Academic journal article Business Case Journal

It's a Bond ... It's Solar Energy ... It's a Rental Property ... or, All of the Above?

Academic journal article Business Case Journal

It's a Bond ... It's Solar Energy ... It's a Rental Property ... or, All of the Above?

Article excerpt

Introduction

"The time bomb is ticking," referring to the fall in bond prices that will accompany rising interest rates, "The Risk of Ultralow Yields, January 28, 2013.

Mike Atherton looked at the latest rates for municipal bonds at year end 2012 and sighed. Interest rates had not been this low since the mid-1940s. Doomsayers had been predicting a bloodbath caused by rising interest rates in the bond market for years. They weren't right yet, but that didn't mean they'd never be right. Mike was a conservative investor--he valued the safety of principal, but not at the price of only earning a pittance on his assets. Mike was a private investor, retired and living in Florida, with impressive investment credentials. He retired from the position of Chief Investment Officer for Aberdeen Funds and still served as a director of T. Rowe Price. He had an undergraduate degree from the University of Maryland and a law degree from Georgetown University. After many years of successfully investing for others, he had his own substantial portfolio to manage. How could Mike maintain a diversified, conservative portfolio and at the same time make a decent return?

To answer the overarching question posed, Mike thought that real estate investing might be the answer. His nephew, Andy Barnes, lived in Tucson, Arizona, with his wife, Valerie, both graduates of the University of Arizona. Andy had started his own successful home remodeling business. As residents of the city for the past 20 years, they were both familiar with the city, its neighborhoods and its culture. Mike and Andy had formed a limited partnership, White Dove Real Estate LLC, to purchase rental properties in Tucson. Their rental properties included nine single family homes and one fourplex, an apartment building with four units. This real estate investment represented a small percentage of Mike's total portfolio, but if successful, he intended to increase this asset class in the future. With the addition of real estate to his portfolio, he next wanted to consider taking advantage of Tucson's sunny climate.

Mike also wanted to add a new wrinkle to their real estate business--solar power. Mike thought this was the right time and place for solar electric. First, Tucson was in a sunny, hot area of the country. In fact, Tucson averaged 286 sunny days per year, compared to an average of 205 days of sun nationwide. Second, both the local utility, Tucson Electric Power, and the federal government were encouraging the use of solar power through financial incentives.

Diversifying Portfolios

Mike had traditionally invested his fixed income portfolio in laddered certificates of deposit and corporate, municipal and treasury bonds. "Laddering" a portfolio referred to buying securities of differing maturities. For example, an investor could purchase one year, two year, three year, four year and five-year bonds. When the one-year bond came due, the proceeds would be used to purchase a new five-year bond. This allowed the investor to continue to hold a portfolio containing one, two, three, four and five-year bonds using the interest payments received as income. The investor was somewhat protected against adverse price changes if interest rates increased. While all bonds lost value when interest rates increased, the shorter the duration of the bond and the higher the coupon rate, the less of a price drop when interest rates rise. In addition to interest rate risk, bonds also had credit risk, the risk that the borrower would default. The lower the bond rating, the greater the risk of default. "Interest rates have been rising since July 2012, and I expect this trend to continue," Mike said. "I believe the interest rate rise will be slow but steady as the economy recovers from the 2008-9 recession and financial crisis. But, what if I'm wrong? What if there is a steep jump in interest rates? That would trigger a sell-off that would further depress bond prices. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.