I am often asked why I am so excited about multifamily as an asset class, given the multitude of other investment options or other real estate asset classes. There are a few reasons for this. While many of the factors below would apply to real estate in general, most references below were made to multifamily.
1) Risk vs. return. Multifamily has historically outperformed other asset classes, including during recessions. I will spare you the quant data analysis but have included a few interesting data charts in the appendix that support this conclusion and show that commercial real estate generates among the highest returns while maintaining a risk level near that of US government bonds. It is also interesting to see that on average, real estate has fewer down years relative to other asset classes.
For example, while marketable securities (stock market investments) are more liquid, they are also more volatile and as a result, over time, they have produced a lower return relative to multifamily. Such returns do not even account for other fees and commissions paid. And if liquidated sooner, they would also be subject to a higher (short-term) capital gains tax – also not factored into the return charts in the Appendix below.
Within commercial real estate, multifamily carries the lowest level of risk and generates the highest returns.
2) Potential For Multiple Sources of Return, Including Forced Appreciation. While there are many market factors driving apartment value, as an owner-operator one has the opportunity to force appreciation by improving the profitability of the property – either through revenue growth (by raising rents or creating other sources of income) or through expense reduction (by running the property more efficiently via technology solutions or negotiating contracts to keep expenses at the market or passing on some of the expenses (e.g. utility) to the tenant) or through capital improvements.
There is also the economies of scale factor, given there are multiple units under one roof.
3) Tax Deferral. In a prior article, we discussed briefly depreciation or the non-cash deduction one takes while owning a property, as it is presumed that the building depreciates due to age and wear and tear over time. This non-cash expense could often result in a paper loss that can either help offset current taxable income or other passive income or carry over the losses to offset future capital gains and thereby defers the tax liability. The benefit of such deferral is the time value of money. And if in the end there is still again, there may be an opportunity to further defer such again into the future.
4) Inflation Protection. The min-cash on cash target return for multifamily investments is 7-10%. This is above the current inflation rate and above the returns of other asset classes. However, on top of the cash flow being generated by the property, as noted above, improving the net operating income of a property (assuming all else equal) results in improved property valuation. Over time this real estate appreciation could serve as a hedge against inflation. Other hard assets share the same benefit. In contrast, keeping cash in the bank earning 1% or less in interest over time loses value as that cash loses its purchasing power with inflation.
5) Strong long-term outlook due to multifamily serving a basic human need for shelter with increasing demand driven by population growth, declining homeownership trends, and increasing share of renters (millennials and boomers).
6) Short-term leases (typically 1 yr) allow for timely adjustment to rents based on market conditions. In contrast, for other commercial real estate asset classes such as retail, office, or industrial where it is not uncommon to have multi-year leases (granted some may have built-in rent escalations).
7) Diversified tenant base. Each lease represents a small share of the total thereby creating less risk should one in twenty tenants leave for example. That is not to say there is no tenant sector concentration risk (e.g. if all 20 tenants in your building come from the restaurant sector for example) but one tenant leaving out of twenty is still less impactful vs. a national tenant or an anchor tenant in a 5-unit retail complex or a tenant in a single-family home leaving.
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Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.