Real Estate Bonds: Everything You Need To Know

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September 30, 2022

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Real Estate Bonds: Everything You Need To Know

Investors who aim to diversify their portfolio may look into real estate bonds. Generally, bonds effectively function as a type of loan to provide funds for a borrowing account, which often involves a body of government or corporation.

Bondholders receive interest on their loan, and the borrower has to pay back the entire principal by a predetermined deadline, also called a set maturity date, per the bond’s terms of the agreement. With real estate bonds, an investor can earn passive income thanks to the issuer's consistent interest and principal payments.

What Are Real Estate Bonds?

Real estate bonds are a fixed-income financial instrument. In simple terms, investors benefit from being paid interest during the investment period until the maturity date. The date mandates when the borrower pays the principal amount plus interest to the lender. 

Distinct from the most common bonds, including U.S. Treasury bonds and municipal bonds, real estate bonds are typically backed by land or property. Additionally, real estate bonds potentially finance diverse undertakings and ventures. Issuers of these bonds may invest funds from lenders across various sectors, such as commercial, industrial, and residential assets.

Unlike stocks, which are traded publicly on an exchange, bonds tend to be sold through brokers. The exception is a Treasury bond, as investors can purchase it from the government directly.

How Do Real Estate Bonds Work?

A company or governmental body could turn to issue bonds to investors to raise capital. Bonds work like an IOU, where investors lend money to a borrowing account for regular interest payments and the original sum they paid for the bond. The contractual agreement for a bond usually lays out the details for the set maturity date and the annual percentage rate (APR) that determines the interest charges.

Using the funds from lenders, the bond issuer may invest in residential, commercial, and industrial real estate properties. Then the real estate bonds potentially generate income from rent or mortgage repayments. This cash flow can allow the issuer to make interest payments to the bondholders until the set maturity date when the principal is due.

Investors must tolerate some degree of risk when buying real estate bonds. There is a chance the bond issuer, especially a startup, may declare bankruptcy and default on interest and principal payments. Alternatively, economic conditions like inflation could influence the overall value of real estate bonds.

Are Housing Bonds the Same as Real Estate Bonds?

Housing bonds, also called mortgage revenue bonds (MRBs) or multifamily housing bonds, are often tax-exempt and issued by a municipal authority, such as a local or state government. Federal income tax does not apply to interest accrued on the bonds, and certain states may also exempt income taxes on MRBs. This allows investors of housing bonds to enjoy tax advantages. 

The objective of MRBs is to support affordable housing initiatives by financing the development of apartment complexes for underprivileged families. In addition, the bonds may also fund low-cost mortgages for homebuyers purchasing their first home whose income is equal to or less than the area median income.

What Are the Risks Involved in Buying Bonds?

As with any type of investment vehicle, bonds have several risks. From economic inflation to the issuer defaulting on payments, here are a few considerations before investing in bonds.

Economic Inflation Risk

Inflation occurs when prices of goods and services are trending toward an upward trajectory. Individual investors may experience a decrease in purchasing power, and the fixed interest rate on their bonds may not keep up with inflation, which could lead to a negative return on investment. For example, if a bond provides a 3 percent annual percentage rate (APR), but inflation rises to 5 percent, then the investor fails to benefit from worthwhile gains.

Default Risk

Before investing in bonds, it is important to do due diligence and determine a bond issuer’s creditworthiness. Suppose the company has a poor history of making interest or principal payments on time. In that case, this may indicate that the issuer is likely to default on its bonds eventually. 

A simple way to quickly gauge the safety of a public company and its bonds is to examine the amount it makes in interest payments compared to its operating income. This information can be found on the corporation’s most recent annual income statement. The company should have enough earnings to support its regular payments and other expenditures.

Call Risk

A company or body of government could retire its bond prior to reaching the set maturity date. If there is a downturn in interest rates, the bond issuer could resort to this move. This is similar to how a homeowner potentially refinances their mortgage to take advantage of lower interest rates that have decreased over time.

Are Real Estate Bonds a Good Investment?

Depending on your investment goals, real estate bonds could be feasible as a part of your investment portfolio. Questions to consider before investing your money: Are you saving for retirement or building an emergency fund? For the former scenario, how many years out from now do you plan to retire? 

Bonds may be suitable for your needs. Bonds may be ideal for your needs. Bonds may be suitable for your needs; if you require a fixed income through consistent and predictable payouts from the borrower, then bonds may suit your needs. 

Before investing in real estate bonds, evaluate your risk tolerance as well, since many consider bonds relatively safe compared to stocks. In a case where your retirement is multiple decades away, investing in stocks could yield higher returns than bonds alone, though there is much risk involved with the stock market.

For the most part, investing in real estate bonds may help you diversify your portfolio if that is your objective. When in doubt, consulting a qualified Certified Financial Planner (CFP) or Personal Financial Specialist (PFS) is a good idea. A CFP and PFS can advise on wealth management and how to approach your investing strategy. 

How Are Real Estate Bonds Different From REITs?

In 1960, Congress inaugurated Real Estate Investment Trusts (REITs), which allow citizens to invest in substantial commercial real estate properties, such as malls, warehouses, and hotels. Individual investors who become partial owners of commercial real estate through REITs could earn an income through dividend payments.

Unlike real estate bonds, publicly traded REITs can be bought and sold on a stock exchange. However, not all REITs registered with the U.S. Securities and Exchange Commission (SEC) are available for trading. Regardless of whether or not the REIT is publicly traded, it needs at least 100 shareholders after existing for a year from its established date to maintain good standing with the SEC.

In addition, REITs have to pay dividends to investors that equal a minimum of 90% of their yearly taxable income. As a result, this investment vehicle tends to offer investors a higher fixed income than many bonds. The SEC also requires a board of trustees or directors to oversee and manage a REIT.

What Should I Consider Before Investing in Bonds?

The first step involves conducting research and doing your due diligence, whether you’re a beginner or an experienced investor. Become familiar with brokerages and the different types of bonds, which range from corporate bonds to savings bonds. Each bond potentially carries its special kind of risk.

Find a reputable corporate entity or body of government issuing bonds. If possible, research the bond issuer’s background to see if they have a history of defaulting on loans. Then review the terms of agreement for the bonds carefully. Make a note of the annual percentage rate (APR) and the set maturity date, and determine if these terms align with your long-term and short-term financial goals. 

How Do I Invest in Real Estate Bonds?

Regulated by the SEC, Compound Banc makes investing in real estate bonds easy. Compound Banc offers investors a user-friendly app to streamline the process of buying real estate bonds without any maintenance fees or hidden costs. The app is available on the Apple Store and Google Play.

Compound Banc sells real estate bonds at a modest rate of $10 each using proprietary risk management technology. Every real estate bond provides the investor with a 7 percent annual yield (APY) fixed-income stream, which compounds daily. Establish your passive income stream today by investing in Compound Banc’s real estate bonds.

Sources:

Bonds | Investor.gov 

Individual - Treasury Bonds 

APR and APY Tools 

Housing Bonds — NCSHA 

Investor Bulletin: Real Estate Investment Trusts (REITs) 

Types of Bonds | FINRA.org 

SEC.gov | Rules, and Regulations for the Securities and Exchange Commission and Major Securities Laws

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