Designed to provide broad exposure to the Financials – Insurance segment of the equity market, the Invesco KBW Property & Casualty Insurance ETF (KBWP – Free Report) is a passively managed exchange traded fund launched on 12/02/2010.
An increasingly popular option among retail and institutional investors, passively managed ETFs offer low costs, transparency, flexibility, and tax efficiency; they are also excellent vehicles for long term investors.
Additionally, sector ETFs offer convenient ways to gain low risk and diversified exposure to a broad group of companies in particular sectors. Financials – Insurance is one of the 16 broad Zacks sectors within the Zacks Industry classification. It is currently ranked 1, placing it in top 6%.
Index Details
The fund is sponsored by Invesco. It has amassed assets over $334.59 million, making it one of the average sized ETFs attempting to match the performance of the Financials – Insurance segment of the equity market. KBWP seeks to match the performance of the KBW Nasdaq Property & Casualty Index before fees and expenses.
The KBW Nasdaq Property & Casualty Index is a modified market capitalization weighted index that reflects the performance of approximately 24 property and casualty insurance companies.
Costs
Cost is an important factor in selecting the right ETF, and cheaper funds can significantly outperform their more expensive counterparts if all other fundamentals are the same.
Annual operating expenses for this ETF are 0.35%, making it one of the cheaper products in the space.
It has a 12-month trailing dividend yield of 2.45%.
Sector Exposure and Top Holdings
ETFs offer a diversified exposure and thus minimize single stock risk but it is still important to delve into a fund’s holdings before investing. Most ETFs are very transparent products and many disclose their holdings on a daily basis.
This ETF has heaviest allocation in the Financials sector–about 100% of the portfolio.
Looking at individual holdings, Progressive Corp/the (PGR – Free Report) accounts for about 9.23% of total assets, followed by Chubb Ltd (CB – Free Report) and American International Group Inc (AIG – Free Report) .
The top 10 holdings account for about 61.93% of total assets under management.
Performance and Risk
Year-to-date, the Invesco KBW Property & Casualty Insurance ETF has added roughly 12.50% so far, and was up about 13.09% over the last 12 months (as of 11/28/2022). KBWP has traded between $72.63 and $88.41 in this past 52-week period.
The ETF has a beta of 0.67 and standard deviation of 28.90% for the trailing three-year period, making it a medium risk choice in the space. With about 25 holdings, it has more concentrated exposure than peers.
Alternatives
Invesco KBW Property & Casualty Insurance ETF holds a Zacks ETF Rank of 1 (Strong Buy), which is based on expected asset class return, expense ratio, and momentum, among other factors. Because of this, KBWP is an outstanding option for investors seeking exposure to the Financials ETFs segment of the market. There are other additional ETFs in the space that investors could consider as well.
IShares U.S. Insurance ETF (IAK – Free Report) tracks Dow Jones U.S. Select Insurance Index and the SPDR S&P Insurance ETF (KIE – Free Report) tracks S&P Insurance Select Industry Index. IShares U.S. Insurance ETF has $539.01 million in assets, SPDR S&P Insurance ETF has $595.30 million. IAK has an expense ratio of 0.39% and KIE charges 0.35%.
Bottom Line
To learn more about this product and other ETFs, screen for products that match your investment objectives and read articles on latest developments in the ETF investing universe, please visit Zacks ETF Center.
Should you be considering a commercial investment rather than residential when buying property? Photo / Supplied
The default setting for investing in the property market usually involves a residential rental property.
This normally means having someone pay a weekly rental to live in a home that you own – an approach used by many New Zealanders to pay off the mortgage on a second home.
However, there is an alternative that isn’t used quite as often and this involves purchasing a property that’s used for commercial purposes.
Speaking to Paula Bennett on her Ask Me Anything podcast, Bayleys head of insights, data and consulting, Chris Farhi says investors are often more likely to go the residential route because this process is far more familiar to them.
“There are pros and cons for both commercial and residential investment.
“With residential, there are always going to be tenants in New Zealand because the rental market is so strong.
“However, with commercial property you’re typically dealing with lower-maintenance tenants. You typically have a lot of service providers in place to deal with things like light bulb fails or those sorts of issues. Also, because you’re dealing with a business, you don’t have some of the issues that you might have with people living there.”
This isn’t to say that commercial property investment is always a good idea.
Farhi says prospective investors need to take a number of factors into account before signing on the dotted line of a commercial property deal.
“If you’re dealing with retail, as an example, you have to be quite selective about the location and style of building that you’re dealing with because an extremely well-located retail property will probably always be able to get tenants.”
Factors like the availability of parking, the presence of other tenants on the block and the quality of the business occupying the property should all be taken into consideration when it comes to a commercial property deal.
“If you get a good retail property, you’ve got a stronger chance it will be consistently occupied,” Farhi says.
“[You need to avoid] those ghost areas, where in some townships where maybe over time traffic patterns or the pattern for the major anchor tenants have moved away. This can create a higher risk of hitting vacancies, which can become a problem if you need money to pay the mortgage.”
Farhi adds there is a need to be conscious of the quality of the tenant occupying the space in a commercial property as well as the length of their lease.
“When you get into the commercial space, it is much more negotiated. There are very few safety nets – and so, if you’re looking to pick up an investment, you need to be a bit smarter about the tenant and the lease contract that they’ve got.”
This includes the length of the lease, the conditions applicable and also whether there’s provision to allow for the rent to be increased in line with inflation.
“Generally a longer term will be better. And you also want to consider the quality of the business in terms of its brand and performance.”
Farhi says that well-established brands with a long track record of commercial success generally make better tenants because there is a lower risk that they’ll fall over, necessitating the need to find another tenant.
Whether investors decide to go residential or commercial, Farhi’s recommendation is that due diligence is always key.
Listen to the full Ask Me Anything podcast for an in-depth discussion on the ins and outs of the property business.
• Ask Me Anything is a NZ Herald podcast, hosted by Paula Bennett. New episodes are out every Sunday.
• You can follow the podcast at iHeartRadio, Apple Podcasts, Spotify, or wherever you get your podcasts.
Higher interest rates will benefit the Zacks Investment Management industry stocks, which bore the brunt of low rates during the pandemic. While elevated technology costs might hurt profitability, investment managers’ margins will no longer be under pressure given the rate hikes. This should aid revenue growth.
Moreover, investment managers have benefited from higher volatility and client activity amid the pandemic. Although markets normalized in second-half 2021, client activity has gained momentum once again. Hence, BlackRock, Inc. (BLK – Free Report) , Ameriprise Financial, Inc. (AMP – Free Report) , Affiliated Managers Group, Inc. (AMG – Free Report) and Prospect Capital Corporation (PSEC – Free Report) should benefit from growth in assets under management (AUM).
About the Industry
The Zacks Investment Management industry consists of companies that manage securities and funds for clients to meet specified investment goals. They earn by charging service fees or commissions. Investment managers are also called asset managers, as they manage hedge funds, mutual funds, private equity, venture capital and other financial investments for third parties. By appointing an investment manager for one’s assets, investors get more diversification options than they would have if they managed their assets by themselves. Investment managers invest their clients’ assets in different asset classes, depending on their needs and risk-taking abilities. Hence, the diversification, which investors get by appointing asset managers to manage their assets, helps reduce the impact of volatility and ensures steady returns over time.
3 Investment Management Industry Trends to Consider
Interest Rate Hikes to Aid Margin Growth Despite Shift in Preferences: Similar to the past few years, demand for passive investing has been on the rise on the continued need for low-cost investment strategies. Thus, rising demand for passive investments is expected to negatively impact investment managers’ margin growth to some extent. Nevertheless, the interest rate hikes since the beginning of this year to tame the raging inflation will likely result in an improvement in margins in the near term. Also, the rise in industry consolidation witnessed since the beginning of 2020 is likely to support bottom-line growth.
Growth in AUM Likely to Continue Despite a Volatile Trend in Asset Flows: In 2020 and the first half of 2021, there was a significant rise in equity market volatility and solid client activity, owing to the coronavirus-induced uncertainty, which aided total AUM growth. In the second half of 2021, markets began to normalize, with client activity remaining decent. Nevertheless, the first nine months of 2022 again witnessed an unexpected rise in volatility and relatively higher client activity, resulting in asset inflows for the majority of the industry players. Thus, despite a volatile trend in flows (seen recently), growth in AUM is expected to continue in the near term. Asset managers’ top lines are, therefore, expected to improve, supported by higher performance fees and investment advisory fees, which constitute the majority of their revenues.
Elevated Costs Remain Concerning: The tightening of regulations to increase transparency has led to a rise in compliance costs for investment managers. Also, as wealth managers are constantly trying to upgrade technology to keep up with evolving customer needs, technology costs are expected to keep rising. These will likely lead to an increase in overall expenses, thus, hurting investment managers’ bottom line.
Zacks Industry Rank Indicates Bright Prospects
The Zacks Investment Management industry is a 44-stock group within the broader Zacks Finance sector. The industry currently carries a Zacks Industry Rank #89, which places it at the top 35% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is the average of the Zacks Rank of all the member stocks, indicates outperformance in the near term. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of bright earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts have just started gaining confidence in this group’s bottom-line growth potential. The industry’s current-year earnings estimates have been revised 1.3% higher since the end of October 2022.
Thus, we present a few stocks from the prospering industry that you may want to keep an eye on. But before that, let’s check out the industry’s recent stock market performance and valuation picture.
Industry Lags S&P 500 & Sector
The Zacks Investment Management industry has underperformed both the S&P 500 and its sector in the past two years.
Stocks in the industry have collectively lost 2.4%. The S&P 500 composite has rallied 9.6% and the Zacks Finance Sector has appreciated 12.2%.
Two-Year Price Performance
Industry’s Current Valuation
One might get a good sense of the industry’s relative valuation by looking at its price-to-tangible book ratio (P/TB), which is commonly used for valuing finance companies because of large variations in their earnings results from one quarter to the next.
The industry currently has a trailing 12-month P/TB of 3.90X. This compares with the highest level of 5.27X, the lowest level of 2.04X and the median of 3.59X over the past five years. Additionally, the industry is trading at a significant discount compared with the market at large, as the trailing 12-month P/TB for the S&P 500 composite is 10.30X, which the chart below shows.
Price-to-Tangible Book Ratio (TTM)
As finance stocks typically have a low P/TB ratio, comparing investment managers with the S&P 500 may not make sense to many investors. But a comparison of the group’s P/TB ratio with that of its broader sector seems more meaningful. When we compare the group’s P/TB ratio with the broader Finance sector, it seems that the group is trading at a decent discount. The Zacks Finance sector’s trailing 12-month P/TB of 4.69X for the same period is above the Zacks Investment Management industry’s ratio, which the chart below shows.
Price-to-Tangible Book Ratio (TTM)
4 Investment Management Stocks to Keep an Eye On
BlackRock: The New York, NY-based Zacks Ranked #3 (Hold) company is the largest asset manager by assets in the United States, with a market capitalization of $110.6 billion. The company’s diversified products, revenue mix and inorganic expansion efforts have been aiding AUM growth. As of Sep 30, 2022, BlackRock had total AUM worth $7.96 trillion.
The company’s AUM has witnessed a seven-year (2015-2021) compound annual growth rate (CAGR) of 13.6%. While its AUM balance declined in the first nine months of 2022 due to the tough operating backdrop amid the macroeconomic concerns, the trend will likely reverse in the future.
The company has been continuously strengthening its iShares and exchange-traded funds (ETF) operations. Its efforts to gain market share in the active equity business will likely keep aiding profitability.
Supported by a solid balance sheet and liquidity position, BlackRock has expanded via acquisitions, both domestic and overseas. In June 2021, it acquired the Climate Change Scenario Model of Baringa Partners. In February 2021, it completed the acquisition of investment management services provider, Aperio Group. Apart from these, over the years, the company has acquired several firms across the globe, thus, expanding its footprint and market share.
Moreover, in August 2022, BlackRock partnered with cryptocurrency exchange, Coinbase Global, to provide its institutional clients with access to digital currencies. Through the partnership, BlackRock’s institutional clients will have access to crypto trading, custody, prime brokerage, and reporting via Coinbase Prime, which is the exchange’s institutional platform, providing a wide range of features and tools.
In the past three months, shares of BlackRock have gained 8.8%. Over the past 30 days, the Zacks Consensus Estimate for the company’s 2022 earnings has been revised marginally upward to $33.88 per share, whereas its 2023 earnings estimates have witnessed a downward revision of 1% to $34.08.
Price and Consensus: BLK
Ameriprise: Headquartered in Minneapolis, MN, Ameriprise has a market cap of $35.4 billion. Since 2005-end, the company has been operating independently of American Express Company. As of Sep 30, 2022, it owned, managed and administered assets worth $1.1 trillion.
Ameriprise operates a well-diversified portfolio compared with its industry peers. It constantly modifies its product and service-offering capacity to keep pace with dynamic market needs. This strategy, along with asset growth, has helped the company witness a rise in total net revenues.
Moreover, AMP has grown inorganically and restructured its business from time to time to remain profitable by focusing on its core operations. In November 2021, the company acquired BMO Financial Group’s EMEA asset management operations, which will bolster its wealth and asset management businesses and global diversification efforts. In July 2021, it closed a deal for RiverSource Life Insurance Company (its insurance subsidiary) with Global Atlantic’s subsidiary, Commonwealth Annuity and Life Insurance Company, to reinsure $7 billion of fixed deferred and immediate annuity policies.
In 2019, it divested the Ameriprise Auto & Home business. These initiatives, along with a few others, are expected to continue supporting revenue growth. Notably, AMP maintains long-term issuer ratings of A- from S&P Global and Fitch, and A3 from Moody’s Investors Service, with a rating outlook of stable from all three agencies. The company currently carries a Zacks Rank #2 (Buy).
AMP’s shares have gained 21% over the past three months. Over the past 30 days, the Zacks Consensus Estimate for its 2022 earnings has been revised upward by 3% to $24.56 per share. Likewise, earnings estimates for 2023 have been revised upward by 2.1% to $29.09.
Price and Consensus: AMP
Affiliated Managers: Headquartered in Massachusetts, Affiliated Managers has equity investments in a large group of investment management firms or affiliates. The affiliates manage more than 500 investment products across each major product category — global, international and emerging markets equities, domestic equities, and alternative and fixed-income products. The company has a market cap of $5.9 billion.
As of Sep 30, 2022, this Zacks Ranked #3 company had total AUM of $644.6 billion. AMG is expected to continue generating meaningful growth through new investments. Its successful partnerships and focus on strengthening the retail market operations will likely keep aiding profits.
Affiliated Managers has been targeting investments in alternatives and global strategies, given the strong investor preference for the same. The acquisitions of the majority stakes in Parnassus Investments and Abacus Capital Group, along with the buyouts of minority stakes in OCP Asia, Boston Common Asset Management and Systematica, are steps in this direction.
While Affiliated Managers’ affiliates have been witnessing overall net outflows over the past few years, the company’s differentiated product categories are likely to support cash flows across channels.
AMG has appreciated 20.1% over the past three months. The Zacks Consensus Estimate for its 2022 earnings has been revised upward by 7.5% to $19.53 per share over the past 30 days. Likewise, earnings estimates for 2023 have been revised upward by 5.2% to $19.48.
Price and Consensus: AMG
Prospect Capital: Headquartered in New York, NY, PSEC has a market cap of $3.1 billion. The company is a leading provider of private debt and private equity to middle-market companies in the United States, with a focus on sponsor-backed transactions and direct lending to established owner-operated companies. It currently sports a Zacks Rank #1.
PSEC invests primarily in first-lien and second-lien senior loans and mezzanine debt, which in some cases include an equity component. Since its inception in 2004, Prospect Capital has invested $19.6 billion across 403 investments, exiting 274 of these investments.
As of Sep 30, 2022, the company had investments in 128 long-term portfolio investments and CLOs, which had a fair value of $7.58 million.
Over the last three fiscal years (ended June 2022), the company’s total investment income witnessed a CAGR of 6.8%. The upward trend continued in the Sep-end quarter.
Given a solid balance sheet and liquidity position, the company is expected to enhance shareholder value through efficient capital deployment activities. On Aug 24, 2011, its board of directors approved a share repurchase plan to buy back shares worth up to $0.1 million. As of Sep 30, 2022, $65,860 worth of shares were available for repurchase under the authorization.
PSEC’s shares have lost 0.2% over the past three months. Over the past 30 days, the Zacks Consensus Estimate for its current fiscal year earnings has been revised 5.2% upward to $1.01 per share. Likewise, earnings estimates for the next fiscal year have been revised 8.3% upward to $1.04.
Price and Consensus: PSEC
A downtrend has been apparent in Atlas Technical Consultants, Inc. (ATCX – Free Report) lately. While the stock has lost 10.9% over the past week, it could witness a trend reversal as a hammer chart pattern was formed in its last trading session. This could mean that the bulls have been able to counteract the bears to help the stock find support.
While the formation of a hammer pattern is a technical indication of nearing a bottom with potential exhaustion of selling pressure, rising optimism among Wall Street analysts about the future earnings of this company is a solid fundamental factor that enhances the prospects of a trend reversal for the stock.
Understanding Hammer Chart and the Technique to Trade It
This is one of the popular price patterns in candlestick charting. A minor difference between the opening and closing prices forms a small candle body, and a higher difference between the low of the day and the open or close forms a long lower wick (or vertical line). The length of the lower wick being at least twice the length of the real body, the candle resembles a ‘hammer.’
In simple terms, during a downtrend, with bears having absolute control, a stock usually opens lower compared to the previous day’s close, and again closes lower. On the day the hammer pattern is formed, maintaining the downtrend, the stock makes a new low. However, after eventually finding support at the low of the day, some amount of buying interest emerges, pushing the stock up to close the session near or slightly above its opening price.
When it occurs at the bottom of a downtrend, this pattern signals that the bears might have lost control over the price. And, the success of bulls in stopping the price from falling further indicates a potential trend reversal.
Hammer candles can occur on any timeframe — such as one-minute, daily, weekly — and are utilized by both short-term as well as long-term investors.
Like every technical indicator, the hammer chart pattern has its limitations. Particularly, as the strength of a hammer depends on its placement on the chart, it should always be used in conjunction with other bullish indicators.
Here’s What Makes the Trend Reversal More Likely for ATCX
There has been an upward trend in earnings estimate revisions for ATCX lately, which can certainly be considered a bullish indicator on the fundamental side. That’s because a positive trend in earnings estimate revisions usually translates into price appreciation in the near term.
The consensus EPS estimate for the current year has increased 53.9% over the last 30 days. This means that the Wall Street analysts covering ATCX are majorly in agreement about the company’s potential to report better earnings than what they predicted earlier.
If this is not enough, you should note that ATCX currently has a Zacks Rank #2 (Buy), which means it is in the top 20% of more than the 4,000 stocks that we rank based on trends in earnings estimate revisions and EPS surprises. And stocks carrying a Zacks Rank #1 or 2 usually outperform the market. You can see the complete list of today’s Zacks Rank #1 (Strong Buy) stocks here >>>>
Moreover, the Zacks Rank has proven to be an excellent timing indicator, helping investors identify precisely when a company’s prospects are beginning to improve. So, for the shares of Atlas Technical Consultants, Inc. a Zacks Rank of 2 is a more conclusive fundamental indication of a potential turnaround.
Environmental, Social and Governance (ESG) criteria continue to be at the forefront of ETF issuers’ minds. I’ve written before about funds claiming to be ESG funds that actually are ESG, and funds that are anti-ESG. This piece will take a look at the latest ESG offering from Blackrock/iShares that focuses on real estate.
The iShares Environmentally Aware Real Estate ETF (ERET) was launched last Tuesday, Nov. 15, and sports a 30-basis-point expense ratio, meaning that a shareholder with $1,000 invested over a calendar year would pay $30 in fees over that period. The fund is passively managed and tracks the FTSE EPRA Nareit Developed Green Target Index.
As with any passive ETF, the fact sheets and prospectus are good resources to get a feel for what the fund strategy is. However, if you really want to get into the weeds and learn about security selection criteria, weighting methodologies and other data-handling approaches, the best place to go is the index methodology, so let’s start there.
The index
You may be familiar with the National Association of Real Estate Investment Trusts (NAREIT), but if not, it bills itself as “the worldwide representative voice for REITs and real estate companies with an interest in U.S. real estate.” The group has been around since the 1960s and acts as a keeper of REIT data as well as a proponent of the real estate industry and real estate investors with regulators and legislators in Washington, D.C. The group has a longstanding relationship with index provider FTSE (Footsie) Russell in publishing a number of globally focused real estate indexes. Also included in this real estate index effort is the European Real Estate Association (EPRA).
The FTSE EPRA Nareit Developed Green Target Index uses the non-Green Target version of the index as its starting universe, namely the FTSE EPRA Nareit Developed Index. According to the Green Target methodology, analysts source data from GeoPhy to determine what I’ll call the “greenness” of a company as well as to make assessments of the energy demands and carbon emissions of a company’s portfolio of properties. In looking at GeoPhy it should be noted that unlike firms such as Sustainalytics, GeoPhy is not an ESG-focused data provider but a property valuation company that focuses on providing valuations for commercial and multifamily properties from what I can tell in reviewing its website.
Part of what this means is that it is not making any determinations as to the quality of a company’s portfolio of properties. It is just passing on the self-reported Leadership in Energy and Environmental Design (LEED) property certifications and energy use and carbon emission figures from reporting properties.
The suitability of a real estate company is determined by FTSE and is achieved by splitting up the global bucket of potential constituents into regions and generating metrics within each region. If you can reach back to the last statistics course you took, the Z-Score metric is doing all the heavy lifting here. Another thing I noticed in the methodology is that in the event a company does not report Green Certification (Leed), it is given a Z-Score of -3. However, if LEED certification is not widely used in a region, then the company is assumed to be an “average” company and is given a Z-Score of 0. Also, companies that end up with an energy usage Z-Score greater than plus or minus 3 will have their score set at a maximum 3 (+/-), and the entire data set is re-ranked using these new limits.
Weights initially are set using market capitalization but then adjusted to reflect the various green certification, energy and carbon scores.
Wrapping it up
Regular readers know I’m sometimes tough on issuers claiming ESG bona fides. There are some things I like about this strategy, but instead of relying on the power of statistics to smooth, blend and otherwise homogenate the underlying data, I rather would have seen some bright lines when it comes to selection criteria.
For example, why not just use a LEED certification threshold that states eligible constituents must have at least 80% of their properties rated Silver or better? I have a feeling the reason why is that the resulting portfolio would end up being fairly small, which would lead to portfolio liquidity and other issues. I’m interested to see what kind of difference these additional screens will make on performance. For now, this is a watchlist item for me, but if you believe that “best efforts” ESG is good enough, then by all means work ERET into your allocation mix.
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svetikd / iStock.com
REITs, or real estate investment trusts, allow people who may not have the funds to invest in properties, especially commercial properties, to purchase a stake in real estate development projects, buildings and land.
See: 5 Things You Must Do When Your Savings Reach $50,000
When you purchase a REIT, you are investing in a company that owns or finances income-producing real estate. REITs offer dividends to shareholders, making them a profitable investment even before you sell them.
Keep reading to learn about the 11 best REITs to invest in this year.
Which REITs Are the Best To Invest In?
Experts have differing opinions on the best REITs, so you’ll need to evaluate each one based on where it might fit into your general investing portfolio. Keep in mind that many lower-yield REITs based on the dividend percentage may end up outperforming higher-yield REITs if the company is more profitable. You’ll want to find that sweet spot between a high yield and a high-performing REIT to balance your portfolio and create passive income through your investments over time.
Based on GOBankingRates’ research, these are some of the best REITs of 2022:
- Gaming and Leisure Properties Inc. (GLPI)
- Camden Property Trust (CPT)
- Iron Mountain Inc. (IRM)
- VICI Properties Inc. (VICI)
- Realty Income Corp. (O)
- STAG Industrial Inc. (STAG)
- Getty Realty Corp. (GTY)
- Gladstone Commercial Corp. (GOOD)
- AGNC Investment Corp. (AGNC)
- Digital Realty Trust Inc. (DLR)
- Armour Residential REIT Inc. (ARR)
Gaming and Leisure Properties Inc. (GLPI)
Gaming and Leisure Properties Inc. is hailed as the first gaming REIT. The company holds 57 gaming facilities and related properties, such as hotels, across the U.S. The company manages triple-net lease arrangements for gaming facility operators.
The gaming industry has rebounded recently, and that is reflected in GLPI’s recent growth. GLPI has distributed annual dividends of more than $2 per share since 2015. It is offering a 5.70% dividend equal to 71 cents per quarter.
Camden Property Trust (CPT)
One of the largest publicly traded REITs related to multidwelling units, sometimes called multifamily, Camden Property Trust is listed on the S&P 500. Based in Houston, it owns and operates 171 properties across the U.S. The company is currently issuing a quarterly dividend of 94 cents and has a dividend yield of 3.29%.
Iron Mountain Inc. (IRM)
Iron Mountain is traded on the Nasdaq composite and could be considered a tech REIT, since it specializes in record storage and data center buildings. At the beginning of 2022, Seeking Alpha called it a “must-own stock.” It offers a dividend yield of 4.78%, delivering a quarterly dividend of 62 cents.
VICI Properties Inc. (VICI)
With gaming, hospitality and entertainment on an upswing recently, VICI Properties is a promising REIT investment. The company owns and operates 43 gaming and entertainment facilities, also consisting of hotels, restaurants, bars, nightclubs and sportsbooks. Some of its highest-profile investments include Las Vegas’ Caesars Palace, MGM Grand and the Venetian Resort. VICI pays a quarterly dividend of 39 cents per share and has an annual dividend yield of 4.93%. This dividend has risen steadily in recent years, more than doubling since 2018.
Realty Income Corp. (O)
Realty Income Corp. calls itself “The Monthly Dividend Company.” Part of the S&P 500 index, Realty Income has more than 11,700 commercial real estate properties. The company’s success has enabled it to increase its dividend payout 117 times since 1994. The dividend yield is 4.66%, with a current quarterly payout of 74 cents.
STAG Industrial Inc. (STAG)
Boston-based STAG Industrial focuses on industrial properties across the U.S. The company recently received an “A” rating from GRESB for its sustainability efforts and Public Disclosure Level. The rating compares favorably to the average score of “C” among 10 industrial real estate companies in a comparison group, as noted in a press release issued by STAG. STAG ranked second on the list of 10 comparison companies. The rating results in an interest rate reduction for three of the company’s unsecured loans and its $1 billion unsecured revolving credit account.
In the fourth quarter of 2022, STAG disbursed monthly dividends of 12 cents. STAG offers a dividend yield of 4.47%.
Getty Realty Corp. (GTY)
Getty Realty Corp. holds 1,021 single-tenant properties, including convenience stores, gas stations, car washes and other stand-alone retail properties across 38 states and Washington, D.C. The company has a dividend yield of 5.43%. The company delivers quarterly dividends of 43 cents per share.
Gladstone Commercial Corp. (GOOD)
Gladstone operates multiple REITs. Gladstone Land Corp., which purchases, leases and manages farm properties, is currently considered overvalued, according to Zacks.
But Gladstone Commercial, which specializes in single-tenant and multi-tenant industrial and office properties, delivers a high return and is rated as a fair value. Gladstone Commercial has one of the higher percentage dividend yields on this list, at 8.12%. Investors receive a 38-cent quarterly dividend per share.
AGNC Investment Corp. (AGNC)
AGNC has one of the highest annual dividend yields you will find right now, at 15.22%. However, keep in mind that higher percentages don’t always mean bigger payouts. The company pays a quarterly dividend of 36 cents per share, which is roughly the same as many other investments on this list that have a lower annual yield. Nevertheless, Zacks gives AGNC a rating of 1, or “strong buy,” and says investors can expect an above-average return from the REIT relative to the market. The REIT may be undervalued, making it a good pick. AGNC’s portfolio is comprised primarily of residential mortgage-backed securities.
Digital Realty Trust Inc. (DLR)
While Iron Mountain specializes in both paper record storage and also digital data centers, Digital Realty specializes in industrial buildings that house physical servers for businesses that use cloud storage as part of their operations. Digital Realty has an annual dividend yield of just 4.44% but has a high quarterly dividend payout of $1.22 per share. Seeking Alpha says Digital Realty has “exceptional growth potential.” Some of Digital Realty’s clients include top players in tech like IBM, Oracle, Meta and Lumen Technologies.
Armour Residential REIT Inc. (ARR)
Armour invests primarily in residential mortgage-backed securities. The company has faced some difficulties over the past year, reducing its monthly dividends from 17 cents per share in 2020 to 10 cents per share in 2021. However, it does have one of the highest annual dividend yields we’ve discovered in our research, at 21.54%. Armour currently delivers a quarterly dividend of 30 cents. It’s also an affordable investment, trading at just $5.57 per share as of Nov. 16.
According to Zacks, Armour is fairly valued at the moment and has solid financial health and growth prospects, which make it an investment to consider.
What Is a REIT?
A REIT, or real estate investment trust, is a company that develops, manages or finances commercial real estate. REITs make costly building projects possible without putting the burden on a single investor. Meanwhile, they allow people to invest in a portfolio of commercial real estate passively. REIT investors do not have to manage the property but can profit from its income. REITs are mandated to pay at least 90% of their taxable income back to shareholders, so many have very hefty dividends compared to stocks.
According to the worldwide organization Nareit, more than $4.5 trillion in real estate assets are owned by REITs. Of that money, $3 trillion is owned by publicly held REITs, or REITs that you can invest in.
You can invest in REITs through 401(k)s, individual retirement accounts, pension plans or other investment funds, as noted by Nareit. You can also invest in REITs through most brokerage firms, such as Charles Schwab or TD Ameritrade, and investment apps.
Are REITs a Good Investment in 2022?
Commercial real estate continues to be a lucrative market, even amid a bear stock market. Seeking Alpha calls REITs a “resilient” investment. When you’re choosing REITs, you want to look at the income benefits derived from dividends more so than the portfolio value. The value of the REIT will change in line with the real estate market as a whole. Likewise, look at REITs that scale their income based on inflation.
One of the key goals when choosing REITs is to invest in companies that pay high dividends so you can build passive income. But keep in mind that high annual yields don’t always mean the largest dividend checks, since dividends depend on the company’s net profits.
In general, REITs are an excellent way to create cash flow from your investments. They also tend to be less volatile than other investments, including stocks. They allow you to create a diversified real estate portfolio without any of the disadvantages of investing in real estate directly. As with any investment, there is risk involved in REITs, so be sure not to invest more than you can afford to lose.
Data is accurate as of Nov. 16, 2022, and is subject to change. Information on dividends was sourced from Google Finance.
Our in-house research team and on-site financial experts work together to create content that’s accurate, impartial, and up to date. We fact-check every single statistic, quote and fact using trusted primary resources to make sure the information we provide is correct. You can learn more about GOBankingRates’ processes and standards in our editorial policy.
Wonderful, wonderful news.
At least if you’re a creative money manager with a good line in blarney.
Nine out of 10 financial advisers say they plan to pour clients’ money into “alternative” investments over the next couple of years, including such lucrative high-fee vehicles as private equity, private credit, hedge funds, venture capital and the like.
Whether this will be such good news for the clients is another matter. But they, famously, are rarely the ones with yachts.
“As they face uncertain markets, nearly nine in 10 financial advisers (88%) surveyed plan to increase their allocation to alternatives over the next two years,” reports a new survey published by CAIS, which calls itself “the leading alternative investment marketplace for independent financial advisers,” and Mercer, an asset-management company. It adds that, “Of those, more than half (53%) estimate that their allocation to alternatives will make up more than 15% of their overall client portfolios. Meanwhile, more than 20% said they would allocate more than a quarter of their portfolio to alternatives.”
A mere 8% said that they do not plan to increase these allocations at all during the next couple of years.
Granted, this may not be a fully representative sample of the entire money management industry. CAIS and Mercer polled 200 financial advisers who had turned up to their Alternative Investment Summit last month at the Beverly Hilton Hotel in LA. Those attending were, naturally, more predisposed toward “alternatives.”
But there’s no reason to think this finding is directionally wrong. Institutional investors have been lured by the siren song of alternatives for several years. And the latest poll coincides with a moment of extreme revulsion—some might say, “capitulation”—toward the traditional assets of stocks and bonds because this year they have absolutely sucked.
So far this year, the S&P 500
SPX,
stock index has lost 15% and the S&P U.S. Aggregate 13%. The bond market has had one of the worst, and possibly the absolute worst, performance on record. No wonder the latest BofA Securities survey of institutional investment managers worldwide show they are shunning both stocks and bonds, while holding more than usual levels of cash, alternatives and commodities.
There are multiple problems with most alternatives. There is the fallacy of composition: If private-equity managers and hedge-fund managers plan to outperform by “beating the market,” there is only so much money they can take in. Otherwise you end up in the situation where everyone is expecting to beat the market.
Then there is the Heraclitus problem, meaning that the future will not be the same as the past. Private-equity managers benefited enormously from the long-term collapse in interest rates from 1982 until, well, last year. They were able to buy companies with cheap debt and then flip them. What happens if rates continue to go back up? We shall see.
Then there are the liquidity and transparency problems. You know what your publicly traded stocks are doing, because you can see the prices in real time. Not so private funds, many of whom furthermore make their money on untraded assets. How do you properly “value” an untraded asset, like a small company in the middle of an uncertain, multiyear turnaround? You can’t, really.
But above all there is the “agency” problem. The people running these ventures generally make out very well, but that doesn’t always translate into big bucks for the investors, because of the fees.
It is mathematically implausible for hedge funds to beat the market over time. And business school professor Ludovic Phalippou at Oxford University calculates that overall private equity returns have been no better than the stock market since at least 2006.
Important note: That is especially astonishing because during that period, from 2006 to 2020, the interest rate on BBB-rated corporate bonds halved. So the private equity crowd, who make their money by purchasing undervalued companies with debt, should have been making out like bandits.
Some people argue that things like real-estate investment trusts (REITs), infrastructure investments and master limited partnerships (MLPs) count as “alternatives.” But they have suffered this year along with stocks and bonds.
The one standout so far in 2022 has been commodities. The S&P GSCI Commodity Index is up 30% so far this year.
A fascinating research paper by the number crunchers at AQR, a hedge fund firm in Greenwich, Conn., suggests that if anyone feels they need to add something else to their portfolio of stocks and bonds, they might not need look any further than commodities. The paper, using commodities data going back to the 1870s, finds that commodity futures have added value to a traditional portfolio over time, zigging when everything else zagged (like this year) while generating a positive overall return.
“We find that, over the entire sample, the optimal mean-variance portfolio allocates 17% to commodities, 29% to stocks and 54% to government bonds,” write the authors, Ari Levine and Yao Hua Ooi of AQR and professor Matthew Richardson of NYU’s Stern School of Business. “Moreover, a 54%/36%/10% portfolio of stocks, bonds and commodities consistently outperforms a 60%/40% allocation of just stocks and bonds.”
Doug Ramsey’s “All Asset No Authority” portfolio at Leuthold, arguably the ultimate all weather portfolio, includes the commodity index and gold as two of its seven components.
Those who want to own commodities can do so without dealing with high-fee investment managers. There are a variety of ETFs that invest in commodity futures, including the iShares S&P GSCI Commodity-Indexed Trust
GSG,
among many others. (Thanks to the tricky nature of commodity futures, many perform slightly differently from each other. You need to check the data before buying.) Their fees aren’t low—GSG charges 0.75%, which is expensive compared with stock and bond ETFs, but a bargain compared with any private-equity fund or hedge fund.)
Naturally the best time to buy commodities was last year—or actually during the COVID-19 crash in 2020, but that’s another story—and not now, once they have already risen a long way. If we are heading into a recession the next move may be down. And when commodities go down, they can really, really go down. (The S&P GSCI Index fell two-thirds during the global financial crisis.)
It is dismally predictable that the global money managers who say they are shunning stocks and bonds are heavily into commodities.
But commodities can at least genuinely claim to be a third asset class, alongside stocks and bonds. And timing aside, there are worse ideas than, in general, including some alongside the others. It helped this year and it may help again in the future.
But hedge funds? Private equity? We shall see.
Brayden Hooper has ambitious plans for growing his real estate investments over the next five years.
The Toronto mortgage broker bought his first investment property, a three-bed, three-bath condo in Cambridge, Ont., in October 2021 for $489,900, with a 20 per cent down payment. Renting it for $3,000 a month, Hooper is able to make a $300 monthly profit in what is called a cash-flow positive transaction — meaning, the investor isn’t bleeding money.
He hopes to buy four more long-term and short-term rentals, including delving into Airbnb’s and a mixed-used commercial property (a shop on the first floor and an apartment on the second).
Now, the biggest question for Hooper remains: When is it the best time to buy his second investment property?
“We’re still waiting for the spring of 2023 for prices to fall down even further,” Hooper said. “We have another Bank of Canada rate hike coming in December which will continue to put downward pressure on home prices.” (Economists predict home prices could drop by 30 per cent from the February 2022 peak to spring 2023.)
But if a good deal presents itself, Hooper is open to buying a property earlier. Being a mortgage broker, he is constantly looking for deals, which is his biggest tip to clients.
“Whether we’re in a busy or slow market, if you’re not constantly scanning for deals you could miss something,” he said. “That’s general good practice if you want to be a good investor.”
It’s investing adage that the time to invest is typically when the market is down because it’s easier to enter the market when the asset is cheaper to buy. Since the February 2022 peak, home prices have dropped by more than 15 per cent in Toronto. However, mortgage rates have also tripled at the same time, meaning higher rates are offsetting lower home prices.
But higher rates aren’t sticking around forever, said Ralph Fox, broker of record (a manager of a brokerage) and founder of Fox Marin Associates.
“We have higher interest rates to help offset soaring inflation and we know that will cause an economic slowdown,” Fox said. “When that happens interest rates will also come down because it’s not sustainable.”
It’s unknown when mortgage rates will come down, but when they do it will be a good time to invest, real estate experts say. Or, if home prices drop by another 10 to 15 per cent by spring, the costs could be low enough to mitigate the impact of higher rates.
What makes the market appealing now, according to Fox, is that buyers are facing less competition, with sales activity having dropped by a whopping 49 per cent in October 2022 compared to October 2021. It’s becoming less of a seller’s market — when there is high demand and inadequate supply — and becoming a more balanced market for buyers, as there is currently less demand, Fox said.
“Buyers aren’t having to compete nearly as much as the January and February 2022 market frenzy,” he said, adding buyers can put more conditions on their offer such as a home inspection, and can have more time to negotiate with the seller.
An investment property should be bought with the intent to rent it out, not flip it, said Tom Storey, sales representative and team lead with Royal LePage Signature Realty in Toronto.
When prices are declining, it’s not wise to flip a property as it could make less money on the resale. But if it’s a rental, and is seen as a long-term investment — that means owning the property for at least five years, but ideally 10 years — then it will be a profitable investment, Storey said.
Currently, the average rent in Toronto is $3,360 for a two-bedroom apartment, which is up 27.7 per cent year-over-year. And it doesn’t look like rent is going down any time soon, experts say. Skyrocketing rent can help investors cover the higher mortgage payments, Storey added.
However, while rent is drastically up in Toronto it still won’t be enough to make an investor cash-flow positive — at best they can be cash-flow neutral, meaning they’re not making any profit from the property at the end of each month, he said. That’s because higher mortgage rates make it difficult to charge rent that will cover the monthly mortgage cost in addition to making a profit — the rent would be too high and above market value.
If the rent is too high, prospective renters will scout for landlords who are charging less and are likely taking a financial hit.
“In Toronto, it’s a market where you’ll see greater appreciation of the property overtime, which is why it should be a long-term investment,” Storey said. “You’re typically losing money each month but have the goal of building substantial equity in the long-term.”
Ron Butler, mortgage broker of Butler Mortgages, warns that even being cash-flow neutral is dangerous. Investors must conduct a meticulous review of the economics of the rental before buying.
That includes: the monthly mortgage payment; the property tax and the annual rate of increase the municipality imposes on the tax; around one per cent of the property’s value should be set aside for repairs (if the house is valued at $1 million you should set aside at least $10,000 for repairs); and 30 days of vacancy should be set aside in case the tenant leaves, Butler said.
Buyers also need to evaluate their cap rate, which is the cash yield you get from the property after accounting for all expenses but before mortgage payments. It’s calculated as the ratio between the annual rental income to its current market value. The rate needs to be higher than the interest paid on the mortgage otherwise money won’t be made.
Around 10 years ago the goal cap rate would have been six to seven per cent, Butler said. But now, southern Ontario has deviated so much from cap rates that it’s about three per cent, he added. In the pandemic, when interest rates were as low as 1.5 per cent, it was possible to make a profit. But now, with interest rates close to six per cent, it’s difficult to get a cap rate higher than the interest rate in urban centres.
To be cash-flow positive, Hooper said buying property outside of Toronto is a safe bet. That’s why he bought a property in Cambridge, and is looking in places such as Ajax or Oshawa where property prices are cheaper.
It’s a trade off, as homes farther from Toronto don’t appreciate as much, but it means you can make a monthly profit, he said.
“You need to crunch the numbers and see if you’re cash-flow positive. If the answer is no, you have to ask yourself, can I afford to lose that money?” Hooper said.
That’s why Hooper emphasized being prepared to buy outside of Toronto, and to look into growing communities that have the potential to appreciate in value over time.
“I really encourage investors to look elsewhere, because places like Cambridge have lower land transfer tax and ‘cheaper’ prices,” Hooper said. “You can have better cash flow and sell it down the road for a higher price than what you bought it for.”
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“I always knew I wanted to get into business for myself since I was very little,” Army veteran and real estate investor Andrew Davis says. “I think a lot of kids like doing a lemonade stand — I got a real thrill out of that when I was younger. So it was already in the back of my mind.”
Courtesy of Andrew Davis
Before he went into business for himself, Davis graduated as a signal officer from the United States Military Academy at West Point. He served eight years in the Army after that, five of which were active duty. But Davis knew he didn’t want to spend his entire career in the military.
So he began to explore other options. Davis had family members involved in the real estate business already, and after speaking with them and doing more research, he decided to give it a go. In 2014, he launched his new career with New Western, a private marketplace for fix-and-flip residential investment properties.
Davis started to buy rental properties slowly, working at his new venture part-time while he was still in the Army. Then, when his time on active duty was coming to an end, he got his real estate license.
“I wanted to learn a little bit more about the industry and be closer to the front lines of where the action was happening,” Davis explains. “I graduated from just trying to buy and hold rental properties to fix and flipping properties, using the proceeds to buy more properties.”
Entrepreneur sat down with Davis ahead of Veterans Day to discuss how his time in the Army helped him prepare for a successful career in real estate investment and what would-be investors should always keep in mind — no matter what the market’s doing.
Related: 6 Ways Small-Business Owners Can Celebrate Veterans Day
“When you’re studying the art of warfare, you’re breaking wars down to a strategic, operational and tactical level. And you can do the same thing in business.”
By the time Davis left the military, he felt confident in his ability to move forward with a full-time career in real estate investment. A lot of what he learned at West Point and beyond was applicable to his new business, he says.
One particularly helpful course at the Academy was called “The Art of Military Warfare.”
“That’s the best business class I’ve ever had,” Davis says, “because the funny thing is when you’re studying the art of warfare, you’re breaking wars down to a strategic, operational and tactical level. And you can do the same thing in business — how you operate your business strategically, operationally.”
Additionally, Davis’s time in the Army taught him how to lead and run an organization effectively.
“It helped me wire my engine in an efficient way,” Davis explains, “and I attribute a lot of success [to that].”
Another critical skill Davis honed in the military? The ability to adapt and plan accordingly.
Real estate is always fluid, Davis notes, which means you have to assess a situation or hurdle as it comes — and react in due course.
Covid’s impact on real estate serves as a perfect example. Although the market quickly heated up, it’s since cooled, rewarding those investors who continued to rely on solid business principles.
“It’s important to learn the fundamentals of the business early on so that no matter what the market does, you have a business plan that you can change and mold to [suit] what’s happening now,” Davis explains. “Sticking to the fundamentals of real estate investing goes a long way, though there’s a lot of talk about interest rates going up.”
Related: How Entrepreneur Millionaires Prepare for a Recession
“The principles stay the same no matter what’s happening.”
What does holding onto those business fundamentals look like in practice?
“The principles stay the same no matter what’s happening,” Davis says, “buying properties that are quality, buying with a profit margin built in. Stuff like that keeps my business running no matter what. And then a lot of hard work too — being persistent and working hard go a long way, especially during the harder times.”
As he began his real estate investment career, Davis prioritized buying and holding rental properties. He says owning rentals comes with some stability, as you’re basically guaranteed a monthly residual income. Generally, those properties will rent, he explains — it’s just a matter of how much for and what makes sense on the back end.
For those early in their real estate investment career, Davis recommends “cutting their teeth” on easy projects, like a cosmetic renovation to rent, before exploring what can be more complex and risky fix-and-flip properties.
Once you’ve purchased a property to flip and attached that “value-add component,” you’re banking on it being worth more when it’s finished. But that assumes that the market will remain consistent, doing what it’s done in 2021 in 2022, for example. Of course, that’s not always the case.
“There’s room for things to go sideways when you peel back the onion on a property,” Davis says. “Maybe you uncover things that you didn’t originally anticipate. Maybe the project takes longer. Maybe the supply chains are messed up. So while [fix-and-flip] can be a profitable business, there is more risk associated with that business model, in my opinion.”
Related: How to Find Funding to Start a House-Flipping Business
“There’s a steep learning curve, and a lot of people have a negative experience early on.”
Regardless of if you’re interested in buying to rent or buying to flip, Davis suggests keeping a few important things in mind.
For those younger investors who are just getting started, Davis recommends easing into the process.
“I see a lot of people who get aggressive early on,” he says, “and maybe they’re not as well-established with the process of real estate or real estate investment. And in real estate, there are always walls, and it’s up to that individual [if they’re going] to run into a wall at a million miles an hour or ease [into it], bump into a wall and be able to bounce back.”
Davis also cautions against believing what you see on a lot of TV shows that make fix-and-flipping “look like a cakewalk.”
“There’s a steep learning curve, and a lot of people have a negative experience early on because most flippers cut their teeth on a bad project,” he explains. “A lot of the seasoned investors that I know are people who just stuck with the process and were persistent: When there was a lesson to be learned, they learned it and then applied it to the next project.”
Additionally, Davis suggests having several things going on. That way, if one area slows down, another component can help make up for it.
“So, for example, I started a property management company in 2020,” Davis says. “It’s been really hard to find the same amount of fix-and-flip opportunities, although not impossible. The property management business took focus while some of my investments slowed down. As the real estate market slows down, it might be a good buying opportunity. So things are definitely being changed in and out.”
Those who are willing to ease their way into real estate, applying what they learn along the way and eventually spearheading multiple projects at once, stand to build a lucrative business.
“As far as actual investments, I only own real estate properties,” Davis says. “It’s a timeless venture. If you dissect a lot of investments, it just comes down to supply, demand and ability to pay. I’m a big fan of consumer staples, things like grocery stores and real estate. There’s always demand for shelter or usable space. And a lot of these structures are going to last for generations — so it’s a great place to park money.”
Home buyers are looking for ways to whittle down their mortgage rates. As a result, a once-popular home-selling tactic is making a comeback. It’s called a temporary buydown, and it was widely used when mortgage rates were zooming upward in the late 1970s and early 1980s.
The revival of the temporary buydown is timely, as mortgage rates are at a two-decade high, with the Federal Reserve expected to raise the floor under mortgage rates twice more this year. Fewer people are buying homes because rising rates make homeownership unaffordable. In some markets, negotiating power is even shifting from sellers to buyers.
In these conditions — when interest rates are rising and home sellers must make an effort to lure buyers — temporary buydowns can flourish. It’s time to dust them off and put them to use.
How do you buy down a mortgage rate?
A temporary buydown reduces the home buyer’s monthly payments in the first year, or sometimes in the first two or three years. Instead of making the mortgage’s full monthly payments from the get-go, the home buyer will make discounted payments for a year or more.
This is accomplished by subsidizing the interest rate that the borrower pays. For example, let’s say a buyer gets a mortgage at a 7% interest rate, with a one-year buydown. Because of the buydown, the monthly payments in the first year are based on a 6% interest rate before rising to 7% thereafter.
If the borrower got a $300,000 mortgage in this hypothetical example, the buyer’s principal-and-interest payments in the first year would be $1,799 a month, before rising to $1,996 a month in years two through 30. A buydown under these terms would save the borrower about $197 a month in interest in the first year, for a total of $2,367.
Traditionally, most temporary buydowns are paid for by home builders and home sellers as a closing cost equal to the buyer’s interest savings. In the example above, the buyer saves $2,367, and the seller deposits that amount into a custodial account at closing. The loan servicer draws from the account every month to make up the difference between the full loan payment and the discounted bill the homeowner is paying.
The twist these days is that some lenders are offering temporary buydowns as a means of competing for business when there are fewer mortgages to write. When comparing lenders, this is a feature worth watching for.
What the buyer gets out of it
“Buydowns were a routine affair when I got into the real estate business in 1978,” says Lou Barnes, senior loan officer with Cherry Creek Mortgage in Boulder, Colorado. Mortgage rates were rising fast in those days, as they are now, and buydowns were designed to ease the buyer’s transition from a lower interest rate or cheaper rent, Barnes says.
Nowadays, temporary buydowns appeal to first-time home buyers who are shocked by the speed at which mortgage rates have risen, and who will deplete their savings on the down payment and closing costs. The temporary payment reduction allows borrowers to replenish savings or spend the money on home upgrades.
“You know how it is when you buy a home: You might want to buy new carpeting, new appliances — what it takes to make it your home,” says Bill Banfield, executive vice president of capital markets for Rocket Mortgage.
Rocket is paying for one-year buydowns through the end of 2022, Banfield says, with a product the company calls Inflation Buster. New American Funding offers lender-paid buydowns, too, said Ben Lane, New American’s managing director of editorial, through email. And other lenders have recently begun to market buydowns paid by sellers.
Buydowns can last longer than one year, allowing borrowers to extend their savings:
- A 2-1 buydown reduces the interest rate by two percentage points in the first year, then by one percentage point in the second year, before rising to the full rate after that.
- A 3-2-1 buydown lasts three years, with the interest rate reduced by three percentage points in the first year, by two percentage points in the second year and by one percentage point in the third year.
- With a 1-1-1 buydown, the rate is reduced by one percentage point for three years.
Learn more: Here are ways to lower your mortgage rate, according to this mortgage company CEO
What the seller gets out of it
Temporary buydowns are “older than bell-bottoms,” Banfield says, and there are signs that they are coming back into fashion as negotiating mojo shifts from sellers to buyers. The reason: Buydowns are a time-tested way to entice reluctant buyers.
A seller may offer a buydown instead of dropping the price. That way, the seller gets to brag about getting the desired price while the buyer saves money.
For example, let’s say the buyer and seller are $7,000 apart after days of haggling. A temporary buydown resolves the impasse:
- The buyer pays the price the two sides are stuck at: $7,000 more than the buyer wants to pay.
- As a compromise, the seller pays for a 2-1 buydown on the buyer’s $300,000 mortgage at a 7% interest rate. The 2-1 buydown saves the buyer $6,992 over the first two years of the loan. That $6,992 comes out of the seller’s proceeds at closing — equivalent to a price cut, but invisible to the neighbors.
Negotiating a buydown
Either side can suggest a buydown. The seller can offer one proactively, as a competitive tactic. The buyer can request one as a seller’s concession.
The lender must qualify the borrower at the full interest rate, which requires the lender to determine that the borrower can afford to repay the loan after the rate reductions have run out.
Government-sponsored mortgage companies Fannie Mae
FNMA,
and Freddie Mac
FMCC,
impose limits on seller concessions, including temporary buydowns. Limits vary, depending on down payment size.
Fannie and Freddie also restrict temporary buydowns to a maximum of three years. And to soften payment shock, the effective interest rate can go up only one percentage point each year. So the borrower’s effective rate can’t jump from 5% to 7%; it would have to go from 5% to 6% for a year before settling at 7%.
How buydowns differ from ARMs
A temporary buydown resembles an adjustable-rate mortgage because the borrower starts out making payments at one interest rate and later makes payments at another interest rate. But a buydown is not an ARM.
A key difference is what happens with the interest rates. On an ARM, the interest rate and the monthly payments can change periodically for the life of the loan. With a buydown, the interest rate never changes. Instead, the seller (or sometimes the lender) pays part of the borrower’s interest payments in the first year or two or three, but the underlying note rate remains the same.
One argument in favor of ARMs is that they last longer and can result in greater savings, at least in the first five years, says Carolyn Morganbesser, assistant vice president of mortgage originations for Affinity Federal Credit Union in New Jersey.
“The ARM is going to get you into your home; it’s going to give you the lowest possible payment at this given time,” Morganbesser says.
While that may be true, one drawback to ARMs is that a seller can’t offer them as a concession. Morganbesser says that in her area, this objection is irrelevant right now because it’s still strongly a seller’s market, so sellers have little incentive to offer concessions.
But in some places away from the East Coast, sellers already are competing for a dwindling pool of willing buyers. In these markets where buyers have the power to pick and choose, sellers might be inclined to offer buydowns.
How buydowns differ from discount points
Paying discount points is a way to permanently reduce the interest rate, and therefore the monthly payments. Sellers can pay discount points as a sales incentive. But with discount points:
- The monthly savings are less. Paying one discount point — equal to 1% of the loan amount — typically reduces the interest rate by about one-quarter of a percentage point.
- Even though the monthly savings aren’t much to boast about, the cumulative savings can be substantial over several years.
- It usually takes six or seven years of regular payments for the accumulated savings to exceed the upfront cost.
“If you sell or refi before those six years, you leave money on the table,” Barnes wrote in an email.
In contrast, the buyer’s savings from a temporary buydown equal the seller’s upfront cost in one to three years.
Also read: Home buyers are looking older — and whiter
A welcome return to normality
The imminent revival of temporary buydowns is a harbinger of a more traditional housing market in which sellers and their real estate agents are no longer sorting through a dozen desperate offers for every house.
“There will be an effort to sell properties where this creative structuring and financing might come into play,” says Michael Kelczewski, real estate agent for Kurfiss Sotheby’s International Realty in Wilmington, Delaware. “Or, you know, just time-tested methods like holding an open house, a broker’s open, calling agents, sending out emails, sending out postcards — doing all the salesman stuff to get these properties sold.”
Holden Lewis writes for NerdWallet. Email: hlewis@nerdwallet.com. Twitter: @HoldenL.