Many single family landlords have it easy. Their tenants tend to stay for a while. They are oftentimes more stable. Some of them even take good care of the home that they are renting. It can sometimes make landlording look pretty easy. I’ve experienced this myself—many of my SFR tenants have been in their homes for years.
As you move up to the world of multifamily, you might start out with similar perks but perhaps to a somewhat lesser degree. If you own a duplex or four-plex, it’s not uncommon to have long term tenants and a fairly manageable property, evidenced by the numerous successfully self-managed small multifamily properties.
Large apartment complex owners, on the other hand, live in a different world. The tenant dynamics are much more complex, and you can find yourself managing personalities of both tenants and employees in addition to property. That’s one of the reasons why self-managed apartment complexes frequently underperform.
There Will Always Be Apartment Demand: Myth or Reality?
One of the theoretical perks of owning apartments over other asset classes is that “people always need a place to live,” so thus it must be a safer investment. I’ve even heard it said that if the economy takes a turn for the worse, tenants might stop paying their other bills but they won’t stop paying the rent, and there is always demand to fill your units. But is this myth or reality?
During the foreclosure crises of 2007-2010, it wasn’t uncommon at all for homeowners to stop paying their mortgage, and instead many were diverting their income to pay down other debt. It was the first time in history that we have witnessed a large number of people prioritize consumer debt over housing. Many apartment renters stopped paying too, and this had a big effect on many apartment owners, myself included.
When the economy weakened, many tenants lost their jobs and stopped paying rent. Many simply waited to get evicted and then moved to the next complex that didn’t screen properly. When occupancy suffers, apartment owners can be tempted to relax their qualifying standards. They also tend to offer concessions such as a free month of rent to attract tenants. These practices are the perfect recipe to attract “concession hoppers”—folks who would rent a unit to get their free month, then skip out and move to another complex offering free rent, but not until racking up another month of unpaid rent and creating a big pain (and big losses) for the owner.
Feeling the Impact of the Market
A much under-appreciated fact is that a large apartment complex will feel the impact of the broader market. Job growth will drive occupancy, and contractions in the job market will ultimately be felt by apartment owners in reduced or negative rent growth and increasing vacancy, concession and credit losses.
It’s important that when you are underwriting a potential acquisition that you project conservatively, so that you don’t have to have a perfect economy every year to hit your numbers. Doing so gives you a margin of safety when the economy moves against you, which is likely to happen at some point during your hold period. It’s better to be prepared than surprised.
The Results of Development
Development is another impact to your bottom line. If there is a 10% increase in apartment supply as a result of a run of construction, you might feel the pinch. When analyzing a property, you also need to analyze the market and what is in the development pipeline. Everybody might need a place to live, but if there are more places to live than there are people to live in them, you’ll have a problem. If there is development in your market, pay attention to the absorption rate—how many units are being leased relative to how many are being built. If absorption rates are declining and construction is not, consider this the yellow light before the red. Time to hit the brakes.
So it is true that everybody needs a place to live, but this does not always directly translate to consistent income at your apartment complex. When the going gets tough, people double up, move in with family, or move out of the area in favor of a better local economy or job market. If the economy suffers, you are likely to suffer. If occupancy in the broad market drops, your occupancy will drop, and you might be forced to drop rents or offer concessions (or both) to attract tenants.
The bottom line is that the fundamentals for multifamily are very good in a lot of markets. Done correctly, I think that multifamily is one of the best investment vehicles that exists today. But that doesn’t mean that it is a sure thing. Underwrite carefully and conservatively, pay attention to the broader economic climate and market statistics in the submarket and don’t fall into the trap of feeling invincible just because everybody needs a place to live. Happy investing!
What do you think about this myth? If you’re an apartment investor, what have you experienced in your market?
Be sure to leave a comment below.