Bond yields are still historically low and the return of market volatility makes diversification even more important in mitigating risk. Investing in real estate may offer investors attractive income and diversification in a market where both are hard to find.
Beyond investments in real estate equity, investments in floating-rate real estate debt may offer a differentiated way to invest as we move later into the current cycle.
With real estate equity, you are a shareholder in a portfolio of properties, similar to a landlord without the management headaches. Your returns are based on rental income and changes in property values, which are historically tied to changes in interest rates. However, if a tenant defaults on a lease or property values decline, you will experience first loss in value. For the increased risk, real estate equity investments seek to generate outsized returns.
Floating-rate real estate debt investments are different. Think of yourself as the “bank” that provides loans and financing to property owners. You are paid income that adjusts in tandem with interest rates, which makes floating-rate mortgages especially attractive in a rising rate environment. Also, if a tenant defaults or property values decline, you are first in line for repayment, potentially preserving the value of your investment.
Like real estate equity, supply-and-demand dynamics dictate debt opportunities. Today, supply is low, as higher capital requirements have eliminated many commercial banks from the market. In fact, one-third of the top commercial real estate lenders from 2007 are no longer actively lending. Demand, however, is high, with more than $1 trillion in U.S. commercial real estate loans set to mature over the next three years. This set-up has opened the door for alternative lenders that are not constrained by tightened regulations.
At Resource, we believe real estate investing is not an “either or.” Leveraging both equity and debt investments may help you build a real estate portfolio that offers broad diversification, satisfies the returns you need, and generates attractive risk-adjusted income in today’s rising rate environment.