Is there a better alternative to the stock market?
Investing in the stock market has been the standard advice from financial planners for decades; however, we’ve learned over and over again that the stock market can turn on a dime and market volatility can erase years of growth without notice and without prejudice. After reaching record highs in January 2020, the stock market lost over one-third of its value by mid-March. What’s more, this is not a new phenomenon – similar drops have occurred numerous times since 2000. With so much on the line – from retirement accounts and pension plans to college savings – is there a better alternative to the stock market that can deliver solid returns without the volatility? In this blog, I will discuss how investing in multifamily real estate (apartments) can bring very stable, high-yield returns.
What is multifamily?
When most people think of real estate as investments, they think of single-family homes, which are considered residential real estate; however, in commercial real estate, there are four main property types: office, retail, industrial, and multifamily. Of these property types, multifamily has historically produced the most consistent high-yield returns and has been the most resilient in economic downturns. By definition, multifamily commercial real estate is any property that has five or more housing units. Most people refer to these as apartments.
What makes investments in multifamily so stable and resilient?
There are many reasons that multifamily investments generally do well. A recent article by CBRE, a national commercial lender, indicated that multifamily assets tend to lose the least value during recessions and bounce back much quicker. Here are a few reasons why this is true:
- Everyone needs a place to live. Shelter is a fundamental and basic human need and more people are choosing to live in apartments now than at any time before. During a recession, a business can disappear, which leads to vacant office, retail, and industrial properties; but people always need somewhere to live.
- More and more people are choosing to rent. Homeownership rates are at near all-time lows; millennials are increasingly delaying homeownership and baby boomers are downsizing in as they begin their retirement years; immigrants are flocking to working-class apartments. The overall demand for apartments is high and will continue to be high for the foreseeable future.
- Recessions create supply/demand imbalance. During a recession, new development tends to slow down, but populations continue to increase. By the time the recession is over, the demand for housing far outweighs the supply. This tends to be a counterbalance the negative effects of a recession and boost the growth on the back-end. During 2008-2010, average (nominal) rental prices nationwide still continued to climb while single-family housing market crashed.
- Unlike the stock market or single-family home valuation, multifamily investments are not linked with consumer confidence. Investors losing confidence will sell, driving stock prices, and market indices down.
Why are the returns so high?
This may be one of the best-kept secrets of all time. There are many reasons for historical high yields, and we’re still bullish about the future of multifamily investments. Here’s why:
- Inflation. There are two primary ways to earn returns in real estate: first, from increasing equity in the property; second, from the cash flow, and inflation drives both upward over time. The Federal target for inflation is typically about 2% per year, which means year over year, the property value and rental income of most properties generally increase by a minimum of 2% per year.
- Leverage amplifies growth. Lenders of all types will routinely provide up to 80% of the purchase price of multifamily units, meaning the ownership group will need to bring only a fraction of the purchase price to the table at closing. Assuming a 25% down payment, if the value of the property increases by 10%, the return on investment is actually 40%. Due to the leveraged position, the year-over-year increase in property value is multiplied, leading to consistently high returns that outpace inflation.
- Cash flow. One of the fundamental laws of successful investing is to find properties that cash flow. If a property has a net positive cash flow from day 1, the inflationary pressures will continue to push rents and expenses up at roughly the same rate absent supply/demand imbalances. Overall, inflation will drive cash-flow up year over year which only increases the annual rate of return. In areas of high growth, rents will typically increase much faster than inflation, which serves to push cash flow and property value up even more.
- Debt pay-down. Just like with a normal home loan, during the life of the multifamily investment, the loan principal is gradually paid down, which increases the investor’s equity in the property. The cumulative effect over several years can be significant. At the sale of the property, the amount of debt paid down is released as equity in the property, which boosts returns even higher.
- Forced appreciation. Similar to a fix-and-flip investment in single-family, an apartment building’s value will increase by making improvements to the living conditions (i.e. renovations). What’s even better is that we can renovate a small percentage of units at a time and keep the cash flowing while we renovate.
- Tax advantages. In a nutshell, because of the ability to depreciate a property (decrease its book value), it is common to show a net loss on the property on tax returns while actually making significant returns. Personally, I think this is how President Trump legally avoids paying federal taxes – and like him or hate him, you can’t disagree that finding a way to legally not pay taxes makes a person smart.
How can I invest in multifamily real estate?
We’ll discuss two main ways of investing in commercial multifamily (though there are more).
- Active investing: this is where the investor is actively seeking to purchase and manage investment opportunities. This requires time, research, and a ton of effort.
- Passive investing: this is where the investor provides funds to an active investor in exchange for an ownership percentage in the property. There are several types of funds in which you can invest in real estate or you can invest through syndication.
So, in conclusion, why worry about the volatility in the stock market? Why risk your hard-earned investments in what essentially is legalized gambling? Investing in multifamily can provide steady, high-yield investments to your portfolio that over time will outperform index funds and other types of commercial real estate. For more information on how you can invest in real estate, please visit our website at www.fouroakscapital.com.
Brian Briscoe is a founding member of the real estate investment firm Four Oaks Capital, which currently manages an $8M multifamily portfolio. He is a lieutenant colonel in the United States Marine Corps with nearly 20 years of active service and is transitioning to a career in multifamily. To contact him directly, please email him at [email protected] – and tell him you saw the article on the Military Millionaire blog.