Today’s Interest Rate Spread — Using This Chart to Decide When, Where, and How to Buy Real Estate

Ivan: Happy Thursday, March 20. I’ve been buried here, putting out some content to my investors, prospective investors, and my audience. hope y’all are doing well. Socially distancing and staying safe. I wanted to get some content out today not on what we’re doing to protect our portfolio and how we’re managing through this, this unprecedented disorder, we put out several pieces on that as well as some information to our investors on how we’re positioning ourselves to ride through the economic storm here for the next 6090 days or more, if that occurs, in really looking at the long term, trend and why. 

Right now we want to get our hands on as much of our niche real estate as we can, which is workforce apartments here in the Midwest, where we can bring in our team and fresh capital to add value, make improvements, managed more efficiently, reduce costs, all to get that two and a half x return target of five to seven years. So this is one of my favorite charts. been tracking this chart watching it for 20 years ever since I discovered it. And Marcus and Millichap thank you guys put out a very recent graph of what this chart is doing right now. So basically, what we’re looking at, as you can see, is it’s the spread between average income-producing asset cap rates. Right now, you know, averages are high across all asset classes, but just keep that in mind for a second, it’s an average that can be 10 year Treasury, which is also called the risk-free rate. 

So it’s very similar to the interest rate you can expect by keeping your money in the bank and taking no risk versus investing in risky assets in real estate. And as you know, the cap rate is simply the unleveraged yield. So if you went out and paid cash for a property, what would be your rate of return without the use of debt without this good debt and leverage? That’s the simplest way to explain the cap rate. And so what you can see here over time is that these sort of move together. But then there are these periods where they were they widen. 

Before the Great Recession, the spread got pretty, pretty tight there, people were taking on riskier income-producing assets, real estate of all kinds, for very little return above the risk-free rate. And then I want to show you where we’re at today, interest rates have crashed, and the government is forcing interest rates down. They’re injecting a lot of capital into the market to keep it liquid. And so rates have gone way down, and cap rates have sort of stayed here, level. So what does that mean? Well, it means if you can find good assets that meet your return objectives, you’re going to get a higher return right now than you normally would. And from a trend perspective, Japan is a great example to look at they’ve had this low-interest-rate environment for a long time, myself and many others included, consider the US to be going through sort of a Japan ification time right now. What that means is, is that these rates thanks to trillions of dollars in the system and stimulus have to stay down. 

Simply put, the government can’t afford to let the rates go up against everything, including their own debt payments, get more expensive, so they’ll do what Japan’s done for decades, which is artificially keep rates down. This will punish you for saving your money, and it will reward you for investing it in riskier assets. At bam, we want to take as little risk as possible and get as much spread as we can. So if you follow this trend out, and you believe that interest rates are going to stay low, one other thing has to occur over time, these cap rates are going to go lower, as well. And remember, the cap rate goes down, the price of the real estate goes up. So right now we’re working very hard to get some deals in our pipeline. 

So that we can deploy equity, knowing that past the short term disruption to the market, our real estate is going to do one thing, it’s going to get more expensive as even more yield, excuse me, even more capital is going to chase this sort of yield, because capital wants yield. And there’s even more capital floating around sloshing around in the world today. So if you borrow some short-term problems, even midterms, it does take six months. If you look outside of that, and you look with your long term hat on as an investor, black and white, removal of fear, you can make a pretty, pretty strong argument about what’s going to happen to real estate and why it’s a really good time to put more money into income. Using assets so that you can achieve a spread from the risk-free rate to the cap rate, but good debt on it to get that spread higher. And then as we always do we look for value add deals, where we can reduce expenses, raise rents by making improvements. 

Use the residents to pay down our debt, so on and so forth to achieve those 18% return projections, as well as our target investor multiple with capital, two and a half x in five to seven years. If I got this more confusing for you, please give me a call. Let me know what you need more information on. Let me know by email text call or comment below. It’s a lot of guys to comment below. What I can define further for you and expand on is why this graph chart is so important and why it’s one of the premier charts in my laboratory as far as what I look at, in deciding when and where, and how to buy real estate. Thanks for watching. See you next time.