Commercial Real Estate Shines Amid Increased Volatility

Commercial real estate is a great hedge during volatile markets like those we have been experiencing this week. Whether the stock market is up or down 3, 4, or 5% means very little to the myriad of tenants that we have in place - whether they be neighborhood retail and service businesses, long standing medical practices, or apartment dwellers who are paying their rent each month on time. The value of a well managed building or shopping center is little impacted by the day-to-day noise in the markets.

Of course diversification is important, and owning a basket of equities is a great long term way to build wealth, but real estate returns also compound over time as rents are collected and the mortgage principal is reduced. If one is worried about inflation, then worry no more - property values increase over time due to inflation, and real estate rent increases are one of the single largest contributors to the CPI. If one is worried about rising interest rates, then simply lock in a long term mortgage at near record low rates - plus, if interest rates go up then it means it is easier to raise your rents by 3 or 4% per year to keep pace. Finally, if things stay as they are, then we will have lower interest rates for longer, and that is excellent news for those of us who own real estate investments with double digit returns.

The current spread between the average real estate cap rate - which is simply the return of the underlying real estate asset - and the 10 year US Treasury yield is one of the widest we have seen in years, making commercial real estate even more attractive - and also providing a "buffer" for possible Fed rate hikes next year.

This chart paints the picture:

And that is just looking at the Average Cap Rate - roughly about a 7.00% cap rate. When one considers the cap rates that Prudent Growth has been finding amongst smaller, but still well managed assets, the spread is even wider - more like 600 basis points over the 10 year Treasury!

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Prudent Growth Partners, LLC  (2020)    1829 E. Franklin St, Suite 800-F, Chapel Hill, NC 27514  (919) 590-4119