The Search for Yield

It comes as news to no one that interests rates are historically low and, in light of the public market volatility of recent weeks, there remains no clear timeline for raising rates. With the safest investments all pegged to these low interest rates, investors are forced to broaden their search for yield. There is nothing inherently problematic about this search; it is, in fact, the hallmark of a successful sophisticated investor. Problems start arising when the only assets offering any yield are risky assets. It is impossible to talk about yield without talking about risk (whether you use the word or not) – they are two sides of the same coin. The key is, of course, minimizing risk by finding opportunities that are underpriced compared to their true value. As a great thinker once said: “buy low, sell high.”

The issue investors are currently faced with is that underpriced or even fairly priced assets are proving difficult to find. Howard Marks, co-founder and Chairman Oaktree Capital Management, is always insightful on understanding risk and value. While most financial services firms struggled in 2008, Oaktree took the opportunity to raise the largest distressed debt fund in history and the fund has performed remarkably. Take a few minutes to watch this interview with Marks from a few months ago.

Real estate offers the opportunity for higher yields and, even in a growing economy where prices are climbing, private real estate investments can still offer relative value. This is partially attributable to the historical inefficiency of the real estate capital markets, particularly compared to the stock market. Commercial real estate transactions have traditionally been difficult for individual investors to participate in and, even for professional and institutional investors, accessing attractive deal flow can be challenging. Crowdfunding platforms are beginning to provide direct access to real estate investing in a way that has never before been possible.

With platforms quickly proliferating, the question remains how to find opportunities with the right risk profile. Fix-and-flips can offer attractive yields but is their value attractive compared to their risk? I generally don’t think so because we’ve seen over and over that they exhibit far higher volatility in changing market conditions than more institutional real estate assets. Fix-and-flips have historically been the most accessible way for individual investors to invest in real estate but now, thanks to the rise of online marketplaces, investors can easily access opportunities that were only available to institutions and industry insiders.

If you’re considering investing in real estate through an online marketplace, you should consider three things in your decisions: 1) the experience of the team behind the platform; 2) the experience and track record of the sponsor behind the investment opportunity and 3) the risk/reward profile of the deal itself. Make sure that the platform is being fully transparent and providing all the information you need for your due diligence. Part of the beauty of crowdfunding platforms is that they offer investors the opportunity to make these decisions themselves. That being said, the same rules apply to modern real estate investing that applied to old school real estate investing – find someone you trust and who will give you the information and answers you need.

Ultimately, I can’t claim to know how long the bull market will continue (and you shouldn’t listen to anyone who tells you they know). What I do know is that markets have cycles and investors should be focused on value and diversification. Value will come from doing appropriate due diligence – first find the platform or platforms you trust, look for good sponsorship, then find the investment opportunity or opportunities that match your criteria and strategy. Diversification is a little more tricky and depends on the rest of your portfolio. Real estate investments have some inherent diversification benefits – they exhibit far lower volatility than the S&P 500, they provide a natural hedge against inflation and they have only a limited correlation to public market performance – but diversification is all about portfolio context. The ideal online marketplace will offer investors a range of opportunities to fit their particular goals, from cash flowing deals in primary markets to higher upside development deals in secondary markets. It is intelligent to search for yield given current market conditions, but you should remember that yields reflect risk, and a good yield doesn’t necessarily mean a good deal.