Interest rates are cratering due to an ongoing and escalating global trade war and expectations for slowing global growth. Investors around the world are placing more capital in safe havens like the U.S., driving bond yields lower. The Federal Reserve recently dropped interest rates as well. While this action pays for our growing national debt, it hurts retirees and those looking to live on fixed income. Read this article here where investment strategists are now overweighting real estate as a result.
Historically, when interest rates are cut the article cites, real estate outperforms over time. As a syndicate involved in over twenty multifamily deals across the country, investors have been receiving cash on cash returns in the 7 to 8% range consistently and with a preferred return in that same range. All our deals are set up to where investors get paid up to 8% before the general partner in the deal receives their profit split. The preferred returns are cumulative, so that in any one year, if we had a downturn, it catches up later when there is a capital event like a refinance or eventual sale.
To gain an even higher yield and a more secure position, I recently participated in a multifamily real estate deal in Austin. It offered a two-class option for investors versus the traditional hybrid model of one class for all investors. This offering earmarked 25% of the equity raise to income investors seeking higher yields. The return expectation is 10% cash on cash annually for up to 5 to 7 years. It’s a preferred equity position (Class A) over the growth investor (Class B) giving up some cash flow in the deal for an opportunity to get 25% higher growth.
When you look at the risk, the data supports an overwhelming secure, confidence of achieving that return. Example, noting that in the 2009 market crash, vacancy in Austin was no higher than 10%. In a typical market, it hovers closer to 5%. Our model stress tested vacancy at 20% (2x the 2009 crash) and showed ample room to support the 10% yield (4.5% cash flow at 20% and all we needed was a 2.5% cash flow to pay it).
Plus, Class A has a preferred return of 10% and sits ahead of Class B investor and Class C general partner in receiving their payout first. If we ever were less than that in any given year, the 10% is cumulative and would be caught up later when times get back to normal or at a capital event like a refinance or sale.
Lastly on apartments, the downside market protection is proven. In 2009, less than .5% of all MF owners were seriously delinquent in paying their debt on the property while single family homes were 4.5%. That’s a pretty powerful reason to be in this niche.
I’m also exploring other opportunities with a trusted partner in Manufactured Home Communities (MHCs), contemplating coming out with a bond fund backed by MHC real estate. This hybrid could pay say a higher 9% yield monthly backed by a portfolio of a very secure pool of MHCs with a small equity kicker that could put this investment’s overall returns to investor in the low to mid-teens. The beauty of MHCs is that during the 2009 crash, it was the only commercial real estate asset class where the net operating income continued to increase.
So, for those who only know bonds, consider looking at real estate for income and safety in the right deals – preferred equity positions or hybrid debt with equity kickers backed by secure, income-producing real estate. Consider strong local markets where jobs and population are moving to above national averages. Find operators who are experienced and conservative in their underwriting assumptions and focused only on one niche, like MF apartments and MHCs, that have a history of performing well in downturns.