Since 2008, investors have been subject to extremely low interest rates, and, just as rates appeared to move upward, the coronavirus pandemic forced the U.S. Federal Reserve to cut rates to effectively zero.
The Bank of Canada followed suit and shaved its overnight interest rate to a never-before seen low of 0.25 per cent.
With the U.S. Federal Reserve indicating U.S. rates may remain close to zero per cent for the next three years, it is more than likely Canadian rates will also remain extremely low until 2023, since both sets of rates normally move in lockstep.
The possibility of a prolonged period of low interest rates has left income-oriented investors feeling anxious since traditional sources of stable income have basically dried up.
The dramatic rate cuts and the related bond rally to record-low yields begs the question: Where can investors find stable yield in a low-interest-rate environment?
Take a cue from pension plans
Investors should take their cue from pension plans, which in periods of prolonged low rates have moved into non-traditional assets, such as commercial real estate in order to generate a stable income stream even when interest rates are low.
Commercial real estate has been popular with pension funds in low-rate environments because they offer a good source of return when fixed income is underperforming and can generate modest positive rates of return in almost any environment.
Savvy investors understand that a diversified investment portfolio typically includes bond investments, but given chronic low interest rates, they may not be the most attractive option right now.
Commercial real estate investing can increase returns and counteract the effect of low interest rates that depress returns on fixed income securities.
Although most individual investors do not have the financial wherewithal to buy their own diversified portfolio of real estate properties, they can invest in real estate investment trusts (REITs).
REITs provide investors with indirect ownership in commercial real estate and offer both stable income distributions and the potential for capital appreciation.
REITs can offer higher returns for same risk
Because of the strong tax-efficient income stream provided by REITs, they are an important investment both for retirement savers and for retirees who require a continuing income stream to meet their living expenses.
REITs also offer attractive diversification in the current, low-interest-rate environment. Private Canadian REITs, in particular, have historically displayed low correlations to many of the traditional major asset classes, thereby providing investors with potentially valuable diversification benefits, improving the efficiency of their investment portfolio and increasing their risk-adjusted returns.
In other words, when portfolio investments are efficient, investors may achieve higher levels of return for the same level of risk. As well, using commercial real estate to diversify a portfolio may potentially generate more consistent returns.
Historically, income-producing commercial real estate has produced favourable relative and absolute total returns.
Over the past three decades, the four primary classes of Canadian commercial properties have yielded average annual returns ranging from 8.6 per cent to 10.6 per cent. All four classes have exceeded Canadian bonds.