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March 27, 2018
It’s no secret that bonds have failed to deliver compelling yields in recent years. In many parts of the world, like Japan and Sweden, yields are now negative. Due to the shortage of viable options for risk-adjusted income in the public sector, global investors are being forced to consider all options to quell the need for yield. But yield is like fashion — eventually, if the Federal Reserve continues to raise interest rates as we have observed over the past year, it will come back around.
Usually, when rates begin to raise at a steady (but not excessive) rate, it signals that the economy is in a healthy place. However, many analysts believe that this is just a screen to disguise other problems looming in the dark crevices of the global economy. In most economic environments, Treasuries (buying the US debt) have been the safest bet for yield, and are considered to have “zero-risk.” Not everyone is sure of this anymore, so investors are looking for safer alternatives, more so than ever before. The question becomes: What investment vehicle historically protects against inflation, is not susceptible to daily valuation risk, and creates consistent and steady income?
Look no further than one of the oldest (and arguably most effective) ways to generate yield, in an environment insulated from global risk: private equity real estate, specifically commercial real estate.
Unlike traditional private equity, which is predominantly centered around purchasing operating companies that (in many cases) are not profitable, and “turning them around” for a sale or roll-up, commercial real estate investments can offer immediate, real-time cash flow. Unlike other investment alternatives, real estate can help spread out the risk in a portfolio because it’s secured by a hard asset; something tangible. Investors feel more secure because there’s a building or land that protects the investment — unlike many other options that are simply backed by a piece of paper.
The last recession taught us that even with values taking a massive hit, real estate can not only rebound to its original value relatively quickly, but can even increase substantially, even when other investments continue to suffer or disappear altogether.
One of real estate’s most dynamic benefits is that it counteracts volatility. Recently, increasing volatility in the markets has caused unreasonable valuations and irrational buying and selling behavior. Historically, commercial real estate investments have withstood similar conditions.
The world of institutional commercial real estate is usually divided between those seeking to purchase distressed assets — and needing significant capital to make them viable — and assets deemed “value-add,” which already have a requisite level of occupancy. For example, a self-storage facility that that has a historical occupancy of 82% most likely has sufficient net cash flows to service any existing debt on the property. And if bought at a discount to market price, there could be free cash flows, or yield. Properties with these or similar characteristics in varying asset classes like office, industrial, retail, or multifamily, can offer an alternative to bonds.
Finally, one of the most important reasons to consider private equity is the specialized expertise that comes with it, significantly lowering the risk profile. Most often, this type of investment is utilized by institutional investors with high net worth, who meet the minimum requirements of an accredited investor. By definition, an accredited investor must have a net worth of over $1,000,000 excluding their primary residence, or maintain an annual income of $200,000 for the previous two years.
We have been taught that bonds are the “safer” and more prudent investment, and that as we age, our asset allocation should favor bonds more than equities because they offer consistency, income, and less risk.
The underlying sentiment is still appropriate today, but as volatility and uncertainty looms, security and consistency are more valuable than ever. Creating a safe and diverse alternative investment portfolio is harder now than it has been the previous cycles — it requires more due diligence, professional expertise, and thoughtful analysis. Those that have the option to consider private equity should consult with their advisors to see if this fits into their overall strategy as an income alternative.
Written By: Ari Rastegar – Founder & Chief Acquisition Officer