nvestments in real assets, whether on the equity side or the debt side, offer seemingly endless options for fixed income. If you can build it or finance it, you can invest in it.
One easy-to-understand way to attain real estate participation for clients is through real estate investment trusts, which allow individual investors to buy shares in commercial real estate portfolios that generate income through leasing and property management from a variety of properties, said certified financial planner Chris Schiffer, executive vice president with AEPG Wealth Strategies in Warren, New Jersey.
“Generally, when the economy is doing well, there is a higher demand for real estate, benefiting the REIT through appreciation, higher occupancy and higher rent payments,” he said. “Also, REITs can protect in down markets, due to their low correlation to stocks.
“The REIT still collects its rents in recessions and down markets, which is paid out to the investors.”
Schiffer cautioned that some REITs may be excessively leveraged, overly speculative or illiquid (if non-traded).
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Some advisors are using so-called interval funds, non-traded closed-end funds that offer to buy back a percentage of outstanding shares at different time intervals, to generate income for portfolios.
For his part, Michael Ciccone, CFP, investment advisor with Tradition Capital Management in Summit, New Jersey, uses these in the forms of private real estate funds that invest directly in income-producing real estate properties, and private real asset funds that invest in timberland, farmland and infrastructure.
“Because the majority of these interval funds are invested in private non-traded funds, with just a small public security sleeve for liquidity, these investments are largely insulated from market volatility, and instead the [net asset values] are mainly driven by the appraised values of the underlying properties,” he said. “This serves to provide investments with very stable and low volatility growth and income production.”
In contrast are limited partnership vehicles, or LPs, available only to accredited investors and less liquid than interval funds but, in general, more efficient and able to deliver better returns, all else being equal, said Eric Mancini, CFP, director of investment research and wealth advisor with the Traphagen Financial Group.
Mancini uses limited partnerships for both private real estate credit and equity. LP investments are more “pure,” he said.
“Most interval funds hold some amount of public securities or cash, in addition to private investments to enable the liquidity needs, usually quarterly,” said Mancini. “This … waters down the pure returns from the private investments and sometimes can create cash drag.
“With LPs, the 100 percent, or nearly so, allocation to the private investments, along with their limited needs for liquidity — usually the investor has no liquidity for one to three years or more — enables the manager to really maximize returns.”
Another illiquid structure used for fixed income is private preferred stock.
”It’s a type of private equity with less risk than traditional private equity and less reward, but it provides fixed-income payments, ” said Matt Chancey, CFP, a Tampa, Florida-based investment advisor with ClaraPHI Advisory Network. He has used this type of vehicle for assets such as institutional quality self-storage buildings, industrial warehouses and even tugboats.
The stock is held for a defined period, often from three to seven years, and generally offers a higher yield than a public preferred stock because a premium is paid to the client for giving up liquidity. Furthermore, because it does not trade in public markets, it is not susceptible to investor behavior and volatility, he said.
Not to be overlooked is direct ownership of rental property, according to Kristin Sullivan, CFP, owner of Sullivan Financial Planning in Denver.
“In the modeling for retirement income planning, I’ll often show the impact of keeping the rental property and using the income throughout retirement versus selling at some point in the future,” she said. “Realistically, most people won’t want to be landlords into their 80s, so it’s good to see how that change would affect the retirement plan.”
Investing in the debt side of real estate, Diane Pearson, CFP, wealth advisor with Legend Financial Advisors in Pittsburgh, uses two types, via mutual funds:
- Non-agency (non-governmental) residential mortgage-backed securities, which are senior secured loans, usually with a variable rate, generally containing jumbo rate mortgages that are no longer underwater.
- Asset-backed securities, such as corporate leases on properties such as airplanes, oil rigs and commercial property.
“This [debt] type of asset class makes sense in certain times of the market … in rising-interest-rate environments, so you want to evaluate if you’re in the right part of the cycle,” she said.