How Alternative Investments Weather Interest Rate Change

Alternative Investments Deliver Strong Cash Flow

One of the reasons why I love alternative investments as an asset class is that they have the capacity to deliver strong and predictable cash flow.

From an investor’s point of view, when times are turbulent and tough, having an income stream that you can bank on becomes important.

Cash is proving to be king with where we are in the current economy.

Although we’re in a high inflationary environment and people do not necessarily want to stockpile too much cash, when you’ve got security over income and when you’ve got money in the bank, it contributes to the better-sleepat-night factor.

I want to start with why people are so worried about interest rate rises.

You might already have a good handle on this, but I just want to pull it apart more from an economic perspective.

When interest rates are rising and money becomes more expensive to borrow, that puts pressure on businesses with capital borrowings and the cost of money goes up.

Homeowners that have overextended could be forced to liquidate.

Over the last two years, we saw a lot of people buying in very frothy market conditions, sometimes paying over the odds, just to secure a piece of real estate.

A lot of the stimulus meant that the average wage earner had more money in their pockets and felt exuberant about wanting to spend that on their own home, investment properties, or other household toys that they could enjoy while they were in lockdown. 

We are in a situation now where we can already see that people who are looking to sell are, in some cases, creating heavy discounts in the market. 

Unfortunately, whenever someone sells at a discounted rate, that sets the new bar and then it becomes hard for others, so it has a bit of a trickle effect.

The Ripple Effect

When interest rates rise, the government’s goal is to slow the economy and try to swing back to being a buyer’s market again.

I understand that there are a lot of people who want home ownership but have not been able to manage that.

When interest rate rises occur, the hope is that it will create more stock in the market and give first-time homeowners a chance to get a foot in the door.

Unfortunately, the flip side is that the borrowing costs go up, making it harder again. So it’s a bit of a double-edged sword from that perspective.

There are a lot of businesses right now who are in the unfortunate position of feeling some of the ripple effects finally starting to emerge in a post-COVID world where people or organisations like the ATO are certainly being less lenient.

When I talk to my colleagues who run accounting firms, the number of letters being issued to business owners and the ATO’s powers to declare them bankrupt is becoming considerable. 

Certainly, that is happening worldwide, and we’ve had a bit of a reprieve as businesses over the last couple of years.

Tax organisations at large are saying, “Let’s not rock the boat too much,” and they are allowing businesses to make debt arrangements or not pay any tax debt and that tax debt has now swollen to such a huge volume.

The ATO has basically turned around recently and said, “No more. We want to collect that money.”

They are categorically forcing businesses that can’t repay that debt into liquidation.

We are going to see business profits and cash flow starting to reduce, and many businesses may go bust in the months and years ahead.

Lending has to tighten. I think in spite of the reforms that have happened over the last three or four years where lending has become a lot more stringent, in the last two years there has been a push to support people in acquiring more real estate.

But I’m already hearing murmurs of lending becoming tighter and household spending is becoming more stressed as a result of interest rate rises.
 

The Side Effects of Interest Rates

There’s a bit of a cocktail of yucky things happening in the context of interest rate rises, which, unfortunately, the side effect of a lot of that is that there’s a lot of fear in the market and a lot of concerns from an investor point of view.

Whenever there’s fear in the market, that has ripple effects in terms of buyer behaviour and investor behaviour.

So it seems from most people’s perspective that it’s a time of great uncertainty and a lot of people want to stay out of the market right now.

I wanted to shine a light on how I feel about alternative investments in this current environment. As many of you know, alternative investments represent a completely different asset class for me.

When I speak about alternative investments, I am talking about assets backed by real property, simply because of the fact that you can structure deals in a very creative way that sits outside of the mainstream. 

It just allows you to participate in deals in a completely different way from what we think of in traditional property investing.

The Biggest Risk to Take in Alternative Investment

If I were going to describe the observations that I’ve gleaned over the last decade, plus from the time that I’ve been in the alternative, the most significant risk that you face in the alternative investing space is who you put your faith in and who you partner with when you do these deals.

With that said, the metaphor I want to give you here is that of a skilful surfer.

One of the things I’ve observed about surfing is that your skill as a surfer is about your capacity to adjust your weight and ride the waves regardless of surfing conditions.

I think the same is true of the deal makers and the trusted advisors I work with in the alternative investing space. 

If I think about it from their perspective, they’re always looking for a specific rate of return.

The Opinion of My Advisor

They’re looking for a minimum net return of 10%.

I was talking to one of my advisors this morning who has a lucrative opportunity where it pays cash flow as high as 18 to 20%.

But when they’re out there looking for deals, they’re looking for a certain rate of return.

When they run their analysis, regardless of what is happening with interest rates and what is happening in terms of the business environment and economics, they will not compromise on their criteria when selecting investments.

The better deal makers will not compromise on their criteria, their due diligence, and their underwriting simply to get a deal across the line. 

That is the huge difference between many of my trusted advisors and what I would describe as institutional fund managers.

The way that institutional fund managers work is that they get paid based on assets under management, and so there’s going to be an incentive for them to put money to work regardless of the quality of the deal.

There’s no question, if you look historically at the performance of hedge funds and hedge fund managers, there are very few that go the distance.

They come and go like flashes of gold in the pan. Not many fund managers at an institutional level have managed to survive multiple crashes and decades because of their inability to stick with their guns and stick with their rules when it comes to asset selection.

Are Dealmakers Willing to Compromise?

One of the things that I’m always conscious of when I’m working with a deal maker is, “Are they going to compromise on their outcomes?” 

I love that in my world, it’s almost that deal flow would slow before they would make those compromises. 

So in the alternative investing space, as I see it, you want to work alongside skilful surfers, who would look at something like an interest rate increase.

They need to bake that into their understanding of what’s happening in the market but won’t compromise on the returns they want and the risk profile of the deals themselves.

What that translates to in practical terms is that as interest rates actually go up, the better deal makers and the trusted advisors that I work with will simply look for deeper discounts on acquisitions.

The bottom line is that the profit on the deal, the cash flow on it, or whatever it is that they’re looking for still has to be there.

If everyone in the market is fearful or struggling due to interest rate hikes, then these guys can go in and apply leverage to negotiate better terms.

What I’d add to that is that their continued focus in my world is on affordable housing.

They’re not necessarily trying to operate at either end of the bell curve, meaning they don’t want to be slum lords, and neither do they want to buy blue chip property.

They’re focusing on that market sector, affordable housing, which is very close to the median. It has the largest volume of potential renters and buyers, whether multi-family commercial or the sector they’re trying to focus on.

With all of those factors combined, the message I’m trying to give you here is that interest rate changes have a huge impact, both in terms of physical and psychological impact on cash flow.

The psychological impacts in the market lend themselves to potentially better deal negotiations than in very frothy times like we’ve had over the last few years.

Essentially, what I’m witnessing is that as interest rates increase, as investors at large become more sceptical and more uncertain about the future, it creates opportunities for skilled investors to go in people who know a particular market or a particular strategy well, who are narrow and deep in their focus, and who have access to opportunities that may be predominantly off-market. 

Those people can take advantage of some of that fear in the market and structure deals in a way that still gives a very low-risk profile overall, as well as delivers epic outcomes for those who are prepared to partner with them.

Final Thoughts

So that’s where I wanted to leave it today.

I don’t want to go too deep into this, but you need to recognise that these interest rate changes flowing through the economy, both local and global, will have continued impacts.

I’m not trying to predict what will happen. I feel like there are some pretty stormy waters and dark clouds brewing. How those actually pan out in our economy and in our property market is still to be seen.

We don’t know what rabbits the government will pull out of their hat to support the economy, so it’s almost fruitless or pointless to try to predict with any certainty, as I continue to hear a lot of alleged experts doing.

We can actually use this opportunity to deepen our understanding and knowledge of how the world works and get a sense that there are opportunities that sit outside of the mainstream that can continue to deliver great results at a time when everyone else is floundering.

So, guys, I hope this has been a useful podcast. I look forward to unpacking more practical podcasts that help you understand why I am madly in love with alternatives and why they are a complete game changer in hitting your financial goals.

Till next time, guys. Take care.

If you’re a business owner feeling frustrated that despite doing everything right in the property investing playbook and you’re no closer to financial freedom, then head over to www.inkosiwealth.com to learn more about how you can use alternative investments to catapult your investing income and blend strategies to shave decades off your timeline to financial freedom.

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