T-Bills: Guaranteed Returns?
I met with a potential client recently that wanted a guaranteed return 100% sheltered from State and Federal Taxes. I told him that in commercial real estate we create proformas reflecting current operations, and projections with potential results, but there are no guarantees. He was disappointed that I couldn’t duplicate the guaranteed return he was getting on his 10-year US Treasury Bonds.
I told him I refused to do that poor of job and he asked what I meant.
The simple truth is that if you invest $1,000,000 in 10-year US T-Bills paying 1.6% for one year you will earn $16,000 in interest. The good news is that interest is exempt from State and Federal Taxes. The bad news is that due to inflation af 2.5% a year you will have a net loss in buying power of $9,000 after tax. In short you have a guaranteed return that is a loss. (Inflation data supplied by The US Dept. of Labor-Bureau of Statistics, Western Information Office.)
There are no investor of the year awards for minimizing losses…we want gains…so if the only guaranteed return is a loss…where should you go?
The Stock Market?
Investors loathe losing money…particularly if they are guaranteed a loss. Certainly there are no guarantees on securities and no sheltering from Fed and State Taxes, but returns over the past 3-1/2 years have been stellar. The recent bottom of the market occurred the week of March 2, 2009 when the DJIA hit 6626.94. The market is now hovering at 13,000, almost doubling in just 40 months. I used to have an employee named Mark Dean who fancied himself quite the horse-racing tout. Mark used to say: “Rick…there are fast running horses and there are long running horses, but God didn’t make any fast + long running horses”. If Mark’s metaphor is applied to investing it would suggest that markets that double in a few years may be overdue for a correction at worst, or a dramatic slow down in their growth at best.
I’m not only concerned about a possible correction, but how safe should you feel if your equity is invested in a market that can lose a trillion dollars in less than an hour? At about 2:45 PM on May 6, 2010 the bottom dropped out of the DJIA and 1 Trillion Dollars in value was lost in about 18 minutes. Some folks refer to it as “The Flash Crash”…I think of it as more than a little scary. I shared my concerns with a “stocks only” investor and he said: “It was a mistake. It corrected itself shortly…these things happen.” A mistake is when you forget to hold the bell peppers on a pizza. A mistake is when you err and use “there” instead of “their” in a letter. Mistakes shouldn’t, involve a billion dollars…much less a trillion bucks.
Investing in mutual funds or indexed funds may mitigate risk to a degree…that insulates some from the impact of a single company or even market segment performing poorly, but it doesn’t ameliorate risk from a market turndown/correction.
Investment Real Estate
I’ve worked on a series of deals with investors recently with varied returns matched to their risk strategy:
- I represented one cash poor developer that relied on owner financing to acquire an 18,000 sf commercial property in an up and coming area. Their intent is to re-purpose the property. Comparing their cash contribution to their profit potential produced an incredible Internal Rate of Return of over 50% per year. They feel that investing in an up-trending neighborhood increases their chances of success…but they are aware that their risks and rewards are both quite high.
- I represented a cash rich institutional investor in acquiring a 26,000 sf medical office building. This was an “all cash” transaction. The closing price negotiated was a 9.72 Cap on existing income and expenses. There was a 20% vacancy factor…so any new tenants are part of the upside strategy. At the end of the day this has very low risk and a nice Internal Rate of Return.
I use these two examples to demonstrate how acquisition strategy impacts risk and returns. Some of the projects I’m working on favor stability of monthly cashflow and low risk over long term appreciation. Projected Internal Rates of Return vary from 8% to over 50%. While I can’t guarantee total sheltering of profits from State and Federal Taxes, the use of Cost Seg, and 1031 Exchanges significanlty reduces overal tax liabilities. Managing your property tax liability helps too! There is some degree of risk in investing in commercial real estate…but my clients prefer that to the guaranteed loss from T-Bills!
To learn more about moving from a guaranteed loss to a possible gain, contact Rose City Commercial Real Estate at: rick@rosecitycre.com or: 503.577.1034.
Other articles you may like:
Multifamily real estate investment basics – part 1 of a series | Rose City Commercial Real Estate