The Controllable Determinants of Liquidity in the Context of Securitised Real Estate Companies in South Africa

By Belgrove, J. B.; Smit, Eon van der Merwe | Management Dynamics, January 1, 2016 | Go to article overview

The Controllable Determinants of Liquidity in the Context of Securitised Real Estate Companies in South Africa


Belgrove, J. B., Smit, Eon van der Merwe, Management Dynamics


(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

This study explores the controllable determinants of liquidity in the context of securitised real estate companies in South Africa. Past research has shown that there is a link between share performance and liquidity. Therefore, it is useful for management to be conscious of the various factors, especially those under the control of management, that influence this metric. Very little research has been published in this field in the South African context. The findings of this study could potentially assist the management of real estate companies by providing them with mechanisms that they can use to influence liquidity and, in turn, shareholder value.

The study is structured as follows: The next section provides an introduction to and literature review of the topic, while the third section outlines the methodology employed and the fourth provides a discussion of the findings in relation to previous research. The final section summarises the findings and discusses their implications.

CONTEXT OF THE STUDY

Price and liquidity play a critical role in the real estate investment decision-making process. Investing in securitised real estate avoids the need for the high entry-level capital normally required for this type of investment. Perhaps the most compelling reason for investing directly in the securitised asset is the increased liquidity. According to Clayton and MacKinnon (1999: 36), "liquidity is the single most important factor driving the equitisation of real estate". As with any other exchange-traded security, securitised real estate can be bought and sold with ease in an efficient market. Investors therefore do not have to wait for months to liquidate their positions.

The benefits of increased liquidity through securitisation have not been lost on the South African public. The number of real estate companies listed on the Johannesburg Stock Exchange (JSE) grew from eleven in 2000 to twenty-eight in 2014. The question that arises from the above observation is, "What effect does securitisation, and consequently liquidity, have on companies?"

LIQUIDITY

The definition and measurement of liquidity

Liquidity relates to the speed and efficiency with which assets can be acquired or sold. This definition, however, precludes measurement. As a result, various authors have attempted to define the concept in the context of exchange-listed shares to allow measurement. Various liquidity proxies have been suggested in the literature, but there is no consensus about the best definition or measurement proxy.

Kyle (1985: 1316) emphasised the elusiveness of liquidity because it embodies various transactional properties of markets.

These include 'tightness', which refers to the cost of liquidating a position in a short space of time; 'depth', which is the size of an order required to change the price by a predetermined amount; and finally 'resiliency', which refers to the speed at which prices recover from an unexpected shock (Kyle, 1985: 1316). Cooper, Groth and Avera (1985) argued that liquidity does not encompass all three of these components, and thus it can be observed simply in the relationship between trading volume and changes in the market price of an asset. Cooper et al. (1985: 25) suggested the use of the liquidity ratio as a proxy to assess the impact of liquidity on common stock performance. This proxy is defined as the monetary volume amount required to move a security's price by one per cent.

In their seminal paper on how liquidity affects asset pricing, Amihud and Mendelson (1986: 223) focused on measuring illiquidity through the bid-ask spread. They proposed that investors face a trade-off when transacting, in the sense that they can transact at the current bid-ask spread or choose to wait. The asking price includes a premium for an immediate trade, and the bid price includes a discount for an immediate sale. …

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