It’s not often that bonds and stocks end up in the red in the same year, but that’s what happened in 2022 when rising interest rates sunk both asset classes.
As painful as that may have been for many investors, it reinforced the importance of owning a diversified portfolio – one that holds more than just equities and fixed income.
“You need assets that low correlation to the equity or fixed income markets,” says Geoff Lang, senior vice-president of business development at Equiton, a private real estate investing company that gives average investors access to funds that hold multi-residential properties. “That’s where private real estate can fit in.”
Lang says that private real estate investing, which falls under the alternative investment category, tends to have a different risk-return profile than stocks and bonds and is known to be less volatile than traditional markets. That’s especially true today.
“We’re seeing markets more and more correlated to one another,” he notes. “This is where alternatives can really play a significant factor in client portfolios to generate that absolute return profile.”
Reducing volatility through real estate
Equiton, which offers investors access to real estate funds, including the Apartment Fund (Equiton Residential Income Fund Trust) that holds multi-residential properties, and the Income and Development Fund (Equiton Real Estate Income and Development Fund) with a mix of income-producing assets and development projects, did well in 2022 because of the lack of correlation to stock and bond markets.
“We did just over 15 per cent in 2022 and the Fund went on to deliver 11.93 per cent in 2023,” Lang said about returns for the Equiton Residential Income Fund Trust (Class F-DRIP).
Saying that, real estate has certainly not been without its challenges over the last couple of years, with mortgage rates increasing and certain areas of the property market, such as office space, continuing to recover from the impacts of the COVID-19 pandemic. Private Canadian apartments, on the other hand, continued to demonstrate consistency through this economic turmoil.
Equiton, in particular, has done well because it makes a point of keeping volatility in check by locking into 10-year borrowing terms. This provides far more cost certainty than going with three- or five-year terms or variable-rate mortgages.
“We want to lock in our mortgage rate for a decade, so we know what our payments are going to be over that time frame,” says Lang. “That can help mitigate the risk of interest rate sensitivity.”
Currently, Equiton is paying, on average, three per cent interest on its properties, with a 6.5-year term-to-maturity. “We’ve locked in rates for a long period of time, so we’re well below market, and that’s how we chip away at that volatility,” he explains. “We take interest rates out of the picture, and so we’re then just focusing on generating monthly returns for investors.” The Apartment Fund is targeting an eight to 12 per cent return, net of fees.
It also helps that Equiton deals in apartment buildings, an area of real estate that’s increasingly in demand in Canada with strong population growth and the high cost of homeownership. Apartments also tend to be inflationary hedges, as rents often climb when prices jump.
“Apartments are a good inflationary hedge,” says Lang. “Equiton is constantly upgrading its properties by renovating units over time and even adding new units in underutilized space leading to increased rental income.”
As at Q2 2024, Equiton’s Apartment Fund has a revenue gap to market of 35.8 per cent, which means the average rent is 35.8 per cent below the current market in its geographic area. As it renovates more units, it can increase rental income and boost cash flow and value.
The company is also fairly conservative when it comes to buying properties.
“We’re not just going to spend money for the purpose of spending money–the price has to be right and each property goes through a thorough due diligence process,” he explains. “We see what the return metrics could be, look at what the capital expenditures are on that property and then make our assessment from there.”
Unlike stocks or traditional mutual funds, Equiton’s unit prices are updated once a month, rather than in real time or even daily. That helps take the emotional market swings out of investing. “It provides a level of stability and reliability that clients like,” says Lang.
Rising interest in alternatives
Over the last few years, Lang has noticed more investors adding alternatives to their portfolios, with some dividing their assets into 60 per cent stocks, 20 per cent bonds and 20 per cent alternatives.
“The traditional 60/40 equity fixed income model is no longer giving investors the returns they’re hoping for,” he says. “We’re trying to provide that income source with a little bit of upside, with stability and ballast to those equity and fixed-income segments of the market.”
However, the desire for alternatives, and real estate in particular, is only getting started, as geopolitical and economic events continue adding more volatility to the broader market.
“We want something that’s differentiated for a client portfolio, that fits in quite nicely with what they already have, that’s a stable asset class,” he says. “Our approach is straightforward and effective at Equiton. We acquire Canadian apartments, provide excellent care for our residents, and this ensures protection for our end investors through consistent monthly distributions.”