Video Update - Why Commercial Real Estate Keeps Getting Better

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Welcome to this week’s Real Income Report update.

Let’s get right into the big news.

Commercial real estate just continues to improve. We got the latest commercial mortgage-backed securities (CMBS) delinquency report this morning, and for the second month in a row, things are getting better. Even the much-maligned office sector is showing signs of improvement. It’s still at high levels, sure, but the trend is heading in the right direction. That wave of delinquencies that everyone was bracing for in 2025? So far, it hasn’t materialized.

Of course, the market is still trying to figure out what’s happening with multifamily and office properties. But here’s something really interesting about multifamily that most people aren’t paying attention to. Last year, we talked about how the oversupply fears were largely based on properties expected to come online in 2024. Well, everything built in 2023 got snapped up immediately. Fast forward to 2024, and while new projects hit the market, they’re filling up just as quickly because of the housing shortage. People aren’t buying homes, they’re staying in apartments, particularly Class A units.

Now, here’s where it gets interesting. A lot of banks and commercial REITs pulled back on financing new apartment projects, concerned about oversupply and the broader economy. That means in the second half of this year, we’re going to see new deliveries slow down.

The vast wave of oversupply that was supposed to flood the market?

It’s not happening, and that’s incredibly bullish for multifamily real estate,both as an equity investment and from a lender’s perspective. We’ve got exposure to both in our portfolio, so we’re well positioned to benefit.

The 4.2% Conundrum

Now, let’s talk returns.

I spend a fair amount of time digging through academic research. A new study out of NYU caught my eye this week. What’s unusual about this one is that the finance department teamed up with the engineering department.

I guess they needed someone to check the math.

Their study projects a compounded annual return of 4.2% over the next decade for the US stock market.

That’s interesting because right now, I can lock in 4.2% risk-free with a 10-year Treasury. I could have done better a few weeks ago, but that yield’s been coming down.

Meanwhile, I could go out and buy an Occidental Petroleum bond maturing in 2034, yielding 5.65%. Or a Seagate bond due in 2035 at 5.9%.

Better yet, I could own our REIT portfolio, which yields nearly 6%, with excellent dividend growth prospects and capital appreciation potential.

Add that to the income side of our portfolio, where we’re locking in 8% yields with some capital appreciation, and we’ve got a blended return north of 7%, with inflation protection built in.

Now compare that to broader market projections.

If you use the CAPE ratio—the cyclically adjusted PE ratio that looks at 10 years of earnings—it’s signaling a 2.2% compounded return going forward. Historically, that’s been pretty accurate.

The excess CAPE yield, which measures earnings yield relative to Treasuries, is basically saying, “Hey, expect zero.”

GMO’s Jeremy Grantham? His firm is projecting negative real returns for U.S. stocks over the next decade. They like Japan and Europe much better.

Even Vanguard, who has every incentive to be as bullish as possible, forecasts U.S. stocks returning somewhere between 2.9% and 4.9% compounded.

I can beat all of that in our REIT portfolio, with far less risk than the S&P 500.

It’s not even a tough decision.

If you look at aggregate investor allocation to equities, which measures how much total return investors have in stocks, the higher that number, the lower the projected returns. Right now, it’s signaling long-term returns will be close to zero.

Not great!

Our portfolio is built differently. We’re collecting most of our returns in cash, through high-yielding, high-quality real estate. These are Class A properties with strong occupancy rates, solid credit ratings, and a history of dividend increases. And we’re buying them at discounts to net asset value.

That’s an edge.

Meanwhile, the traditional asset allocation model says you should have maybe 5% in REITs.

That’s absurd.

Since 1972, REITs have outperformed the S&P 500. Why would you allocate less to the asset class that does better?

Depending on where you are in your investment lifecycle, the balance between our total return portfolio and our income portfolio will shift.

If you’re still in aggressive accumulation mode, we need to talk about undervalued small banks and deep-value stocks. That is an entirely different conversation for another day.

What A Trump Economy Could Look Like (And Why It’s Good For REITs)

There’s a lot of noise out there about what happens next with the economy. Best case? Tariffs bring more manufacturing back to the U.S., interest rates stabilize or fall, and we get a business-friendly regulatory environment. That would be massive for commercial real estate—offices, warehouses, factories, apartments, single-family homes. It all fills up. Huge tailwind for REITs.

Worst case?

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