks. An illiquid investment does not have a daily market. You are dependent on a buyer or the end of an agreed-upon term.

What is an illiquidity premium?

This is the extra return that investors can expect in exchange for locking up their capital. The premium is not guaranteed and varies by investment. Therefore, always assess whether the expected return outweighs the period during which you cannot access your money.

Can I exit a real estate project early?

With a project participation, this is generally not possible. At Dutch Value, your investment is project-specific and cannot be withdrawn early unless contractually agreed otherwise. Therefore, when planning, assume that the capital is locked up until the end of the term.

How much of my capital can I invest in illiquid assets?

There is no fixed percentage for this. It depends on your time horizon, your fixed expenses, your planned expenditures, and the size of your total assets. A personal financial advisor can help determine that ratio. In our article on real estate as part of your wealth planning, we discuss the broader considerations.

What happens if I unexpectedly need money?

Then you will have to pay for it from other assets. That is why an illiquid investment should always be held alongside a liquidity buffer. In some cases, transferring your position to another party is possible if the agreement allows it, but you cannot count on that when planning.

How do I evaluate a party that offers illiquid investments?

Because you cannot exit during the term, the choice of partner carries more weight than with a liquid investment. Ask, among other things, whether the party invests alongside you, how projects are vetted, and how you will be kept informed during the term. Our checklist with six questions for every real estate partner will help you with this.

Conclusion

Illiquid investments can have a meaningful place in a portfolio with a long horizon, provided you know in advance how long the capital will be locked up and you can bridge that period without these funds. Compare the term with your planned expenses, account for potential delays, and maintain a buffer that is separate from the investment. You can read about how we vet a project and keep you informed during the term on our methodology page.

Would you like to explore which part of your capital is suitable for a project-based investment? In a personal meeting, we can outline the possibilities and terms for you.

Stated returns are indicative and not guaranteed. Investing in real estate projects involves risks. You may lose all or part of your investment.