How We Are Protecting Our Investments From What Could Go Wrong in 2025

Has the Federal Reserve tamed inflation? Where are interest rates headed, and when will they move?

The truth is, no one can say with certainty whether the Federal Reserve has successfully subdued inflation, nor can anyone reliably predict the trajectory of interest rates in the coming years. Anyone claiming definitive answers to these questions should be met with a healthy dose of skepticism. Despite this uncertainty, we remain undeterred our commitment to realizing long-term value via strategic real estate investment.

As we approach 2025, our focus is on safeguarding investments against the ongoing risks of inflation and the possibility that interest rates may remain elevated for a longer period than many have anticipated.

Investment Strategy: A Blend of Equity and High-Yield Debt

During periods of inflation, low-interest, fixed-income investments—such as bonds—typically underperform. Consider 2022, when inflation soared to 9.1%, while some Treasury bonds were offering yields as low as 2%. Bondholders faced an effective loss of 7.1% or were forced to sell at a significant discount.

Equity investments, particularly in stocks and real estate, have historically outpaced inflation. Businesses can adjust their pricing in response to inflationary pressures, and real estate investors can similarly raise rents.

My portfolio primarily consists of equity investments in both real estate and stocks, with a smaller allocation to high-interest debt secured by real property. In the event of a sharp inflationary surge, these debt investments might see their returns eroded. Nevertheless, I remain confident that, overall, I will still realize a positive return.

The true threat of inflation to real estate equity lies in financing structures and exit cap rates.

Fixed-Interest Financing: A Long-Term Safeguard

For several years, my firm has been cautious about relying on short-term bridge financing and floating interest rates.

While it is impossible to predict how long elevated interest rates will persist, we recognize the potential for prolonged high rates if inflation resurges. This is a scenario that could be exacerbated by certain political measures, such as tariffs proposed under former President Trump's policies. As a result, interest rates may remain higher than expected well into 2024 and beyond.

Each week, my team of analysts and I review investment opportunities with a clear focus on mitigating the risks of rising rates. We favor investments that are secured with fixed-rate financing, rate caps, swaps, or other protective mechanisms. Additionally, we seek ample time before debt maturity, which provides flexibility to either refinance or sell when market conditions are favorable.

Emphasis on Strong Cash Flow

There is no inherent virtue in focusing exclusively on cash flow versus appreciation. Ideally, a balanced portfolio offers both. However, my preference lies with cash flow.

Why? Because cash-flowing investments can endure through buyer’s markets without the pressure of liquidity events. For instance, the latest investment vetted by our firm offers an 8.6% cash flow return in the first year, which increases to 12.7% upon stabilization.

On the other hand, investments with slim cash flow margins can quickly become untenable in less-than-ideal conditions, especially when investors are eager to recoup their capital if the cash flow falls short.

In real estate, strong cash flow provides the luxury of time. It allows investors to hold onto assets until the right moment for a sale or refinancing while generating reliable income in the interim.

Investments Independent of Interest Rates

Earlier this year, I decided to stop obsessing over the Federal Reserve's every move.

The aforementioned investment that we recently evaluated? It is not dependent on rate cuts or hikes by the Fed. The plan is to refinance within three to five years, aiming to return 100% of the invested capital, creating a scenario for "infinite returns." Even if rates remain high, this investment will continue generating robust cash flow, positioning us to refinance or sell when market conditions are more favorable.

Moreover, we’ve also invested in a land-flipping fund that doesn't require low interest rates to be successful. The fund turns over parcels on average every 4.1 months, and has consistently delivered returns in the low 30s since its inception. It also offers 16% annual distributions without fail.

In recent months, we've expanded into several private ventures, including house-flipping projects and the construction of spec homes. While lower interest rates could enhance our returns, these investments will continue to perform well even if rates remain elevated. The same, however, cannot be said for certain multifamily syndications funded with short-term bridge loans.

Seizing Opportunistic, Distressed Deals

While our primary focus remains on mitigating downside risk, we recognize the current environment as offering significant opportunities to acquire undervalued assets.

Last month, our team identified a distressed property being sold at a substantial discount by a hedge fund facing difficulties with floating-rate debt. The hedge fund's misfortune became our gain.

This asset is already generating 8% in distributions, with expectations to rise to 9.5% in the near future. Our target annualized returns for this deal are over 20%, with a medium-term holding period of about three years.

As with every opportunity we evaluate, risk remains a key consideration. If interest rates are still elevated in three years, we can afford to hold onto the property for a bit longer and wait for a better market for a sale.

The Importance of Diversification

A key principle underlying our investment strategy is diversification.

While others may try to pinpoint the next "hot" market or asset class, I prefer a more passive, diversified approach. I am not bound to any single property type or geographic location, and I invest across various markets throughout the U.S.

Many believe they can time the market. I, too, once entertained that notion, only to find that the market’s complexities and unpredictabilities often defy such efforts.

The Value of Long-Term Thinking

Diversification may not sound glamorous, nor will it make you the center of attention at a cocktail party. However, it remains one of the most reliable strategies for enduring inevitable market downturns. By diversifying across different timelines, markets, property types, and operators, you place yourself in a position to weather shifts in the economic landscape when others are struggling to regain their footing.

Sure, I may occasionally face setbacks with individual investments. But the broader portfolio continues to grow, allowing me to invest consistently while others are left scrambling to recover.

"Cleverness" in timing the market is often a fool's pursuit. It is far wiser to invest with a focus on longevity and sustainable growth.