Real Estate Investors Chasing Low Yields in Commercial REITs Can Do Better. Here is How…

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One of the most valuable characteristics of holding real estate in an investment portfolio is the opportunity to receive annual dividends and interest. Savvy real estate investors are always seeking better ways to add yield to portfolios.

As recently reported in the Wall Street Journal (Commercial REITs for Small Investors See Increasing Demand), large investment firms like the Blackstone Group and Starwood Capital Group have created new commercial real estate funds that target ‘the average investor’. These REIT funds have been raising substantial amounts of capital again, now that investors are returning to commercial real estate after abandoning the space during the height of the Pandemic.

As the Journal report states, “these real-estate funds yield more than 5% and compare favorably with many investment-grade fixed-income investments yielding less than 1.5%. We would agree that these investments do indeed compare favorably to investment-grade fixed income. However, we are not convinced that this is a fair comparison on a risk-reward basis. As mentioned in the article, some of the REITs – particularly those that were invested in office, retail and lodging – saw declines on the order of 30%.

So, let’s do some quick math. An investment that has the potential to yield 5% annually yet has a 30% potential downside (or more). I am not sure I like those odds. All kidding aside, we believe that investors have better options when seeking yield in real estate. Particularly those that are searching for an investment with better risk-reward characteristics. 

By investing in residential real estate lending, we are achieving annualized returns of more than double this. In addition, we are doing it in a more consistent and stable fashion. Since our inception in 2015, we have yet to have a down month. Translation – that is 69 months of consistent, positive returns at double the yield these commercial REIT investors are receiving. At Aloha Capital, our fund is laser focused on creating consistent, stable and repeatable returns by investing in the residential real estate lending market.

We have written extensively about the challenges currently facing the commercial real estate market (our recent post here – COVID19 Causing Significant Stress in Commercial Real Estate. Here is How Investors Can Diversify). As we mention in that – and other articles – we are commercial real estate investors as well. However, we see residential real estate lending as a strong complement to commercial real estate lending. There is no reason why an investor should have to choose between the two. Investors looking to prudently diversity should be looking to invest in both.

Why do we think that residential lending is a good complement to commercial real estate?

Well, for several reasons. First, the supply/demand dynamics that drive residential real estate are very different from those driving commercial real estate. Therefore, the two markets are typically not strongly correlated. This alone is a compelling reason that investors looking to gain yield in real estate should diversify.

However, there are other compelling reasons. The U.S. residential real estate market is in the midst of a housing supply crisis. Strong consumer demand is expected to continue for years until the housing supply has had the opportunity to catch up. In addition, we are able to decrease risk by lending only with ‘first-position’ loans, which are personally guaranteed by the borrower. All of these factors, and more, combine for a strong risk-reward proposition and more stable returns for investors.

COVID19 continues to be a huge unknown for providers of commercial real estate investment opportunities. It may take years for the effects of this crisis to work their way through the market. No one really knows how consumer and business behavior changes will affect the commercial real estate market post-Pandemic. In the meantime, we are very happy to continue to achieve consistent high-single, and low double-digit yields in residential real estate lending.

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