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Direct property is illiquid: a transaction takes around three months from agreement to completion

A worked RES examination question on direct vs indirect reits, from our Paper 1 bank — with the rule it turns on, and why each of the four options is right or wrong.

Paper 1Lesson 9Direct vs indirect reitsFree — no sign-up

The question

Ms Rahmat has $400,000 and must be able to convert her holding to cash at short notice, as she may need the money for her mother's medical costs within the year. She is choosing between a strata shop unit and units in a listed real estate investment trust. Her adviser makes four statements, all of them accurate.

Which is most appropriate to her stated concern?

  1. A. No two shop units are exactly alike, whereas the trust's units are identical to one another.
  2. B. A direct purchase attracts stamp duty, legal fees, valuation fees and agency fees, whereas dealing in the trust's units does not.
  3. C. A direct purchase takes around three months to complete, whereas the trust's units sell on the exchange within days.
  4. D. Holding the shop unit would make her responsible for maintaining the building, whereas the trust's manager handles that.

The answer, and why

Answer: C

The rule. Direct property is illiquid: a transaction takes around three months from agreement to completion. Units in a listed trust are liquid and can be sold on the exchange within days. Where the client's binding constraint is speed of access to cash, liquidity is the point and everything else is secondary.

Why C is correct. Ms Rahmat may need the money within the year. Only C addresses how quickly each holding converts to cash. The other options — all four statements are true. That is what makes the question hard: the task is relevance, not accuracy. - A correctly contrasts heterogeneity with homogeneity. It says nothing about how fast she can sell. - B correctly states the transaction-cost disadvantage. A cheap asset she cannot sell in time does not solve her problem. - D correctly states the management burden. A reason to prefer the trust, but not her reason.

Exam note. When every option is factually correct, the question is asking which one answers what was asked. Return to the client's stated constraint and match to it.

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