THE MOST CONSISTENT INVESTMENT TO BUILD LONG TERM WEALTH
Real estate frequently takes the fall for the errors of men.
Take, for example, the Financial Crisis of a little over ten years ago. The real estate market crashed like never before along with it the rest of the economy, resulting in one of the most devastating financial crises of recent memory.
It was easy to point the finger at real estate for being the root cause of the Financial Crisis, but it had nothing to do with the inherent attributes of real estate and more with the irresponsible, greedy actions of bad actors in the banking and financial industries.
The real estate boom and bust that preceded the Financial Crisis was a direct result of subprime lending fueled by the insatiable appetite of foreign investors for asset-backed securities. The unprecedented rise and fall in real estate prices had nothing inherently to do with real estate and everything to do with unnatural demand fueled by sketchy home loans and financial products.
The real estate bubble was man-made, just like the dotcom bubble of the early ’00s.
The boom in dotcom IPO’s was also artificially generated by bad actors in the financial sector pumping stock prices for their financial gain. However, that’s where the comparison ends between the dotcom crash and the real estate crash.
Whereas most of the companies underlying the dotcom crash were worthless to begin with – with no inherent value, real estate in and of itself has value.
That’s why following the dotcom bust, most of those companies disappeared. Real estate, on the other hand, despite the giant fall, picked itself up and moved onward and upward just like it has every other time because real estate has inherent value.
Real estate’s inherent value is why it builds wealth more consistently than other asset classes.
It’s resilient, and except for the one time in its history where Wall Street got its dirty tentacles all over it causing the great crash, it is generally uncorrelated to Wall Street’s volatility and the volatility of broader markets.
There are several reasons why real estate is superior to other asset classes for building wealth:
| Cash Flow |
No other asset class can offer the type of cash flow for consistently building wealth like cash flowing real estate such as commercial real estate and investment properties. Most investments (stocks, art, jewelry, bitcoin, etc.) offer the promise of profit from appreciation. Unlike these asset classes, commercial real estate and cash flowing investment properties generate consistent cash flow from leases that in most cases (depending on the subsegment) are recession resistant. For investors seeking regular income essential for building wealth, cash flowing real estate can provide an attractive alternative to bonds, which also provides cash flow, but at much lower rates.
| Appreciation |
In addition to cash flow, appreciation (i.e., the increase in property value over time) is another way real estate builds wealth. While prices fluctuate over time, in the long run, real estate values have always gone up, and there is no reason to think that is going to change. Also, cash flowing real estate has historically demonstrated capital appreciation exceeding inflation over the longer term, resulting in strong actual returns (after adjusting for inflation) to investors, making it an ideal hedge against inflation.
| Tax Benefits |
Tax benefits such as depreciation enhance the real rates of return on real estate investments. Depreciation allows you to write off part of the value of the asset itself every year. This significantly reduces the tax burden on the money you do make, giving you one more reason real estate protects your wealth while growing it.
| Better Risk-Adjusted Returns |
Because real estate is not correlated to the stock market, it offers diversification and potentially higher returns when compared to mutual funds, stocks, and bonds. In fact, real estate has historically provided higher returns at a lower risk.
| Leverage |
Widespread access and availability of conventional and unconventional financing for acquiring real estate allow investors to leverage their investment capital to acquire multiple properties instead of just one, allowing for accelerated wealth creation and growth.
| Diversification |
With its breadth of real estate options across segments, price, and geographic location just to name a few, real estate offers the type of asset-backed diversification unparalleled by any other asset class.
Yes, real estate has stumbled from time to time, but it has consistently gotten up, dusted off its shoulders, and continued onward and upward.
No other asset class can build wealth consistently like real estate by offering unmatched cash flow, appreciation, tax benefits, risk-adjusted returns, leverage, and diversification.
The beautiful thing about real estate investing is that it lends itself to investment in a variety of manners – whether directly acquiring properties or by relying on the expertise of others.
Discover current opportunities available to partner with Fall Creek Asset Management and enjoy the benefits of the wealth building attributes of real estate.
There are two certainties in life – death and taxes. Might as well add one more to that short list – RECESSION.
Since 1929, there have been 14 recessions. On average, they come every four years and last around nine months in duration. It’s been ten years since the last recession so it seems we may be due for another one here soon.
How close is the next recession?
Depends on whom you talk to, but any discussion around a recession usually starts with the state of the economy.
So, how is the economy doing?
Once again, it depends on whom you ask.
There are bright spots.
Consumer confidence and spending, a popular bellwether for judging overall economic health, seems to be holding up. “The consumer continues to be the driver in the U.S. economy,” said Jack Kleinhenz, chief economist for the National Retail Federation. “Real personal consumption expenditures for 2019 is 2.4% year-over-year growth. It was 2.6% in 2018.”
Job growth, another bellwether, continues to be strong, with the average monthly growth expected to be 184,000 in 2019 and 139,000 in 2020. In April of this year, the unemployment rate fell to 3.6%, the lowest rate since 1969.
While consumer spending and job growth are bright spots in the economy, there are also warning signs and factors that could throw the economy into decline.
The big concerns among analysts are tariffs and trade policy. “The greatest downside risk is trade policy and increased protectionism,” Kleinhenz said. A trade war could stall growth and fuel a recession by as early as the end of this year.
Another warning sign of an impending recession has been the Fed’s recent rate hikes. Ten of the last 13 rate-hiking cycles (more than 75%) since the 1950s have ended in a recession. Don’t be fooled by recent Wall Street gains many analysts warn. Recent attempts by the Fed to engineer a soft landing by pausing its rate-hiking cycle may have stalled fears of an imminent recession, which explains recent stock gains, but many analysts think the wheels are already in motion for a recession. Johnston, Matthew (Apr 18, 2019), “Why There’s a 75% Chance of a Recession,” https://www.investopedia.com.
In matters of priorities, secured creditors reign supreme.
High-net-worth individuals (“HNWIs”) and institutional investors like university endowments and private foundations are always prepared for recessions. How?
By investing in alternative investments exhibiting the following attributes:
The Yale Endowment, one of the nation’s largest and most successful university endowments, allocates more than 80% of its assets to alternative investments. How did the Yale Endowment do in 2018 when the S&P was down 6.2%? It gained 12.3%.
Yale’s model is a prime example of recession-busting investing. Among Yale’s favorite class of alternative investments is real estate where it consistently allocates 12-20% of its investable assets.
Not all real estate investments are created equal, however.
Some are more correlated to the broader economy than others. In general, retail and office properties tend to get hit the worst during economic downturns. Other commercial properties such as multi-family assets are less correlated, offering a recession hedge while providing a consistent income stream during a time of uncertainty.
Besides offering a recession-hedge, well-occupied commercial properties with staggered leases and financially sound tenants provide predictable cash flows with fixed income stability that consistently stays ahead of inflation.
Since the National Council of Real Estate Investment Fiduciaries (NCREIF) began tracking private commercial real estate returns in 1978, the NCREIF Property Index (NPI)* has exceeded inflation in 32 of 38 years. The only two periods where inflation exceeded NPI were during the recession of the early 90s and the Great Recession beginning in 2007.
Nobody really knows when the next recession will hit, but we can learn a lot from HNWIs and university endowments who don’t wait around for the warning signs to prepare for a downturn.
They’re always prepared. By removing Wall Street from their investment equation, these successful investors hedge against recessions by investing in alternative assets like commercial real estate that offer inflation-busting income streams that continue even through difficult times.
For individual investors, private investment funds offer the opportunity to invest in commercial real estate assets with consistent income distributions and without the high entry barrier of acquiring properties on their own.
No matter how you get into the commercial real estate segment, what’s important is that you get into it for its recession-hedging, income-producing, and inflation-busting qualities. It’s what successful investors have been doing for decades.
Partner with Fall Creek to start preparing for the next recession today.
What is an investor’s greatest enemy to achieving true wealth? Themselves.
Human nature prefers simplicity, is impulsive, and prone to the herd mentality. That’s why investors are drawn to Wall Street. The Wall Street players understand this and prey upon simplicity and impulsiveness. So-called financial advisors who profit from fee churning also benefit from the volatility brought about by investor impulsiveness. They have no incentive to change the status quo.
Despite Wall Street’s grip on a large segment of investors, there is a growing movement to break away from the norm and there’s one simple reason for this seachange – RETURNS.
In a previous message, we discussed Wall Street’s outdated 60/40 allocation strategy, which allocates assets between 60% stocks and 40% bonds. In response to the ineffectiveness of the 60/40 rule, there’s been tremendous interest in a new allocation strategy where 40% of a portfolio is dedicated to private investments. Why? Because members of this 40% club have been beating Wall Street returns by a wide margin.
Anticipating the obsolescence of the tired Wall Street model, major university endowments and institutions turned to private investments for above-market returns sheltered from Wall Street volatility and inflation. Private investments including non-venture private equity, venture capital, private real estate, private oil & gas/natural resources, and precious metals have provided the types of returns Wall Street is no longer able to offer and without the volatility.
The private investment firm Cambridge Associates (“CA”) recently published a study finding that private investments have provided the strongest relative returns for decades. Top-performing endowments like the Yale Endowment and other institutions have been long-time allocators to private investment strategies, reaping the benefits of the outperformance. Private Investing for Private Investors: Life Can Be Better After 40(%). (2019, February) www.cambridgeassociates.com.
In recent years high net worth individuals (“HNWIs”) and family offices have taken notice of these successful endowments and institutions and are now pivoting towards adding private investments to their portfolios for good reason.
CA’s past analysis indicates that endowments and foundations in the top quartile of performance had one thing in common: a minimum allocation of 15% to private investments. CA data also showed that the top 10% steadily increased their allocations to private investments over the past two decades, exceeding 15% of allocations, in many cases, exceeding 40%.
CA data shows a clear positive correlation between returns and allocation percentages to private investments.
Figure 1 highlights the meaningful returns that institutions with higher allocations to private investments have achieved over the last 20 years. The median annualized return for a greater than 15% average allocation was 8.1%, 160 basis points higher than the group with a less than 5% allocation. This chart also shows the higher the allocation, the better. As seen in Figure 2, the top 10% of performers have steadily increased their allocations over the years to a mean of 40%.
So, what differentiates these successful institutions from the typical Wall Street investors? Private investors are comfortable with a long time horizon, illiquidity, and complexity inherent in higher private investment allocations. They understand it takes time and skill to build a private investment program, but they are compelled by the potential rewards for this extra effort.
Additionally, what has appealed to many of the decision makers at these institutions is the fact that where they lack the necessary experience or knowledge in a particular field, they have no reservations about deferring to the expertise of the principals at these private firms if the trust is there. This level of trust is achievable because private investment firms are typically more transparent and their directors more accessible than their public counterparts, allowing investors to place money in markets in which they’re not completely familiar but where they’re comfortable trusting the decision makers.
Joining this growing 40% club will require a change in investment approach. Investors interested in building multigenerational wealth through private investments with the necessary long view, patience, and ability to act quickly, will stand to benefit not only from the potential for higher returns but also from the tax-advantaged nature of private investments like real estate.
Discover how you can join the 40% club and take your investing to the next level by Partnering with Fall Creek.
When an investment goes south, whether you’re a secured creditor or an unsecured creditor could mean the difference between recouping your investment or walking away empty-handed.
In cases of corporate bankruptcies and liquidations, priorities matter when it comes down to how a distressed company’s assets are distributed.
In matters of priorities, secured creditors reign supreme.
The most recent study on bankruptcy from Yale University law professors found that in the case of businesses with assets worth more than $5 million, secured creditors received 94% of what they are owed. Arturo Bris, Ivo Welch & Ning Zhu, “The Costs of Bankruptcy: Chapter 7 Liquidations vs. Chapter 11 Reorganizations,” Journal of Finance (2005).
Secured creditors are in the driver’s seat due to the principle of absolute priority. Secured lenders agree to lend money only in exchange for corporate assets being pledged against corporate obligations. This lien over the assets of the company ensures that when a company does go under, secured creditors are paid back before any other creditors, including regular bondholders and any other unsecured creditors.
While secured creditors generally receive 94% of what they’re owed, it’s a different story for unsecured creditors who typically receive pennies on the dollar in the best case scenario and nothing in the worst case.
None of this should be surprising since secured creditors have wielded a disproportionate amount of preference and power over their unsecured counterparts dating back to as early as the Roman Empire – likely even earlier. Since the beginnings of English common law, a precursor to our legal system here in the United States, secured creditor status has always been recognized as having priority and being superior to unsecured status.
In fact, according to English legal tradition still followed today, if by agreement between a debtor and a creditor, specific property of the debtor was pledged to secure the creditor’s claim, the fact that such collateral was untouchable by unsecured creditors was not considered unjust or unlawful. English Statute of 13 Elizabeth I.
I point this out to demonstrate that the differences between secured and unsecured creditor status are immense, especially when a company goes south.
Unsecured creditors and shareholders must wait until secured creditors have been adequately compensated before they receive any compensation for the loss of their higher-yielding investments. Because equity owners are last in line, they usually receive little if anything, and because unsecured creditors are only one step above equity owners in the priority ladder, their chances of recouping a portion of their investment are only slightly better, but still not great.
The type of secured creditor who stands to receive the highest portion of a company’s assets (i.e., 100%) is the secured creditor with blanket security over all the assets of the company. Because secured creditors are dependent on the unencumbered (i..e., unsecured) assets of the company for payment, simple math dictates that a company whose entire set of assets are secured will have nothing left to distribute to unsecured creditors and equity owners.
The list of some of the largest corporate liquidations in U.S. bankruptcy history backs up the assertion that secured creditors usually get paid back their entire amounts owed and the unsecured creditors typically receive pennies on the dollar. One recent high profile bankruptcy demonstrating the dichotomy between secured vs. unsecured claims involved the bankruptcy of Omaha-based brick and mortar retailer, Gordman’s, which operated about 100 stores in 22 states.
According to Gordman’s bankruptcy plan, which was finalized at the end of 2017, the secured creditors, including Wells Fargo with the largest claim at $66m, received the full amounts of what they were owed upon the sale of the company’s assets. Unsecured creditors, as predicted, didn’t fare so well and received only 5 cents on the dollar.
The reorganization plan by Lafayette-based oil and gas company PetroQuest Energy, Inc. proposes to pay unsecured creditors less than a penny on the dollar. In the case of Gordman’s and PetroQuest, the unsecured creditors actually fared better than most unsecured creditors in a corporate liquidation wherein more than half the instances unsecured creditors receive nothing.
Nobody invests money in a company expecting it to declare bankruptcy.
However, when you venture outside of the risk-free realm of government-issued securities, you are accepting this added risk to enjoy above-government level returns. It’s just something that needs to be taken into consideration as you diversify your portfolio.
Investors don’t want to see a company fail. However, when a company does go south, every investor will wish they were a secured creditor since secured creditors have the best chances of seeing the value of their initial investments come back to them (94% according to the latest published study).
If you’re interested in secured investment opportunities to protect your creditor status, discover more about our current offerings here.