Think Real Estate Is Going To Be A Problem? Think Again!
Don’t think for a minute that your investment portfolio should stick exclusively to the traditional “stocks and bonds” structure. Today’s market can be quite challenging when trying to evaluate which opportunities will be the most profitable. Commercial Real Estate is an asset class that can bring you several benefits.
So why is now such a great opportunity to take advantage of the Commercial Real Estate market? Let’s look at the spread between the Commercial Real Estate cap rates and the 10-year U.S. Treasury yield. Historically, this has been an excellent indicator of forward returns in the Real Estate market. When this spread increases above the long-term average or historical norm, REITs are widely viewed as “undervalued” and an excellent investment option moving forward. If we examine the charts below, we find that when the spread widens to greater than one standard deviation or more than 325 bps, the forward earnings are extremely attractive.
The following graph illustrates a 4-year return period that follows a variety of different values for the spread between the cap rate and the Treasury yields.
Unfortunately, most investors, and far too many advisors get stuck in the rut of balancing their portfolios by merely changing the allocation percentages between stocks and bonds. They typically flee to bonds as their “safe haven” even during times when the bond market becomes quite precarious, like it is currently. We’ll save that topic for another article. The anecdote to this format is to include a Commercial Real Estate component in your holdings. Let’s take a closer look at the benefits to this strategy.
Traditionally, stocks are purchased for capital appreciation and bonds are looked upon for income. Whereas, Real Estate can provide both substantial income as well as significant capital appreciation. Diversification is a word heard quite often in the world of investments. Some may say, too often. However, virtually every investor would prefer that all of their investment dollars are not subjected to the same risks. This is called non-correlation and it is very important when constructing your financial portfolio.
Commercial Real Estate has a very low correlation to stocks and bonds and can reduce the volatility of your overall investment strategy. The same risks that often negatively affect the stock market do not have the same affect on Commercial Real Estate. How many times recently have you seen the Dow Jones Index drop several hundred points in a single day? Adding Commercial Real Estate to your portfolio has historically enhanced your risk-adjusted returns as shown in the graph below.
Are you concerned that inflation may damage the purchasing power of your money? Commercial Real Estate can help mitigate the effects of inflation because the growth rate of rental income has historically outperformed inflation (3.36% to 1.73%).
In the current Real Estate markets, the spread is around 400 bps greater than the historical average. The track record for performance under these current conditions shows a 12-month forward return of between 28% and 35%. While there are obviously no guarantees of these returns, the current spread between the Commercial Real Estate cap rates and the 10-year U.S. Treasury yield looks very appetizing to the real estate investor.
For investors trying to generate steady income with low stock market correlation, an allocation including an actively managed Real Estate portion would appear to be a profitable strategy.
While you may have the impression that the Commercial Real Estate market has been cornered by the rich and famous, actually it is now, more than ever, available to the “average” investor at a fraction of the historical costs.
If you would like to see how you can take advantage of this current opportunity with incredibly low minimums, please contact me for a no cost consultation.
Troy Robertson
Troy is a retirement planner, located in San Diego, CA., who enjoys helping people plan for their present as well as their future. He graduated with honors from SDSU with a degree in Accounting and Cum Laude from Law School. As a financial advisor, he is very proud to have helped his clients very successful retirements.
