The Federal Reserve has indicated that it would keep benchmark interest rates held at rock-bottom levels through 2023, with the goal of boosting the economy as it recovers from the coronavirus pandemic. The upshot to this policy is its impact of encouraging economic growth, propping up the financial markets and enhancing general macro stability.
But low rates leave many investor groups who rely on their portfolio for income in a bind by removing the prospect of yield from the market. As a result, these investors are asking themselves, “How do I generate cashflow from my portfolio during a ‘zero’ interest rate environment?”
While it is generally possible to enhance returns by making riskier investments, depending on individual circumstances and personality, it may not be desirable for all investors to increase their risk exposures, especially if the returns are not high enough to compensate for that risk. So how should investors respond in these unprecedented times?
We asked some smart fund managers, who wrestle with these issues daily, for their perspectives on the current low interest rate environment and how investors could continue to earn income during this phase of the cycle. Here’s what we learned:
Sean Lyons, Jackson Dearborn Partners
Investors should consider making strategic real estate investments to maximize their returns in the current environment. We believe income generation comes down to two key points in today’s scenario – what product type or asset class investors are targeting, and whether their investment is in a growth market or not.
In the wake of the Covid-19 pandemic, the two asset classes that have held up the best in the changing environment have been Multifamily Assets and Industrial Real Estate. These have proven to be the most resilient from a risk perspective and offer investors the best opportunity to maximize returns going forward. We recommend focusing on Multifamily Developments, mainly in Opportunity Zones, for which investor demand has remained high during the pandemic.
Secondly, investors should focus on markets that are experiencing growth and are on the right side of the larger migration shift taking place as a result of remote work becoming the new standard. Markets such as the Southeast, Texas and the Mountain West have benefited the most from the ongoing trend as they offer quality housing at a more affordable price along with a high quality of living. We specifically focus on Arizona and Colorado, despite being based in Chicago, as the underlying fundamentals and high-paying job growth have continued to drive increased demand. The number of people leaving the large Metro areas, especially NYC, LA and Chicago, and moving to more cost-effective alternatives is a trend that we believe will continue in the wake of the pandemic. Therefore, to maximize returns as a real estate investor, homing in on growth markets that continue to benefit from the ongoing migration shift in our country is the best strategy going forward.
Tony Huang, Kiso Capital
We believe that investing in venture debt, currently a $30 billion market in the US, is the best way investors can generate yield in the current economic environment. About 99.5% of start-ups never raise institutional venture capital funding and are underserved by traditional commercial banks due to lack of collateral and cashflow as well as by existing venture debt funds which require pre-existing or concurrent equity infusion from institutional investors. Venture debt supports these start-ups by helping to accelerate growth, extend cash runway and minimize equity dilution.
Venture debt strategies can originate and manage diversified portfolios of high-yielding growth capital loans to bootstrapped and institutional venture-backed companies, with a focus on companies which have demonstrated market validation and achieved product-market fit, and to provide these companies with an unrestricted credit facility typically structured with short to mid-term amortization schedules. These loans are usually senior-secured with full blanket lien on all the borrowers’ assets, including intellectual property, and generally carry an annual interest rate in the low to mid teens, with attached warrants and/or other success-based equity participation features which are designed to generate an overall IRR between 20% to 30%, significantly higher than what other asset classes are offering in today’s environment.
Ben Fraser, Aspen Income Funds
As interest rates are being driven to historic lows, finding investments with strong yields is becoming increasingly difficult. This puts investors in a challenging situation – either take more risk to chase higher yields (like junk bonds, for example), or look outside of the public markets.
Real estate has long been an investor favorite for growing wealth, but commercial RE markets, which historically have provided strong yields and growth for investors, have seen yields compressed to historic lows as more institutional capital floods the markets.
But there is another way to generate income: Real Estate Notes.
When a person buys a house, they get a loan and make monthly payments on it. That’s a real estate note. These notes are actively traded behind the scenes.
Investing in real estate notes generally means purchasing an existing mortgage. When investors purchase a mortgage note, they become the lender. They have all the rights of the lender. They don’t own the real estate, but they have a right to take the collateral if the borrower doesn’t pay.
When investors invest in real estate notes, they get all the advantages of being the bank without the difficulties of being a landlord. A few such benefits include: no property management, no maintenance issues, no management of tenants, a lien secured by real estate, and discounts on the real estate notes themselves.
If investors are curious about how to invest in this asset class, there are several ways they can jump into the world of note investing:
- Purchasing Existing Notes – Both performing and non-performing notes are actively available for sale on the secondary mortgage market. This is a great place to start, but there is a learning curve and investors are generally going to pay higher prices
- Investing in a Fund – Many investors prefer a more passive approach to investing in this asset class and partner with Fund Managers. By doing this, they eliminate the need to be involved in the active management of these assets, diversify their risk across many assets and geographies, and leverage the expertise of the Fund’s team
If you would like to learn more about real estate note investing, please click here for more information.
Alec Randall, Yankee Capital Partners
Interest rates are low, inflation is rearing its head and equity markets are at all-time highs. This puts many investors at a crossroads and in need of a strategy that can generate income, hedge against inflation, and is largely secular to the equity markets, and our recommendation would be to look at investing in commercial real estate.
There was a time when commercial real estate investing for a retail investor was speculative and the barriers to entry in acquiring high quality institutional assets proved to be high. Recent policy developments have led to accredited investors being able to access these prized assets and benefit from the income, appreciation and tax benefits once only available to large institutions. Not all commercial real estate has performed well however, with retail and hospitality properties bearing the brunt of negative effects of the pandemic over the past year. On the other hand, one of the shining stars in commercial real estate has been multifamily properties owing to the basic fact that people will always need a place to live.
Within multifamily properties, B-Class middle income housing has proven to be a strong performer simply by being in the middle. It is the largest pool of renters who may have student debt or are unable to afford a down payment and are likely to remain renters for an extended period of time. In times of economic boom, renters in C-Class apartments will upgrade to B-Class and in times of economic uncertainty, A-Class apartment residents will trade down to a B-Class community to save money. Being in the middle is comfortable, relatively safe and lucrative.
With regards to income and returns, B-Class properties can punch above their weight when combined with a “value add” strategy. This involves exterior and interior updates that bring the property up to modern standards, commanding higher rents and driving the overall value of the property upwards. Investors can enjoy a passive stream of tax advantaged income from the property starting on the very first day of investment and will see these cash-on-cash returns grow as the capital improvement plan progresses and the rents grow. At the end of a typical holding period of 5-7 years, the property can be sold, refinanced or rolled tax-free into a different property. This is where the value of the property improvement process is realized, delivering strong returns on the backend at a capital event. Between the income, tax benefits, appreciation, and principal protection of owning a real, stabilized asset, a pivot towards a multifamily investment strategy may be exactly what a sound investment portfolio needs in these times.
Tony is a 25-year veteran of Silicon Valley and Asia’s venture capital industry with extensive experience in venture lending, direct investment, venture fund investment, and corporate development, with emphasis on US and Asia cross-border transactions. Since 1995, Tony has been an active participant in Silicon Valley and Asia’s venture capital and entrepreneurial ecosystems, serving as an investment professional, angel investor, trusted advisor, and a catalyst to facilitate entrepreneurial value creation. During his career, Tony has been responsible for providing over $300 million in venture debt financing to over 200 companies, invested in over 35 start-ups, and sponsored over 25 venture capital fund investments.
Companies that Tony has invested in include Fortinet (FTNT), PayPal (Acquired by eBay), Marvell (MRVL), PowerSet, (acquired by Microsoft), Silicon Motion (SIMO), SMIC (SMI), TransMedia (acquired by Cisco), BCDsemi (BCDS), Carbonite (CARB), among others.
Tony is currently the Managing Partner of KISO Capital, a Silicon Valley based specialty finance company dedicated to providing efficient and minimally-dilutive growth capital financing solutions to start-up companies in technology and other high-growth industries.
After graduating from Boston College and deciding I wanted to pursue a career in Sales, I made one singular decision. If I was going to be in Sales, I might as well try to sell the biggest thing I can. That led me directly into the Commercial Real Estate industry.
I learned the business by working at a large National Firm for over a decade. That experience taught me I was truly wired to be an Entrepreneur and build my own company. Today, I am one of the Founders of two different real estate firms. Triad Real Estate Partners brokers the sale of large Multifamily and Student Housing assets all over the country. Jackson Dearborn Partners is a development firm where we build Multifamily housing, largely in Opportunity Zones based on growth markets.
To date at Triad, we have completed $6.8 Billion in real estate valuations with over $835M in closings. Since 2017 at Jackson Dearborn Partners, we have made over $100M in acquisitions and eleven development projects totalling over $300M in total capitalization.
Ben Fraser is Vice President of Finance at Aspen Funds (an Inc. 5000 company) and has helped raised over $50MM in private investment capital from individual and institutional investors for their real estate note funds. Prior to Aspen, Ben was a commercial lender and a commercial credit underwriter for several publicly traded banks, personally responsible for underwriting over $125MM in commercial real estate and business loans. Before banking, he worked for a boutique asset management firm and helped grow their institutional managed accounts from $3BN AUM to $7BN AUM.
Ben is a contributor on the Forbes Finance Council. He is also a co-host of the Invest Like a Billionaire™ podcast. He completed his MBA from Azusa Pacific University, and his B.S. in Finance from the University of Kansas, graduating magna cum laude.
Alec Randall oversees investor relations and business development at Yankee Capital Partners, a multifamily real estate investment company where the team recently launched the YCP Value Fund II. With a background in investment banking and financial sales, he spent seven years working with Boston’s leading institutional asset managers providing investment research and corporate access as an institutional broker.
Prior to that, he spent three years on an international trading desk in New York City. He understands the need for a balanced, multi-asset portfolio and is excited to demonstrate the benefits of owning commercial real estate with clients.