Real Estate Investments Paying 15%, 17% And More…

While the global stock markets gyrate with volatility, it is tempting to look at alternatives to traditional asset classes such as stocks to get safer returns. Government bonds and GIC’s are yielding in the 3% – 4.8% range. Alberta investors are inundated with marketing on various real estate investments backed by land or property with regular cash flows paying 11%, 12%, 15% and more. What’s the catch? and why can’t your financial advisor offer you the same investment?

I have had the opportunity to review many of the more aggressively marketed real estate investments in this market. Some may work out but many won’t. Here are things that can affect the underlying returns since many people say…”How can you lose investing in Alberta Real Estate?”

When companies market a particular opportunity, the assumed rate of return is based on a certain term such as 2 or 3 years. It may take a company 6 months to raise the capital required to get the project going. It may also take them longer to either complete the project if building and longer to sell the land or real estate upon completion. A 15% investment over 2 years becomes a 10% investment if it takes 3 years to complete.

The marketing materials of many offerings mention that they are real estate or land backed investments. This may be true. However, I have seen deals that are 100% financed or more. How do they get the money to pay the interest to you, marketing expenses and general overhead? Some projects need to increase in value by over 50% in two years to cover all of these costs. It may happen and again it may not. This does not take into account the possibility that real estate or land values may decline. As well, we hear everyday how infrastructure projects are coming in well over budget. The lastest Calgary hospital will cost over $1 billion to construct after an initial estimate of $600+ million. What happens if the deal you invested in has the same problem? It will affect the overall return.

These investments are offered to either accredited investors which in Alberta are people that have $1 million or more in investable assets or have $200,000 in income for two of the last three years or $300,000 as a couple. Alternatively, you are eligible if considered to be a friend, family , or business associate of one of the promoters which is how they can get around the accredited investor rule.

The second part of this discussion relates to why your financial advisor cannot sell these investments to you. Typicall, when you buy a new issue or a mutual fund, a simplified prospectus with the company history, financials, and details of the board of directors is provided and whether anyone in a board or executive position has been bankrupt or convicted of a crime.

Not one of these investments provides any of this disclosure to allow an advisor or the company they represent to do proper due diligence. As such, the advisor would be held legally responsible if something went wrong.

This summarizes why the investments being marketed are not guaranteed and provide insight into what can go wrong. Any comments on this article are more than welcome.

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Real Return Bonds – Protection Against Inflation

In my 20 years in the financial arena, an asset class that almost none of my clients heard about prior to engaging us is Real Return Bonds. As the media talks non-stop about inflation and how basic goods that we buy every week are up in price 44% year over year, I thought a brief course on Real Return Bonds 101 should be provided.

Real Return Bonds in Canada are issued by the Federal government or a provincial government. Unlike traditional bonds that have a fixed rate of retun, Real Return Bonds provide a rate that adjusts quarterly with the Consumer Price Index (CPI). Therefore, if you believe that inflation rates are going to go up, these bonds are a good buy as they pay a rate that is currently about 1.6% above inflation.

They have low correlation to the stock market and can be considered a great way to reduce the volatility in a portfolio. Traditional bonds usually dont do well in an inflationary environment since the rate is fixed and they become less atttractive when rates go up.

As such, you may want to consider a 10% weighting in this area. There are several ways to buy Real Retun Bonds. You can buy an individual holding such as the Government of Canada Real Return Bonds maturing between 2021 and 2041. Alternatively, a low cost way to get diverisifcation is to look at the Ishares Canadian Real Retun Bond Index ETF (XRB). An easy way to get international exposure to this asset class is to look at the Standard & Poors International Government Inflation Protected Bond ETF that trades on the American Exchange (WIP-A). Lastly, the TD Real Return Bond Fund, will give you an actively managed portfolio which can have US, Canadian, and International exposure with the choice of interest income re-invested or paid out regularly.

Any questions on these types of investments or comments relating to inflation are more than welcome.

A Repeat of Yesterday and Solar Power Gets into the Game

Financials advanced strongly while commodity plays got crushed.  CIBC closed up 5.27% and is up 30% from its lows just a week ago. Barrick Gold was down almost 8% on the day just to give you the magnitude of the change in investor sentiment.

Sector rotation seems to be taking shape as everyone gets on the bandwagon. Daily moves of this magnitude are hard to fathom and it makes me quite uncomfortable to see positive or negative swings like this as irrationality on both sides are taking place.

Investors who made money early in the year being over-exposed to oil, gas, and commodities are giving it back while those who hung on through the pain with their banks and financials are seeing their portfolios grow again. Very few have been able to call the trends perfectly which makes the case for fundamental indexing that I talked about previously quite attractive.

I had an opportuntity to listen to Kevin McLean on conference call today. Kevin is the portfolio manager of the Sentry Precious Metals Fund which has had excellent long-term returns. He is very bullish on gold and bullish on copper. Negative on almost all other base metals. He figures that there may be only one more opportunity to buy gold with an 8 at the front of the price before it begins its trajectory higher.

Which leads to my last comments of the day inspired by the University Solar Powered Car Race that started in Texas and ended at the University of Calgary yesterday which was won by the Univeristy of Michigan.

Xantrex Technology (XTX) announced it was in discussions to be bought although the buyer and price are unknown.  Xantrex is a leading developer, manufacturer and marketer of advanced power electronic products. The company is focused on the fastest growing segments of the power electronics market – renewable, programmable, portable and mobile power.

The stock is cheap in the space that it is in. It closed at $12.61 today, up almost 19%. National Bank has a $14.00 target on it but could reach $19.00 if priced at the same multiple as some of its competitiors. Many of you are probably thinking that it is a great place to invest going forward. While P/E ratios are high for the industry at about 40, they are trading at about 22 times this years estimate and 15 times next years estimates which are not unreasonable.

 

What are your thoughts? Will Solar power take over from oil and traditional electricity? Your comments are more than welcome.

Financials Save The Day…Who Would Have Thought?

When the markets closed yesterday, Apple and American Express both announced disappointing earnings. Apple’s shares were down 11% and Amex was down 4.5% in after market trading. European markets sold off on the news. I went to work this morning expecting a real ugly day and it started off that way.

Low and behold the Dow Jones was up 1.2% and the TSX was down marginally with our major banks reversing early losses with upward movements between 2% – 4%. Looking at some of the US financials, they are up 50% from their lows just a week ago.

Sub-prime loan losses seem to be stabilizing although there is still weakness in home loans guaranteed by Fannie Mae and Freddie Mac.

The guys shorting financial stocks have been getting killed over the last few days and the pain of holding on. Oil stocks have been getting hurt as well as demand has been dropping. You can read my posts of last week on short covering of financials and “Buying Oil can be bad for your Health” as those themes continue into this week.

Dennis Gartman, who publishes The Gartman Letter and is followed by analysts and portfolio managers around the world is increasing his exposure to US stocks highly correlated to the index and is shorting oil with the belief that oil prices will continue their downward trend over the short-term.

Even some of the preferred shares I mentioned last week are up about 10% in just a few days as 7.25% bank backed investments are too attractive to ignore. What’s next?

I haven’t mentioned REIT’s. The acronym stands for Real Estate Investment Trusts. I dont follow US or Global REIT’s so my comments pertain to Canadian REITs. As an individual investor, it can be hard to diversify Real Estate holdings. By investing in a REIT, you get broad diversification in a portfolio of holdings, monthly distributions and preferrential tax treatment. REIT’s have been trading well below their highs of a year ago. Most are trading well below their net asset value with sustainable distributions in the 7% – 11% range. Top tier names include Riocan, Primaris, and Boardwalk. Expect some smaller names to be taken over in the next 12 months as this sector moves back in favour. The beauty of REIT’s as well is that you have complete liquidity with the ability to buy and sell a real estate portfolio in the open market on a daily basis.

 

What are your thoughts? Do you think REIT’s have upward potential in the coming months?

All I want is 10% Guaranteed!!!

With the markets as volatile as ever, it can be difficult to stomach the ups and downs as you try and have  a portfolio generate enough income or growth to last a lifetime. I know of many clients who talk about the days when they could get 19% on Canada Savings Bonds, 20% or more on Term Deposits, and those lucky few who annuitized and locked in 16% for life.

Of course inflation was running rampant in double digits and with higher tax rates, you were lucky to break even. Over the last year, while the Fed and the Bank of Canada have lowered rates to stimulate the economy and try and avoid recession, rates on corporate debt and preferred shares have gone up significantly. The spreads between bank debt and government debt are the widest they have been in over 20 years.

You could argue that Canadian banks are going to collapse so the risk of investing in a bank guaranteed bond or preferred share is too high. Looking at things objectively, the likelihood of one of our banks going bankrupt and the common share price going to zero are remote.

If you are on the same page as me and believe that a bank failure in Canada is not likely, there is an interesting opportuntiy that awaits. Preferred shares issued by corporations in Canada are eligible for something called the dividend tax credit. Because Canadian corporations have already paid tax on their earnings, the dividends that flow through to individual investors are subject to a reduced level of tax.

As I look at my stock screen today, I see that CIBC and Laurentian Bank have perpetual Preferred shares currently yielding approximately 7.25% per annum with the dividends paid quarterly. So, how do I come up with 10% when they are paying 7.25%. Interest earned on GIC’s is fully taxable. The preferrential tax treatment on dividends and preferred shares equates to just under 10% for a Canadian in the highest marginal tax bracket on an interest equivalent basis.

Some would argue that there are further write downs to come and that interest rates in Canada are going to rise since inflation is going up. I would agree that government bond rates will probably rise over the next 12 months. Nobody knows how much, but, I would argue that while government rates go up, the spread between government and corporate bonds could fall which means that you wont be able to get 8%, 9% or 10% on these preferred shares next year and that this deal will look like the annuity that we should have locked in at 16% for the rest of our lives.

What are your thoughts on interest rates and corporate debt? Your opinions are more than welcome.

Financials Rally…Are the shorts being squeezed?

Wells Fargo beat street estimates on their earnings announcement leading to a huge rally in financial stocks.  US financials were up somewhere between 10% – 20% at midday. The average investor is probably asking how the earnings of one company can lead to these types of gains for a whole sector in just one day.

While Wells Fargo had something to do with todays gains, there is probably another large factor at play today. Some financials have been beaten down to the tune of 90% – 95%  of their 52 week highs. Do they deserve to lose all of their value? Perhaps. What I do know is that most hedge funds have made alot of their money in the last year shorting financial stocks and reaping the gains as their prices continued to fall.

What is scaring the short sellers is an announcement by the SEC that would make the naked short selling of Fannie Mae and Freddie Mac illegal. Short selling entails borrowing stock that you sell today with the hope that the stock drops later on at which point you buy it back at a lower price and pocket the difference.

With naked short selling, there are no shares being borrowed which can lead to much lower share prices than normal as there can be more shares being shorted than shares actually issued by the corporation.

The announcement yesterday by the SEC is probably leading some short sellers to cover their positions as naked short selling is illegal regardless of the stock and the announcement is giving short sellers warning that the SEC is going to enforce laws already in place.

The other aspect to this which can be read in many other commentaries today relates to something called “The Uptick Rule”. This rule was removed not long ago which basically only allowed a short sale to take place on a stock after the stock ticked up in price. This rule once removed has allowed short sellers to drive a stock lower with abandon. Discussion is taking place to re-implement the uptick rule which should shore up stock prices as well.

What are your thoughts? Do you think financial have hit bottom or is this just a short term rebound?