“Yield…I don’t need no stinkin’ yield.”
Or do you?
I spend my days speaking with wealth advisers, trust officers, clients, prospects and shareholders. It’s a fulfilling job that, along with my incredible team, I tackle with enthusiasm each day. Since my arrival at Broadstone nearly 3 years ago, there has been one common and resounding theme in my discussions: there is no yield to be found in the fixed income marketplace. None. Nada. Nil.
Well, not quite none, but with a 1-yr CD at 0.23% and the 5-year treasury at 1.329% yield, we might as well be speaking about nada. Consider that the average pace of inflation over the past 50 years has been 4.0%. Even in the past 10 years when inflation ran at a measly 2.1% per year, those rates are terrible. You’re barely staying afloat once inflation adjusted returns are calculated on those yields. And clients need income. So what is an investor to do?
Traditional asset allocation would have you believe that stocks, bonds, and cash would have gotten you to where you wanted to be. That has not necessarily been the case. Institutions realized this moons ago and began to invest in “alternative investments”. But with the exception of the most well-heeled investors and those with incredible savvy, the alternatives (let’s call it AI) trend did not catch on until recently. And I hesitate to even refer to it as “catch on”. But why do I mention the AI? Let’s go back to the original question—where to find yield or current income. Guess where you might find it? AI!
First we need to understand what AI is and why a wealth adviser should consider using it with a client. Then we should discuss why real estate is a partial answer to your AI needs.
A simple definition of AI by our friends at Investopedia says it is “an investment that is not one of the three traditional asset types (stocks, bonds and cash)”. Sounds simple enough. It continues “Most alternative investment assets are held by institutional investors or accredited, high-net-worth individuals because of their complex nature, limited regulations and relative lack of liquidity.” This is sounding a bit scarier—maybe my clients aren’t ready for this. Wrapping up the definition “Alternative investments include hedge funds, managed futures, real estate, commodities and derivatives contracts.” Advisers think: Man, run for this hills. Real estate—that’s a roller coaster to be sure. Managed futures? I can hardly explain managed money. Commodities? No way. Derivatives? Only the “Big Boys” make money in those. Hedge Funds? Fees on fees on fees—net 5% to my client and the hedge fund manager has a butler and a helicopter. Suddenly AI isn’t for you. Or your clients. And that is a disservice to all.
But what is the end-goal of utilizing AI? Reducing portfolio volatility through a more broadly diversified allocation utilizing decoupled and lower correlated, non-mainstream investments. Wow, if this exists in a form that you can utilize with your client portfolios, it sounds like a good deal. And if a particular AI investment also generates income, it’s a double win!
As we have seen all too well and expect to continue, the traditional investments of stocks and bonds can be fraught with volatility that clients have a hard time living with. Returns have been choppy and disappointing over time. The public markets move on news unrelated to a specific stock. News of a bombing in Syria whacks the price of your U.S. stocks. The coupling of the global markets has made asset allocation and providing clients with a smooth ride tougher than ever.
Fixed income, our portfolio calming force, no longer has the desired effect. Increased bond trading, financial uncertainty and an increased correlation to the equity markets have increased fixed income volatility. In addition, looking to our old friends in fixed income for yield is dubious as best. And with a stated Fed policy of remaining accommodative for the next 2 years, that’s not going to get any better. Ah, look to dividend paying stocks for income you say? That ship has largely sailed as well as share prices have risen over the past few years and per share dividend increases have not kept pace, despite much of corporate America sitting on record levels of cash.
So where is the income for your shareholders going to come from? Where can income thirsty retirees find it? Where can you steer your clients seeking income backed by actual assets with the ability to sustain that level of income or higher? Real estate.
Real estate investments in most forms will generate a yield of 3-8% (unless wildly aggressive) for your clients. But real estate is a pretty broad asset class with many sub-classes. Heck, you can invest in everything from a large office building in NYC to a Taco Bell in Arkansas to farmland in Montana to a surgical center in Mumbai. Well, maybe not in Mumbai, but I can find you one in Sarasota. Then you can go direct (buy the building outright), buy a publicly traded REIT, a public non-traded REIT, a private REIT, open-ended, closed-ended, mutual fund. Now it just got too confusing again. Or did it?
Not really. Once you understand that real estate is wonderful, relatively stable assets and realize that real estate is going to trade unlike any other asset class, even providing a low level of correlation to public markets and fixed income, you need to ask yourself a few questions about your goals for a client and create a profile.
Is the client accredited or not?
What level of income do you need to generate for them?
Is tax deferral attractive or important?
What level of liquidity do they need?
Are you and your client fee sensitive? (I hope so)
Put this all together and you can narrow the playing field of potential real estate investment vehicles quickly. And generate the income that the client needs. And reduce their portfolio volatility. And provide tax-advantaged income. And look like the best adviser they ever had. And retain their accounts. And your fee stream. And your vacation to Italy with your family.
Don’t need no stinkin’ yield? I bet you do. And I’m willing to bet real estate should be part of it.