All the chatter today is, of course, about the Fed and whether it will or won't raise rates this month. My bet is they will not, but my record as a forecaster is almost as well known as it is horrible. I suspect Fed Chair Janet Yellen and her cohort of central bankers are sitting around in a manner not unlike the Corleone family when it was waiting to hear if the Don would survive. In the Fed's case, though, it's a matter of waiting for Friday's jobs report. If that report is strong, it clears the way for the rate hike the Fed really wants to execute. If it is a less-than-wonderful number, then it is back to the waiting game.
While I don't know what the Fed will do at its meeting this month, I do know that the minutes have contained lower-for-longer language for some time, and I do not see that changing soon. The U.S. economy is only strong relative to the rest of the world; in real terms we remain better but not really good. We are not going to see a growth spurt that brings rates back up to the point that traditional fixed-income investments provide an adequate return for yield-hungry investors. It will continue to be a challenge to find attractively priced investments to meet your income needs.
One answer is going to be commercial real estate-related investments. Cushman & Wakefield just released its August macro outlook for the U.S. economy, lowering its growth forecasts for both GDP and jobs. Despite that, the firm's global chief economist, Keven Thorpe, noted that while commercial real estate returns are moving lower, they remain attractive compared to other asset classes. He concluded his report by saying, "Commercial real estate markets have fared well: vacancy rates are falling, rent growth is positive and, for some asset classes, reaching a cyclical peak, and leasing velocity remains healthy. Capital markets activity will see unique pressures from impending regulations, but the slowdown in sales volume and pricing is in line with a broader return to a more sustainable investment environment."
While that doesn't make me want to run out and buy a bunch of office buildings and apartment complexes, it does make me pretty comfortable with the idea of originating and owning a bunch of commercial real estate (CRE) loans. That seems like an attractive way to earn an above-average rate of return in a yield-starved world. Owning CRE-oriented real estate investment trusts (REITs) with strong sponsors has been working for me the past few years, and I think it will continue to do so for the foreseeable future -- no matter what the Fed does.
Sponsorship is the key. That's why Apollo Commercial Real Estate Finance (ARI) has long been a favorite. This REIT is managed by a subsidiary of Apollo Global Management (APO) , one of the world's largest private equity and alternative investment firms. Its founders started in the M&A department at Drexel Burnham Lambert during the heyday of Michael Milken, so they know a thing or two about credit and lending. The REIT is trading at 83% of book value now, and the shares yield 11.29%.
Apollo Commercial originates, invests in, acquires and manages performing commercial first-mortgage loans, subordinate financings, commercial mortgage-backed securities and other commercial real estate-related debt investments. The affiliation with Apollo Global puts Apollo Commercial in a first-call relationship with real estate owners and operators, senior lenders and brokers that allows the REIT to pick the deals it likes at the price it likes. That's a huge advantage over competitors.
Likewise, consider Ares Commercial Real Estate (ACRE) , a similar commercial real estate financing REIT that I think can be bought around current levels and held for a long time to generate high income. It also originates, manages and service a portfolio of commercial real estate debt-related investments. The REIT is affiliated with Ares Management (ARES) , an alternative asset manager that specializes in credit, private equity and real estate. ACRE is trading at 88% of book value now, and the shares yield 8.27%.
Commercial real estate markets may slow down in the weeks and months ahead, but I do not see any pricing collapse or steep declines in rental rates or occupancy rates anytime soon. While buildings in New York and San Francisco look a little pricey at the moment, I am pretty comfortable owning a portfolio of CRE loans and selectively making new ones on specific projects right now. These two REITs give income investors a chance to be in the CRE finance business with partners who have proven they know how to make money in the field.