Aloha Capital originated 27 loans for the Fund in March. All loans are collateralized by single & multi-family residential real estate and personal guarantees from sophisticated real estate investors. We added 3 new borrowers, bringing us to 44. We also added two additional states – Georgia and North Carolina – making the total number of states in which we can lend 13.
For decades, the standard advice for asset allocation was 60-40: Put 60% of your assets in stocks and 40% in bonds, and re-balance your portfolio annually. It was a solid plan — at least back when Jimmy Carter was president, bond yields averaged 8% and the stock market returned 12%. However, in today’s financial world there is an obvious problem: Bond yields are near historical lows. Even with a recent rise in yield, today’s 10-year Treasury Bond yield of 2.95% is down from about 5% right before the Great Recession, and T-Bond yields approached 7% across the 1990s.
According to the Federal Reserve database, the 10-year treasury bond’s total return since 2009 has averaged 2.53% — barely higher than inflation. The fact is that bonds have been dead weight in investors’ portfolios; and if rates continue to climb as expected, bonds will be an even worse drag on the 60-40 portfolio.
Meanwhile stocks, while providing great returns recently, could be showing stretched valuations and signs of speculative excess. Investors locked into the two “big traditionals” mindset of bonds and equities are being forced to compromise — either sacrifice return for lower volatility by holding bonds or juicing returns at the expense of higher risk by allocating to stocks.
From Aloha’s perspective, it’s time to update the traditional model of asset allocation. Rather than just two major asset class choices, bonds and equities, a third asset should be added to the mix: Real estate. Income-producing real estate investments offer consistent cash flow, as well as the ability to participate in any capital appreciation associated with rising markets.
The downside is generally best protected by being clear and focused on one’s exit strategy, investment time horizon and by not getting overly leveraged with one’s debt to income ratio. And, you might be surprised to learn that on a broad basis, real estate has historically outperformed both stocks and bonds. The Nareit All Equity REITs Index has an average annual total return of 13.87% since 1971. Over the same period, the S&P 500’s average total return was 11.53%, while 10-year T-Bonds averaged 5.15%.
As you can see, since 1972, real estate has outperformed the S&P 500, while the 10-Year treasury has lagged significantly. Traditionally, one of the of the benefits of pairing bonds with stocks was that the two assets were uncorrelated — when one fell the other tended to go up, and vice versa. Real Estate can serve that same function, yet also generate much better returns.
In fact, during equity bear markets, no asset has generally held up better than real estate. During the Great Recession, of course, real estate collapsed along with stocks. However, that was an anomaly, according to economist and Nobel Prize winner Robert Shiller. In 14 of the previous 15 U.S. equity bear markets going back to 1956, the residential home price index rose.
This is certainly a comforting stat to hang one’s hat on, given that we hope real estate will be a superior hedge compared to bonds in the next equity bear market, as rates move higher off of rock bottom levels, and bond prices decline. According to Professor Shiller, REITs are somewhat problematic as a hedge. Because they trade on stock exchanges, they tend be more correlated with equities. You may recall the 2008-2009 stock market meltdown when investors tended to liquidate everything in their brokerage accounts…thus Shiller believes that residential real estate offers a much better alternative as a stock market hedge.
For our current Aloha Fund investors, adding real estate to the standard asset allocation model may be a foregone conclusion. But given the seemingly not-well-known, long term out-performance of REITs vs. equities and bonds, as well as the excellent equity markets corrections stat of residential real estate holding up well in those periods, hopefully we’ve inspired further consideration of our investment approach and asset class. We are actively seeking new capital for deal flow, as we intermittently have more good deals than money. Our space continues to do well given the housing supply problem and relative value, particularly in the Midwest.
Further, we are working diligently on moving the needle back towards higher monthly returns, as discussed with you a couple of months ago. Your questions are welcome.
We greatly appreciate your patronage and trust.