Interest Rates Impacting Real Estate

Why invest in commercial real estate?

A big reason is the Fed.

Last Wednesday it cut interest rates a quarter of a point, or to be more specific the Federal Reserve Bank of the United States reduced the benchmark federal funds rate a quarter of a point to a range of 1.75 percent to 2 percent. Low-interest rates make it cheaper to borrow money to buy real estate, especially if you have the credit ratings of a proven real estate investment company, like Wilson Investment Properties. Lower financing costs, improve investor returns.

But there is also another reason why low-interest rates are making commercial real estate look attractive to growing numbers of investors. Real estate is offering much better prospective returns than other options.

It’s All Relative

In 1982 an investor could buy a 10-year U.S. Treasury note with a yield of over 14.5 percent. That’s a pretty good return for an investment guaranteed by the U.S. government.

Those days are long gone.

After the Fed cut rates on Wednesday, the yield on the 10-year U.S. Treasury note finished the day at 1.79 percent, while the 2-year Treasury finished at 1.75 percent. Earlier this month the Labor Department released inflation data showing the Consumer Price Index for urban consumers at 1.73 percent.

That means cost increases in the good and services people buy are nearly equal to the yield of those Treasury notes. In other words, the investment return from buying U.S. government debt, after subtracting inflation, is close to zero.

If you’re willing to lend the government your money for 30 years and if inflation stays tame over the next three decades the math looks a little better. A 30-year Treasury bond was yielding about 2.25 percent. Maybe an investor dials up the risk to seek better returns by investing in corporate bonds that are not guaranteed by the U.S. government. The Vanguard Intermediate-Term Corporate Bond ETF (VCIT) was yielding 3.44 percent and invests mostly in the bonds of companies rated A or Baa.

Feeling aggressive, you might invest in junk bonds or what is euphemistically called high yield corporate debt. The iShares High Yield Corporate Bond Fund is yielding just over 5.25 percent. If you want better credit ratings and fewer worries over defaults, expect to get a lot less—earlier this month Apple sold 10-year bonds yielding less than 2.25 percent. Apple is flush with $200 billion in cash, but the terms are so good for borrowers and bad for lenders they went ahead and borrowed $7 billion this month.

With low returns like those, it’s no wonder investors are looking for alternatives.

Real Estate Syndication Returns

Let’s look at the most recent retail, multifamily, and office real estate syndications offered by Wilson Investment Properties.

Durham Boutique Retail was closed in March 2019 with a four-year hold period and has a projected average annual return of 18.5 percent. Forest Cove was also closed in March 2019 with a three-year hold period and has a projected average return of 17.6 percent. Cincinnati Business Plex was closed in December 2018 with a five-year hold period and has a projected return of 16.8 percent.

Each of the deals has a preferred return of 8 percent. Are the returns guaranteed like U.S. Treasuries? No. These are projected returns. They could be lower. But they could also be higher. So, it’s important to research the real estate syndication firm. You want a firm that is conservative in its projections and very capable of managing its deals. It's also a good idea to participate in multiple syndication deals across different metros and property types, in order to reduce risk through portfolio diversification.

The preferred return of 8 percent represents the annual amount limited partner investors must be paid before the general partner is paid any management fees or participates in profits. So, a preferred return isn’t guaranteed, but like most corporate debt, its payment is prioritized over equity participation.

Also, while real estate syndication deals like these are projected to generate quarterly income distributions, this often doesn’t take place initially as investments in enhancing the property are initially made. Furthermore, early income distributions can be less than later ones after the cost of improvements paid and the benefits of higher rents or occupancies occur.

There is also no guarantee around projected holding periods. Depending on market conditions a real estate syndication might be exited earlier or later. Unlike publicly traded bonds, real estate syndication is typically an illiquid investment. That means your money is pretty much tied up, until the deal is concluded, typically with a sale of the property.

Conversely, U.S. Treasury debt can be bought and sold whenever convenient and since it is guaranteed by the U.S. government, the limited risk is largely from inflation or rising interest rates that lower its value. Of course, there is no reason an investor can’t own both—some Treasuries for money that is liquid, safe and can be quickly accessed, along with participating in real estate syndication deals to seek returns that are a lot better than barely keeping up with inflation.

There are advantages to all types of investments. But with interest rates so low--less than two percent for Treasury notes--most bonds are simply unable to generate the returns many investors are seeking in order to meet their objectives, whether it’s funding retirement or saving for a child’s college education.

On the other hand, real estate syndication gives qualified investors access to investments often delivering much higher returns, as well as income distributions. That’s a big reason why many people are abandoning simple portfolios composed of only stocks and bonds to also participate in real estate syndication deals.

To learn more visit: http://www.wilsoninvest.com