Why Invest in Multifamily Real Estate

For an individual with funds available to invest, there are a variety of options:  stocks, bonds, precious metals, commodities, currencies, or real estate.  We firmly believe that the key to building wealth over the long term is to build a broadly diversified portfolio of risk assets, which includes an allocation to real estate.

Within the real estate asset class, there are four broad categories:  Industrial, Retail, Office, and Multifamily.  While each has its pros and cons, we believe that Multifamily represents the strongest risk/return profile and have built our company on this thesis.

Why Multifamily is the Premier Commercial Real Estate Asset Class

Unlike other commercial real estate assets, the primary advantage of owning a multifamily property is that it is needed to meet a basic need – housing.  Individuals and families will always need a place to live, and a multifamily rental unit presents the lowest barrier to entry.  As a result, multifamily properties enjoy a relative degree of stability over other asset classes.  However, that isn’t the only benefit.  Others include:

  • Efficiency:  All units are within the same property, which makes property management easier and more efficient than a portfolio of single-family units scattered across a wide geographic area. Also, in the construction of a multi-property portfolio, critical back-office functions like accounting and finance can be centralized to build economies of scale.  An extensive portfolio can be assembled with remarkably little full-time staff.
  • Availability of Financing:  Due to numerous government-sponsored programs and fairly straightforward underwriting criteria, debt financing is widely available under generally favorable terms.  Additionally, in-place rents can be used to make loan payments on day one.
  • Favorable Tax Treatment:  Multifamily property owners can “expense” a portion of the property’s value each year, which serves to reduce overall annual tax liability.  In addition, sophisticated strategies like Cost Segregation and 1031 Exchanges can accelerate depreciation or defer capital gains taxes indefinitely.
  • Distribution of Vacancy Risk:  An investment in a single-family home or industrial warehouse is typically occupied by a single tenant, which means it is either 100% occupied or 0% occupied.  In a multifamily property, there are tens or hundreds of units, so the impact of one vacant unit is much smaller.
  • Forced Appreciation:  Unlike residential properties, commercial properties are valued based on a metric called Net Operating Income or NOI, which is a property’s income less its expenses.  Multifamily property owners have direct operational control over rents and expenses, which allows them to “force” the property to appreciate through rental increases and/or cost cuts.
  • Low Correlation with Traditional Asset Classes:  The price movements of multifamily properties have less correlation with traditional asset classes like stocks and bonds, which means that the prices tend to move opposite each other.  When stocks are down, Multifamily might be flat or even up.

But, like any investment, there are potential downsides to Multifamily as well.

Potential Downside Risks

We want to be honest about risk.  It is present in every investment, and there is a specific relationship between risk and return.  In general, the greater the risk, the more potential variation in return.  For us, the key is to recognize risk and implement specific management strategies to minimize it as much as we possibly can.

The following list describes the traditional risks associated with multifamily properties and the actions we take to reduce them:

  • Changing Market Conditions:  Economic conditions tend to run in cycles, and a contraction will inevitably occur.  When they do, they tend to last for a relatively short period before another expansion cycle begins.  The timing of these cycles can be challenging to predict, so we are incredibly diligent about setting aside a portion of the property’s monthly income to create adequate operational reserves and screening potential residents to ensure they have stable employment and good credit. However, because Multifamily meets a basic need, it tends to perform well in a downturn.  In the last two economic contractions, Multifamily has performed better than all other asset classes.
  • Surprise Repairs:  Things break.  Major mechanical systems like the HVAC, electrical, or plumbing can be incredibly expensive to repair and can have a significant impact on a property’s profitability.  To ensure that the cost for these repairs doesn’t come out of operational funds, we set aside repair reserves to minimize the impact of a surprise large dollar repair.
  • Regulatory Burden:  Depending on a property’s location, governmental regulations can limit annual rental increases or create high costs for adherence to their rules.  New York and California are notorious for this.  These burdens can be avoided by operating in traditionally tenant-friendly markets like Georgia and North Carolina and by performing a significant amount of research before making a purchase.
  • Changing Tastes:  Over time, the changing tastes of residents or potential residents may render a property’s layout or finishes undesirable.  To protect against this, we thoroughly evaluate a property before purchase and plan for needed renovations to bring the property up to current standards.

Again, all types of investments carry risks.  The key to a successful investment is to be aware of the risks and to proactively plan for ways to minimize them. As multifamily owners, we have direct operational control over the property, which makes the risk/return profile of a multifamily investment preferable to the alternatives.