Invest in Real Estate, Not Bonds
Updated: Jan 6
People often turn to bonds as a diversification strategy from a 100% equity portfolio as bonds are generally viewed as safer investments than stocks given their lower volatility (especially in the short and medium term). Bonds can also have higher interest payments than the average level of divided payments on a stock. Historically, folks looking for stable and predictable income have turned to bonds vs gambling on the stock market.
Recently we’ve seen interest rates cratering given the ongoing and escalating global trade war, giving us expectations for slowing global growth. Investors around the world are placing more capital in what’s viewed as safer places such as the U.S., which ultimately drives bond yields lower. Lower bond yields hurt retirees or those looking to live on a fixed income.
As noted in this article, investment strategists are now over-weighing real estate as a result. As the article suggests, historically when interest rates are cut, real estate starts out slow but still outperforms other sectors over time.
Given the less than stellar returns on bonds (1.6% on 10 year Treasury as of this writing), what should folks do who are looking to diversify from the volatile equities market, but don’t want to give up the predictable income streams that a bond can provide?
Enter Real Estate Syndications!
What if you could have both? Predictable and stable income, in a vehicle that is significantly less volatile than the stock market, all while having superior returns. This is exactly what we’re finding in our real estate syndication deals and has allowed me to have great conversations with potential investors looking to diversify their portfolio.
In the deals we do, investors have been receiving cash on cash returns in the 7-8% range consistently, which is in line with our preferred returns. Therefore, investors can expect monthly/quarterly distributions around 7%+. Our deals are set up where investors get paid their preferred return (7-8%) before the general partner starts to share in the profits. These preferred returns are cumulative, meaning if we were to have a downturn and couldn’t pay that month/quarter, then the investors preferred return just accumulates until we’re able to catch them back up.
Another strategy we’ve recently adopted is a two-tiered equity approach that’s discussed in more detail here. This allows us to give investors an even higher yield and more secure position than a typical one class equity structure. Recent offerings are allowing 25% of the equity raise to income investors seeking higher yields. It’s a preferred equity position (class A) with return expectations at 10% cash on cash annually projected over a 5-7 year hold. Class A is in front of, and therefore more secure, than Class B investors who are more concerned with higher upside on the back-end and are willing to give up a little cash flow. Class A looks very similar to a bond in how it’s structured, cash flow throughout with no upside on back-end.
When you look at the risk involved, the data supports and gives us a lot of confidence in achieving that return. I always like to turn to data points from the Great Recession of 2008-2009 as that is the worst economic time we’ve ever experienced. In Austin, TX where we have some apartments, the vacancy in that market during the recession never exceeded 10%. When stress testing our most recent acquisition, we can go to 20% vacancy and still had plenty of room to support the 10% yield to Class A investors. In fact, at 20% vacancy the deal still cash flowed at 4.5%, whereas we only needed 2.5% cash flow to pay the class A investors their 10%. So, we doubled the vacancy from its peak in the worst economy of our lifetimes, and still feel very confident in delivering a solid return of 10%.
And finally, the downside market protection on apartments is proven and the below graph gives us a great visual.
In 2009, less than 0.5% of all MF owners were seriously delinquent in paying their debt while single family homes were around 4.5%. That means roughly one out of every 200 MF owners got seriously behind on their debt payments. That’s not too bad for the worst economic downturn we’ve seen. Combine that statistic with our deals that cash flow from day one, and I feel confident I’m investing in the right niche.