If you're looking for a regular income, forget about putting your hard-earned money in a savings account. The story with Treasury bonds is just about as bleak. True, they're relatively risk-free and stable, but the return on them has been low, too. Ron Kaiser, director of San Francisco-based investment advisers Bailard, Biehl & Kaiser, has been studying the relative returns and volatility of various investment vehicles for years. According to his research, real estate is just as conservative an investment as bonds -- but may be a better source of income.
Short-term rates will likely stay low for some time, by most economists' accounts. "The period in the '80s and '90s when rates were really high was a result of high inflation. We just don't have that today, so there's no reason for interest rates to be high," Kaiser says. Real estate, on the other hand, may fluctuate more than bonds in the short run, but Kaiser says they have a long track record of bringing in solid income -- probably more than Treasuries -- and make sense for any investor looking to have a diversified portfolio.
Kaiser spoke about his research and investment strategy with BusinessWeek Online reporter Amy Tsao on Sept. 25, 2003. Edited excerpts from their conversation follow:
Q: Explain what's behind your thesis that real estate can fill the role of bonds as stable and reliable income? Doesn't real estate fluctuate more than bonds?
A: When you look at the statistics of it, the historic reliability of real estate income is actually superior to interest yields. That's the thing a lot of people aren't aware of. Of course, investors [who, like me, have been] in the [market] for over 30 years are used to thinking of bonds as a superior income-yield vehicle because bonds spent most of our career yielding better than 6%. All of a sudden they're yielding 4%, and we're realizing they're not the best place to get income return after all.
Yields can go higher or lower, and there's the hit from capital loss on bonds, whereas real-estate volatility of income is very low. You're going to get a 5% return on a real-estate portfolio. That looks very attractive next to bonds. And over time, real-estate incomes should gradually grow with inflation because rents and cash flows track with inflation over the long run. You get an inflation-hedged return. If you look at an inflation-linked bond, you're getting 2% or 2.5% interest return. Real estate is clearly superior in terms of cash-flow returns.
Q: What kinds of real estate are you referring to? You're not talking about someone buying and selling individual properties are you?
A: I'm primarily talking about private market properties for institutional investors. They can acquire a diversified portfolio of properties. But for a typical individual investor, they have to resort to the public REIT [real estate investment trust] market. One of the things to be aware of is that while, over a 20-year period, public REITs deliver the same returns to a similarly leveraged portfolio of private property, you can have a lot of [short-term] volatility [because they trade like stocks]. Public REITs have a pretty reliable dividend return of 4% to 6% a year. For the investor looking to the long term, a diversified portfolio of offices, shopping centers, and apartments make a pretty reliable income stream.
Q: Who is this strategy best suited for?
A: I think it's right for the person who has already achieved most of their financial goals and is looking to preserve wealth and cash flows. My mother-in-law, for example. If you're looking for aggressive capital return, this would be a fairly boring strategy.
I manage a diversified portfolio of about 30 different public REITs for my mother-in-law. She gets a monthly check from her brokerage account as her portfolio right now is yielding a 7% dividend. That's a nice return considering her money used to be sitting in a savings account, which today is earning about 2%. She has a monthly Social Security check and then a monthly check from her REIT portfolio. She has been able to double her income just from having a good dividend stream.
Q: What kind of concerns do people have when you suggest that real estate may be better for them than bonds?
A: Again, my mother-in-law is a good case. She thought it was risky. She wanted to know what if these companies cut their dividends. I told her that realistically these companies are in very good shape, not overly leveraged, and are well managed. I would say pick a good portfolio of them -- make sure you diversify over at least 10 of them. If your nest egg is small, you probably want to stick with the biggest companies, which are already well-diversified.
Q: What kind of asset allocation do you recommend to clients?
A: Real estate has always been an important asset class for our clients. Currently, we recommend the average client hold 20% in real estate [in REITs or private property], around 15% in bonds, and the balance in domestic and international stocks.
Q: In the spectrum of investments, where does real estate fit in as far as risk?
A: By the classic risk measure of volatility of return, real estate is lower risk than either stocks or bonds. But with real estate you have the illiquidity problem in the private market. When you factor in liquidity risk, real estate is somewhere between stocks and bonds.
Still, the data indicate real estate is a very good, reliable income source. If you have a diversified portfolio, you shouldn't worry too much about cyclical effects. I tell people, including my mother-in-law, not to look at how prices go up and down, just plan to be in there for 20 years and collect the income.