On today’s show I want to share a perspective on the world of investing.
My mother started an investment holding company back in 1976. She had a portfolio of investments, largely in the stock market. When my mother passed away in 1981, I was 18 years old, I had the task of taking over that investment holding company.
At the time, the conventional wisdom was that you could routinely earn an average return of 10-11 percent. In my world, as a relatively young investor, our target was to invest in primarily high dividend yield stocks like utility companies. They would deliver about an 8% rate of return on their dividends and another 2-3% in long term appreciation. These stable high yield stocks were the so-called granny stocks of the day. We chose these because at the time, my father who would be retiring in the coming 2-3 years would be reliant on the income from the stock portfolio for his retirement income. My sister and I would ultimately become the capital beneficiaries of the portfolio, but my father was the to be the income beneficiary. I was effectively managing a small pension fund for my father as the sole benficary. The market conditions enabled a solid investment strategy at the time. The large pension funds that are responsible for police departments, fire departments, schools boards, public sector employees have had very similar investment objectives as part of their charter.
But the problem is that in the last decade, ever since the 2008 financial crisis, the rates of return experienced by pension funds have been approximately half of what they were in the 1980’s and 1990’s. They’ve been averaging around 5% for the past decade. You don’t need to be a financial wizard to understand that this is a ticking time bomb.
When I talk about stock market yields, I’m not talking about the price of Apple, Facebook, Amazon or Alibaba. Those stocks are not the mainstay of pension funds. They are too volatile and they don’t offer the kind of capital protection that responsible pension fund managers require.
So now if yields in the stock market are falling, investors are going in search of yield elsewhere.
In the world of real estate, I can tell you that I would never undertake a project for only a 5% annualized yield. That’s far too risky.
But if you’re coming from the world of public stock investing, and you’re seeing the types of returns that are possible in real estate, you’re probably getting excited. We’ve seen a lot of investors attracted by the stability and the kind of appreciation that is possible through the combination of forced appreciation and leverage.
These new entrants have been bidding up the prices for real estate, because by comparison, the stock market alternative is too volatile and less attractive. That’s made it harder for the professional real estate investors like you and I who are not willing to pay too much for an asset.