In 2022 my wife and I started investing in alternatives. No, not those alternatives (Crypto) but the other alternatives, the much larger alternative markets including commercial real estate, natural resources and private debt. We didn’t know about these investments before then, and we were surprised to learn that the majority of people we knew also didn’t know about them. This is still the case today!
These types of alternative investments can potentially have much higher returns than stocks, bonds and other types of investments, and they come with tax benefits in the form of depreciation. The bottomline – you get to potentially make more money and keep more of it. Seems too good to be true? We thought so as well, and so we spent many months investigating these investments before we spent a dollar. If it is too good to be true, it usually is, and I wanted to make sure we were making the best investments for our risk tolerance.
We started with an investment in “Multi-Family” (apartment buildings). This asset class is easily “understood” – many of us have lived in them – but who knew there was a way to invest in them? We were excited to invest in an apartment complex that was in a part of the country we believed would experience population growth, associated rising rents, and ultimately growing dividends from our investment.
Part way into our investing in multiple Multi-Family properties, we identified another opportunity, and decided that we wanted to move some money from our original Multi-Family investment into that new opportunity. We assumed we would just sell our shares, reinvest the cash, and move on… right? After all, that is how the stock market and even 401k’s work. Well, we quickly found out just how wrong we were, and we had the harsh lesson of learning what an illiquid investment is.
To those that don’t know, a “liquid” investment is like having stock in a public company. You can quickly find someone to buy it at a market price. The transaction is fast, and has a small cost. On the opposite end of the spectrum, an “illiquid” investment means you can’t sell out quickly. Most likely you don’t have a current price, and most likely it is very daunting to find someone on the other side of the trade (there is no online platform like Fidelity in our 401k example). With illiquid investments, your money is stuck until a “liquidity” event happens (such as the sale of a property or a refinance, in the case of commercial real estate). Those events – the timing, the price – are largely out of your control as a passive investor.
In our instance, there was a way to get our money out – but it was going to take months, and it was going to be “our problem.” We were going to have to find a buyer. We were going to have to get lawyers to paper the transaction (and pay the hefty fees associated with that bespoke transaction work). And to add insult to injury, even though the apartment complex had appreciated in value, we were likely going to take a loss, because we didn’t have current financials to prove that.
As is my curious nature, I started to ask myself questions that led to answers, and those answers led to many more questions… until I got to the Ah-ha moment. My dialog with myself went something like this: “If I am illiquid in this investment, how many others are? How big is the Multi-Family investment market? Wait, is all of the commercial real estate investment market illiquid? How big is that market in the United States, the world? Does illiquidity stop at real estate or does it affect other assets?”
I started some basic online research, and it didn’t take me long to find out that over $50 Trillion (yes with a T, not a B) in assets (investments) are currently sitting locked up and illiquid in commercial real estate, natural resources, infrastructure, franchises, private debt, private equity… and it kept going. As an entrepreneur, you are always looking for a compelling TAM (Total Addressable Market) to target, you hope that it is in the high billions. But this is in the TRILLIONS. Could it be?!
Being the skeptic that I am, I went a level deeper, and asked WHY. Why are assets illiquid? What characteristics make them illiquid, and why in the world has no one solved for this? Why isn’t there an efficient alternative investment marketplace like the stock or bond markets? Why is there no platform for exchange? While I stumbled upon companies trying to solve the problem, no one has, and in my opinion, no one is on the right track.
Had I not already solved large opportunities over the last two decades using Artificial Intelligence and Big Data, I might have missed the solution. This gave me an unfair advantage from anyone else that has tried to solve for this. The problem of illiquidity comes down to two major factors (many minor ones too): 1) not having access to the right financial data to create an efficient market (versus publicly-traded companies that are required to share data quarterly), and 2) not having a standardized, industry and regulator-accepted method of pricing these assets on a regular basis (like stocks and bonds).
Alternative investments like commercial real estate are normally only priced when they are sold or refinanced, which is few and far between. Without a regularly priced asset, there cannot be an efficient marketplace for those assets. An efficient marketplace has other positive follow-on effects: banks can lend against the equity in these assets, investors know the value of their portfolios, and future investors feel confident about getting in and OUT of an investment when they want. We, as investors, need control over our money and should be able to decide when we want to enter and exit the market.
After I identified the two factors impeding liquidity in alternative assets, I set off on the journey to solve the global illiquidity problem. I decided to figure out how to turn all of these assets into liquid. To do this, I used the same principle I have used my entire life (and wrote about in an earlier blog called “The Butterfly Principle”). I started with the end goal, a massive goal: “End the world of illiquidity and help to free more than $50 Trillion dollars into the global economy.”
Obviously this goal is massive – maybe even one of the biggest changes in financial history – but we have to find out where to start. So using the Butterfly Principle, we start to work the problem backwards, identifying and linking each previous step to its future step. Finally, we arrive at the beginning – the place where we can wrap our minds around where to get started. The place where it doesn’t seem too daunting. We begin knowing that each successive step will lead us to that massive financial goal of making markets more efficient and turning illiquid assets into liquid.
The start for this opportunity begins with getting access to relevant data in order to price assets, and make them available for trading. We decided to start by working with commercial real estate (and got very granular, beginning specifically with just Multi- Family real estate). It is an investment I have become intimately familiar with, and an industry where I understand how the asset owners think, where and how they keep their data, and why they would be willing to grant us access.
The initial plan was to build an Exchange (called an ATS “Alternative Trading System”) where asset owners could list their properties, and invite their current and future investors to benefit from the possibilities of liquidity in what has historically been a very illiquid market. This “Exchange” would be non-crypto (web3) to start, but it would be built using blockchain to help with fraud prevention. In addition, my choice was to work – from Day One – with the financial market regulators like FINRA and the SEC. My goal was to provide a fully-approved, safe environment for everyday people to come and trade these types of alternatives. These types of investments that have typically only been reserved and known about by the few, will soon be open to the many.
The only problem with this plan was timing. When I worked through my plan and was ready to go, the economy was going great, investments were yielding high returns, and the promise of liquidity wasn’t something asset owners needed at the moment to entice investors into their next project. There wasn’t a captive audience for the idea.
But every great financial cycle ends – that is why they are called “cycles”. In actuality, many of the greatest technology disruptors were created during an economic downturn (and then took advantage of the upward momentum when the economy started to grow exponentially).
My bet was that the time for a downtime was near, and my bet was that it would pay off to build this idea quietly, in stealth. And so we started building the future of financial systems in secret. As it turns out, and as we all know now, the economy did turn downwards. And while no one can predict when the upswing will start to happen, we know that it will. And we will be ready for it. Stay tuned for more on how we have built this ecosystem, the lessons learned, and ultimately the economic results of getting into liquid.