Posted about 7 years ago

Why Multifamily Real Estate?

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Over the past several years, financial wealth, success and stability have become important goals in my life moving forward. For me, financial wealth comes through education and hard work in an industry I believe will bring me the most success in life, moving towards the goals I have personally while assisting others with their own investment columns.

This has led me towards the real estate industry. My love of real estate originated through my desire to learn about and invest in a sector that I am truly passionate about. This passion began when reading Robert Kiyosaki’s ‘Rich Dad, Poor Dad’, which showed me the importance of both financial education and real estate and how they are some of the most powerful assets in today’s investing world. From here, I have researched numerous sources about how I can become successful in the real estate investment industry. As my knowledge of the sector has deepened, my area of focus has narrowed in on the specific niche of large multifamily apartments where I am currently assisting a firm with their acquisition of properties here in Phoenix, Arizona.

In this article, I share with you why I believe multifamily real estate is one of the best investment vehicles and the significant steps you can take to adding multifamily real estate to your asset portfolio.

What is multifamily real estate and why is it such a good investment
Specific benefits of multifamily real estate
How you can position yourself to invest in multifamily real estate

Multifamily commercial real estate is seen as a large-scale version of the real estate investing that many people know of or do with Single Family Homes. Multifamily commercial real estate is defined to include any apartments 5 units or more. Most real estate investors start their journey by investing in smaller apartments – duplexes, 4-plexes or 10 or 20 unit buildings. This requires being actively involved in managing the investment and most high-income earners simply do not have the time or desire to do so.

Because of the limits on their time to manage these investments themselves, most high-income earners prefer to be passive investors in attractive assets. In my experience, instead of trying to learn and do everything themselves, they would prefer to focus on their area of expertise, whether it be medicine, law, accounting, or business, while making their capital work for them by investing in attractive asset classes like multifamily properties.The SEC regulations prohibit advertising to the general public, which puts an extra layer of mystery around these investments. As per regulations, only accredited investors are able to invest in these types of areas.

My objective as a real estate syndicator is to enhance the value of investments through extensive renovations, while maximizing returns to investors and providing residents with an improved quality of living. This is done by targeting highly desirable locations in close proximity to large employment centers, major thoroughfares, public transportation access points, public schools, retail areas and grocery stores.

The end result is affordable, high quality properties in desirable locations, that are acquired at a discount relative to their respective and local market.

Value Add

As you may or may not know, large multifamily apartments are valued on income production like a business, unlike non-commercial (> 4 units) residential properties are valued on comparables. At its most basic formula, Market Value = NOI (Net Operating Income) / Cap Rate (Cap Rate is the return an investor would expect to earn if they paid 100% cash).

This results in my most favorable method to increase the market value (and equity) in a property. For instance, when investors find value-add properties and increase the NOI, they can greatly increase the market value (and equity) of the property, even if the general market conditions stay the same.

For example if a multifamily property is valued at $1M at a cap rate of 6%, we should expect a return of $60K annually. If the cap rate stays the same and we increased the NOI, the market value will increase exponentially. If we are able to increase NOI by only $15K, the market value would have increased by $250K! This concept is known as forced appreciation and is what makes apartment investing so powerful yet so easily confused by the average investor.

It is imperative to know that we are not relying on comparable properties to drive appreciation as much as looking at what value-add opportunities we have and what residents would be willing to pay in order to increase its over all value. This allows us to have more control in driving value than reliance on outside forces.

Leverage

Leverage is the other big factor that is in a real estate investor’s favor. This goes for all real estate, but is especially powerful in multifamily apartments as we combine leverage with scale where 200 units beats out 1 unit any day of the week. As an example, if we bought a $1M apartment building for cash and the building generated a NOI of $100K/year, then we are getting a 10% ROI (return on investment).

If we assume we purchase the property with the standard 20% down payment (or $200K) and added value to improve the NOI by 50%. Our new NOI would be $150K/year, less new debt payments of $50K, would result in a NOI of $100K (which is the same as buying all cash). However, $100K (NOI) / $200K (down payment) now results in a 50% ROI vs. the 10% on the all-cash deal! This is the power of leverage. The table below for a quick summary of the above example:

Tax Benefits

(* I am an not a CPA so please consult with a professional CPA for tax advice)

Along with forced appreciation and leverage, the tax-advantaged nature of commercial real estate is another major attraction for investors. As already mentioned, syndicators target preferred returns of 8-10% and these can offset as a paper tax loss on your annual K-1 partner distribution tax statement. This is because depreciation (the mother of all deductions!), property taxes and loan interest are significant deductions that offset gains.

Over the course of an average 5-year holding period, with accelerated depreciation, syndicators can easily ensure a stream of positive cash flows offset by tax losses. Put simply, the investor does not have to pay taxes on income. Additionally, most value-add syndicators frequently do a cash-out refinance (akin to refinancing your paid-up residence or getting a loan through a home equity line of credit (HELOC)) after renovations are complete and the NOI is stabilized. The IRS considers the refinance as a return of capital and hence, this is not considered a taxable event. At the time of sale, there is some depreciation recapture, but the expected gain at sale is taxed at the long-term capital gains which are currently 15%.

Strong Rental Demographics

Maslows Hierarchy of needs is a description of the basic human needs that are said to be a necessity for human motivation and behavior. The need for shelter falls into this research through the aspects of Physiological needs.

Maslow states that “Physiological needs are the main physical requirements for human survival. Physiological needs are considered the first step in internal motivation according to Maslow's hierarchy of needs, with shelter being one of the top needs. If these needs are not achieved, it leads to an increase in displeasure within an individual.”

There are an abundance of Americans that are renting their homes instead of buying either by necessity or choice. Shelter is a non-negotiable need with all people and with demographics pointing towards renting apartments, apartment investing is one way that we can provide this quality shelter. With this, we are seeing a major trend shift when it comes to housing in the US over past decade. Home ownership in America has declined from 69.2% (2004) towards the mean of 64% (today). This displacement has driven, and will continue to drive, households out of residential owner-occupied property to renter-occupied apartments. There are numerous statistics pointing towards why this shift is occurring due to two major age groups that will push homeownership to the side and bring apartment rentals to the forefront of housing. These two groups are the Millennials (1981 - 1996) and the Baby Boomers (1944 - 1964)

Millennials

Millennials (ages 23 to 28) are the largest rental group with around 71 million Americans and is set to surpass the number of Baby Boomers, who are currently the largest group in America. The new households aged 18-30 are driving increased rental rates as more people in this younger generation are choosing to rent. Growing up through the 2008 recession has left many millennials disenfranchised with the concept of home ownership and 75% are more likely to rent than own. This is an extremely favorable statistic when looking at the need of apartment opportunities and investing in them across America.

Baby Boomers

Baby Boomers are the largest demographic group in the US with around 74 million in this range, and are the second largest renter group in America. Many baby Boomers are starting to transition from home ownership to renting and are likely never to own again. As the lifespan continues to increase, their rental demand lifecycle is expected to increase over the coming years. This demographic is drawing investors towards both multifamily apartments and senior apartment living.

Multifamily properties exhibit greater resilience in maintaining asset values and have experienced lower volatility with market rents and occupancy levels relative to other property types. Even during the last housing crisis (2008-2010), annual occupancy of Class B and C apartments were strong on average across the US.This is because in volatile timesClass A- and B+ renters may be forced to trade down to Class B/C multifamily. Newer and younger entrants to the renting pool also tend to look for value properties. B/C class fills needs in both robust and weak economic cycles.

How You Can Get Involved

The hardest thing about real estate investing is actually taking the plunge or as we say in Australia ‘Having a go!’. Like anything we do, we don’t gain experience or understanding from just sitting on the sidelines. There are a few steps that you can take as an investor to get in the business of commercial multifamily real estate investing.

Be Educated: By reading this article you should now have some new knowledge as to what multifamily investing is and how it can be beneficial to your portfolio of investments. There are many books, blogs and podcasts in which professional investors provide quality knowledge for you to learn more about this industry. Remember, education is the key step to financial success
Network: Reach out to people doing what you are interested in. BiggerPockets is the ultimate place to do this and I can assure you, professionals will be more than happy to discuss what they do with you.
Find a Deal: There are ways for everyone to invest in commercial real estate. Accredited investors can utilize their network (people like me) to find private firms that offer great returns for passive investors. Check out how to vet a deal sponsor. Non-accredited investors also have options. If you are interested in getting in on the action, provide your assistance to an investor to learn the ropes. You can also utilize online crowdfunding investment platforms, for example CrowdStreet or RealtyShares.

If you are interested in hearing more please do not hesitate to contact me and I can share some closed deals to help educate you further possibilities. If you’re accredited, we can spend time discussing your goals and objectives to see if any future opportunities would be a good fit for you. What is most exciting is finding an asset class that can accelerate your financial goals and get you towards financial freedom that much quicker!

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Photos by Danika Cochiolo @ https://www.instagram.com/danika_design/