In these times of rising interest rates and market uncertainty, should real estate still have a seat in your investment portfolio?
As we know it, interest rates in many countries have been rising in leaps and bounds in the past year or so, thanks to skyrocketing inflation. And naturally, costs of borrowing have also followed suit. For many real estate investors out there, this has made them think twice about ploughing more money into real estate investments, as rising mortgage rates have cast a pall over their potential returns.
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Meanwhile, other than property-related investments, these investors are also constantly on a lookout for the best investments that would earn them the highest yield to beat inflation. In Singapore, for instance, some have turned to shorter-term securities like Treasury bills and government bonds that offer an attractive risk-free interest yield, as well as short-term fixed deposits that offer lower-risk returns.
Along with the rising interest rates, the six-month Singapore Treasury bills saw its interest rate hit a 30-year high of 4.4% p.a. on 8 December 2022, while the 12-month Singapore Savings Bond issued in December 2022 offered an interest yield of 3.26%. Even some fixed deposits with a minimum deposit requirement are offering an interest yield that is well above 4%. With the equity and bond markets roiled by uncertainties and negative sentiment, some investors may be wondering if they should just let their money sit in some of these risk-free or lower-risk investment instruments, or if they should still seek some investment opportunities real estate has to offer?
Are rising rates entirely dismal for real estate investors?
Scary as it sounds, rising interest rates may not actually be all bad news for real estate investors. Yes, that leads to higher borrowing costs, but rents also tend to trend higher when that happens. And if rents rise more than borrowing costs, Net Operating Income will also increase, which would be music to the investors’ ears. In the residential property space in the U.S., U.K. and Australia, for instance, as more people who had intended to buy a home and live in it have now pivoted to renting instead of owning one, rents are holding up well against a tight rental market. So it is looking very much like a landlord’s market now for these markets, as renters outnumber buyers.
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Of course, to investors who choose to invest in real estate financing deals, such as a real estate debt fund, rising interest rates may also be good news as they can usually lead to higher-than-usual yields, as real estate financing is typically directly linked to the central bank’s interest rates.
It’s also about capital appreciation, diversification, and stable returns
It is important to realise that yield is only part of the real estate investment equation. Some investors tend to be fixated on a higher short-term yield, and end up comparing property yields with those of other short-term investments, with the hope of having the flexibility to deploy their monies nimbly when the tide turns. But it is also important to not ignore the capital appreciation potential of a property investment. Historically, the capital value of a property generally appreciates over time. This is especially evident in real estate investments that adopt value-add and opportunistic investment strategies. And it is one important component of the returns investors seek when investing in real estate. So, while investors chase after risk-free or lower-risk investments with a satisfactorily high yield, let’s not forget about the potential for capital appreciation too. Property investments are also lowly or negatively correlated with commonly invested assets like equities and bonds. This makes them an ideal component in a diversified investment portfolio comprising multiple asset classes.
In fact, to take diversification to the next level, investors could even further diversify their investments within this asset class by adopting different investment strategies, investing in different markets and asset types, as well as varying the investment durations and amounts. These help investors to harness different investment opportunities, spread out their investment risks, and enhance risk-adjusted returns. And now with investment avenues like fractional property investments, you can actually diversify your property investments more easily and affordably than ever. In addition, property investments have also shown to generate a stable income for investors over time. This makes real estate a should-have investment for investors who aspire to grow their wealth progressively over the long term.
In fact, long-term property investments can usually ride out the impact of short-term interest rate risks, without having investors lose sleep over where else to look to invest their monies.
Borrowing costs may peak for some markets in 2023
As the old adage goes: “What goes up, must come down”. And that applies to inflation and interest rates too. While interest rates in many countries have been on an uptrend for most of this year, they are expected to peak in 2023 for the U.K., U.S. and Australia. While interest rates may not immediately fall after they have peaked, that would have been an important indication that the pressures of high borrowing costs may start to ease in the near future, which will make property investing less onerous in time to come.
So, investors who are keen to invest in properties but are holding back due to high borrowing costs could be seeing light at the end of the tunnel, when interest rates peak. In fact, some analysts are predicting that the U.S. will start to ease monetary policy starting from mid-2023, as inflation is expected to fall back to the FOMC’s 2% target. And from a recent Australian Financial Review report, some Australian economists are also expecting the Reserve Bank of Australia to effect a rate cut either from mid-2023 or the end of next year.
Are REITs a better way to invest in real estate?
REITs offer an easy and liquid way for most investors to get exposure to diversified real estate investments, but these investments are also subject to the volatility of the stock market. And although REITs invest in a diversified basket of properties, investors would not be able to decide on the underlying investment assets, which makes diversification not much of an exercise by choice but by virtue of the investment structure. REITs are also typically levered to a certain extent, and higher borrowing costs will surely depress yields for investors.
What’s more, the yield that investors actually derive from REITs may not be as attractive as direct property investments. In a recent report published by Singapore financial blog DrWealth, the indicative yield of REITs listed in Singapore as at end-September 2022 was only between 3.3% p.a. and 4.5% p.a. In comparison, direct investments in properties through fractional ownership may achieve more attractive returns. Core deals typically yield between 7% p.a. and 9% p.a.; value-add deals typically yield between 10% p.a. and 15% p.a.; while opportunistic deals typically yield 17% p.a. or higher returns. And that is before any capital appreciation investors could further benefit from. In addition, direct property investments also mean that you have direct ownership of the real estate assets you invest in; that is unlike a REIT where you technically only own part of the trust company that is formed to own and operate the underlying real estate assets.
Real estate should still have a seat in your investment portfolio
Generally, real estate provides investors with a stable income and would usually appreciate in value over time. It is also lowly correlated with other investments, such as equities and bonds, which makes it an ideal diversification component in your investment portfolio. And direct investments in properties through fractional ownership would be one of the easiest ways to make an investment. Through this avenue, you can also further diversify your asset allocation by investment strategies, geographies, asset types, as well as investment duration and amounts, which is likely to improve your overall risk-adjusted returns. And with interest rates in some major markets set to peak in 2023, investors may see even more reason to invest in real estate in the near future, at lower borrowing costs. So, don’t be too quick to close your doors on real estate. Who knows? You may actually be better off investing in this unique asset class instead of dabbling with shorter-term investments.
