So, I admit it. I’m addicted. Have been for decades. But I didn’t start out that way.
My entrepreneurial addiction started around 1990 in a cubicle at Ford Motor Company in Dearborn, Michigan. I had recently graduated with an engineering degree and an MBA. Like most of my classmates, I took the corporate route.
I don’t even remember meeting an entrepreneur before that, but as I pined away in my cubicle, it sure sounded good. How many times could I rearrange my desk while I looked for something meaningful to do?
My friend Barry and I met at restaurants after work to discuss our fates. We schemed about starting an oil change shop in Farmington Hills or a property tax consulting firm. He had a great job—he was the controller on the Ford Taurus. But he knew his future was elsewhere.
I actually liked Ford. But the entrepreneurial bug had bitten, and I had bigger dreams.
I don’t want to bore you (it may be too late to avoid that already), so I’ll fast forward through the next two decades quickly.
We both left Ford and started a human resources outsourcing firm. I was finalist for Michigan Entrepreneur of the Year twice, and we eventually sold the company to a publicly traded firm.
On the side, during those years, we started two or three other businesses related to our core HR service. One survived a few years after our sale, but we eventually sold that business, too.
I moved my family to the Blue Ridge Mountains of Southwest Virginia and considered myself semi-retired.
I quickly got bored and joined a friend to flip houses. Then we started marketing them rent-to-own.
Then I started building modular homes. Then a stick built home. I tried a niche of selling brand new homes with lease-to-own financing. (That was a big fail.)
Then I set up a firm to buy and flip expensive waterfront lots. And I developed a subdivision.
I got into online marketing and set up a firm to generate leads for real estate agents selling lakefront residential properties.
When real estate was in the tank, I learned the trade of copywriting and wrote marketing letters on contract for three other companies. And I wrote the first of two real estate books.
And then there was the wireless internet company we started, a cost segregation analysis gig I did for commercial property owners, the oil and gas investment firm I was involved with in North Dakota, and the Hyatt hotel my partner headed up.
Makes you tired just hearing this list, huh? You can imagine how tired I was.
My business partner has a small jet. In 2011, when he was flying to North Dakota frequently to check out oil investments, we realized they had a critical housing shortage. Guys were sleeping on the roadside in their pickups or living in flimsy RVs in the 40-below winter.
We were both involved in real estate, so we grabbed the opportunity to buy 80 acres in an un-zoned area along a main road. Within a short time, we built a multifamily facility with over 100 doors. We knew nothing about the business, had never heard of a rent roll, and initially managed it using Excel.
There’s a benefit to being at the right place at the right time. We rented these nice little 300 square-foot efficiencies for $3,900 a month and kept them mostly full. These were fully furnished with all utilities, and the oil companies were more than happy to pay our $13 per square foot rates. We managed this facility for a few years and made a lot of money.
Sensing too much competition on the horizon, we sold this asset while oil prices were near their peak.
In retrospect, this was an incredibly risky venture. We only realized the risk with the clarity of hindsight.
I considered buying another apartment building in my hometown. While I was researching this, I learned about the boom in the multifamily investment world—a boom that hasn’t slowed down to this day.
Was this a catchy fad that would fade like Chia Pets or bell-bottom jeans? Was this a cyclical business like oil and gas, which you had to time perfectly to make a profit? Was this something mysterious or confusing, like semi-boneless ham? (Does it have a bone or not? No one has answered this question and I’m still wondering.)
I went on a mission to learn all I could about multifamily investing.
And I discovered why multifamily isn’t a fad. It isn’t cyclical. It boasts fundamentals that are predictable for decades in advance. And I believe that it is a multi-generational wealth creation vehicle that will impact my children’s children.
So why do I say this?
I could tell you about the leveraged returns. The stability and safety of this asset class. The stunning tax advantages. And much more.
I may discuss these issues in the future, but today I want to discuss the demographics driving this amazing asset class that I’ve determined to invest the rest of my time, talent, and other resources into. I want to tell you about the demographics driving the perfect investment.
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Demographic Trends Driving the Explosive Growth in Multifamily Investing
Vanderbilt. Rockefeller. Carnegie. Gates. Buffet.
Household names. These legendary moguls were able to read demographic trends and apply the technology of their day to provide solutions that resulted in extreme wealth—wealth that would transcend generations, products and wealth that would benefit millions around the world.
While I was researching apartments, I looked over my life. Where had I succeeded? Where had I failed? What aspects of these business ventures did I want to replicate? Which ones did I want to run from?
And what business and/or investment class would be a fit for my goals? I realized that the boom or bust cycle that most entrepreneurs operated on was not something that I wanted to continue through the last half of my life. I wanted to invest in an asset class that was safe, stable, predictable, evergreen, and based on strong and long trends that had nothing to do with a war in the Middle East, the latest technology breakthrough, or the mood on Wall Street this month.
I wanted something with demographic trends that would last the rest of my lifetime and likely through my children’s.
Now that’s a tall order.
In the last decade, when new horizontal drilling technologies opened up a wild increase in the ability to extract oil from hard-to-access rock, places like the Bakken oil fields of North Dakota exploded. Posted job openings exceeded 18,000, and thousands slept in their trucks or set up tents in this harsh environment.
I saw it firsthand. Hotels, motels, man-camps, RV parks, condos, townhomes and apartments popped up all over the plains. It was literally amazing to watch former prairie towns like Watford City go from 2,000 to about 10,000 almost overnight.
Some North Dakotans recalled the ’50s boom and bust cycle, and they warned about what could happen. More remembered a similar cycle in the early ’80s.
But North Dakota had rocketed past California and Alaska to become the second-highest oil producing state, and the press and many well-meaning bloggers proclaimed:
“This is Not a Boom… This is an Industry!”
So everyone “knew” that oil prices wouldn’t retreat below the recent range of $80 to $100 per barrel, right? And most of the developers who poured millions into real estate there ignored the simple laws of supply and demand (both for oil production and real estate availability), as well as the lack of diversity of the economy, as well as… well, you get the picture.
There were 18,000 job openings, so if we build it, they will come.
Yeah right. You probably know the rest of the story. It didn’t end well for most of these developers.
Anyway, I was 50 and certain I wanted to stop swinging for the fences. I was eager to find something stable and profitable. I wanted something I could count on for decades and beyond. Something I could teach my children. Something that would give them some of the same opportunities I’ve been blessed with, but without the painful learning curve that I (and most entrepreneurs I know) endured.
I found that opportunity in commercial multifamily investing. And the strength and length of demographic trends are one of the most important factors that caused me to invest my time, talent, and resources into this space.
I’m not alone. The national press has been buzzing about multifamily investing for the past several years. A steady stream of headlines tell the tale:
- The U.S. Rental Market is On Fire
- Multifamily Sector Sees New Confidence and Securitization
- The Apartment Boom: Multifamily Continues at a Torrid Pace
- US Multifamily Investment Enjoys Record-Breaking Year, Tops $139 Billion
So what are the demographic trends that have caused the significant growth in multifamily investing? As you review these, please note both the strength and the length of these trends. They’re not going away any time soon, and in fact, they appear to be increasing.
The Big Picture
Rental housing in general is synced to one obvious key driver: the number of renter households. As the number of renters in the nation, a market, or a submarket increase, the multifamily business becomes more profitable and attractive.
You may say, “Yeah, like North Dakota, right? What happens when millions of new units are built? And renting goes out of style again?”
Great point, reader! Those are the types of questions I was asking when I entered this space. Hang with me.
According to John Burns Consulting, new renter households were forming at 7.7 times the rate of new construction from 2010 through at least 2015. Think about it. During the same years that people were losing their homes to foreclosure (and therefore moving into rentals). Their average wages were dropping, and credit markets were tightening for all new construction, which included multifamily.
This caused a significant new apartment supply and demand imbalance. Since most everyone who can afford it prefers newer and nicer, this imbalance obviously trickled straight down from new properties to existing ones, and owners have been scrambling to update their units and raise their rents.
That has trickled down further into older, uglier properties, single family homes, condos, and more. The multifamily industry has expanded rapidly.
This imbalance is partially due to the increase in U.S. population for sure. But that’s not all, because…
Home Ownership is Significantly Declining in the United States
When I was first introduced to this stat, I was suspicious. Is this a temporary setback in homeownership? Strictly a result of the recession? That played a role, but if you look at the long-term trend, it is simply returning to more of a norm after a decade-long failed experiment in government tampering from 1995 to 2005.
You see, in the mid-90s, the federal government, in its great wisdom, thought it best that many more of its citizens stop renting and fulfill the American Dream of homeownership.
So they passed legislation that significantly lowered the bar for people with marginal credit, no savings, and lower wages to buy a home, sometimes a very nice home.
You remember ARMs, stated income, and no-doc programs, right? “Just write down whatever you want on the loan app, and we won’t even check it. Congratulations on your new home!”
I know someone who earned about $50k per year who bought a 7,000 square-foot old mansion for $600,000. As a second home!
His plan was to get cash back from seller at closing, invest that cash in a trading system he studied, then use the profits from trading to fund his mortgage payments. He didn’t have the home for long till the bank got it back.
Needless to say, once folks started—then stopped—making payments, it caused a bad situation. Then the economy slowed, incomes dropped, and home values plummeted.
Millions who had qualified for then purchased homes lost their homes and returned to the renter pool. (This includes the guy with the second mansion, he not only lost the mansion, but was forced to ditch his family’s primary home, and they moved to a two-bedroom apartment.) Home ownership normalized again, and, of course, the government blamed those mean bankers.
The homeownership rate, which peaked above 69% in 2005, has returned to a more normal rate around 63%. And it continues to drop. Check out this graph.
Note that every 1% decline in the homeownership rate translates to about a million new renters. Will we eventually be like Germany, with home ownership rates in the 40-50% range?
Also consider that this historical snapshot demonstrates another fact I really like about multifamily investing: It is counter-cyclical. It has a built-in buffering feature in down economies.
While there was certainly downward pressure on rents in the 2009-2012 era, that pressure was offset by the fact that millions of former homeowners had suddenly become renters. The multifamily business did not suffer to the degree of the housing market in general. And it recovered far more quickly.
The national default rate on multifamily loans is very low. If you take out the four sand states (CA, NV, AZ, FL) with the largest boom-bust cycles, the default rate drops even more. The rate is even lower in stable markets with balanced supply and demand. Top operators with good property managers do much better than this.
Related: 5 Darker Aspects of Entrepreneurship You Need to Accept Before Taking the Plunge
Check out the following graphic showing serious delinquency rates from the Housing Finance Policy Center’s 2015 chart book. As you can see, the Freddie Mac delinquencies (60 days late on mortgage payments) peaked for single family homes at about 4% in late 2009. (FHA loan delinquencies actually hit about 9%.) About the same time, Freddie Mac’s multifamily delinquency rates peaked at only about 0.4%.
At the time of this report, Freddie Mac residential delinquency rates were just below 2%. At the same time, multifamily delinquencies sat at a mere 0.03 to 0.05%.
So the multifamily delinquency rate, at its peak, was 90% lower than the residential rate in the worst downturn since the Great Depression. Then it retreated further to about 98% lower than the residential delinquency rate by early 2015. Did you catch that? Another reason to love the multifamily sector!
Check it out:
Note that the high foreclosure rate on single family homes was in spite of government intervention trying to save homeowners from foreclosure. A benefit not necessarily afforded to commercial property owners. Here is a quote from Freddie Mac’s Multifamily Research Perspectives 2012, in the midst of the recession:
“The percentage of loans in foreclosure proceedings can be used as a measure of single-family housing market conditions. Based on MBA’s (Mortgage Bankers Association) National Delinquency Survey, the foreclosure rate has skyrocketed from around 1% in late 2005 to a historical high of 4.6% by 2010; since then it has decreased from the peak but is still at an elevated level of 4.3%. Foreclosures increase both the supply of housing available and the demand for housing. Even with economic growth we do not expect a rapid decline of the foreclosure rate. Over the past several years, the pipeline of non-performing mortgages to be resolved has become large. In addition to various government efforts to reduce distressed sales, delayed bank repossessions, legal issues, property maintenance, and other issues continue to complicate and slow down the current foreclosure process. There are still 1.4 million foreclosures in process and an even higher number of underwater mortgages (11 million) according to the CoreLogic 2012 May Foreclosure Report. Generally, a higher foreclosure rate is an indicator of a weaker homeownership market. We expect high foreclosure volumes to continue.”
I was impressed with all of these statistics, but I was curious. Why? What has driven this spike, and why should I believe it would continue? To answer that, we need to look at the fundamentals driving this trend. I will review several here.
Multifamily Demographic Driver #1: Baby Boomers Are Flocking to Rental Housing
The Baby Boomers are the nation’s second largest demographic group ever. This group consists of individuals born between 1946 and about 1964.
As of the 2010 US Census, about 77 million baby boomers were alive and kicking. Dramatically increasing lifespans mean that this group will play a major role in the economy for many years to come.
“But don’t Boomers typically own their homes?”
Not as much as you may think. For a variety of reasons, Boomers have been selling (or losing) their homes and renting. Polls and stats say that, on average, when they return to renting, they never buy again.
Excerpts from CNBC article: “The U.S. home ownership rate is at the lowest level in 25 years and is widely expected to go even lower. That’s not just the result of younger Americans struggling to make ends meet to save for a down payment… It is increasingly the result of middle-aged, higher income Americans choosing to rent.
Renter growth is now at the highest level in 30 years, and families or married couples ages 45–64 accounted for about twice the share of renter growth as households under age 35, according to a new study by the Joint Center for Housing Studies at Harvard University. In addition, households in the top half of the income distribution, although generally more likely to own, contributed 43 percent of the growth in renters.
Duncan pointed to demographics. Baby boomers are now moving out of their homeownership years, while Generation X, a smaller group by 6 million to 7 million, also has a growing preference to rent after being hit hard during the recession, losing income, credit and even their homes.
Because of that, rental apartment occupancy is now at an all-time high, and rents are rising at twice the pace of inflation. In turn, that is putting pressure on renters young and old, but not necessarily pushing them to homeownership. Higher rents mean it is more difficult to save for a down payment.”
Multifamily Demographic Driver #2: Millennials Are Choosing or Being Forced into Rental Housing
Millennials now top the Baby Boomers at about 80 million strong. This is the census block group born in the ’80s and ’90s, also called Generation Y or Echo Boomers.
This group makes up the bulk of recent new household formation, and their propensity to buy homes is surprisingly low. While new U.S. households have typically bought versus rented at a 65/35 ratio, the past several years have seen a striking reversal: New households are now owning versus renting at a 25/75 ratio.
“Since 2005, an average of 804,000 new renter households per year have been created compared to just 75,000 per year from 1990 to 2004. That’s a stunning annual increase of 1,040%, inverting the ratio of homeowner/rental household formation to 25/75 from its historic ratio of 65/35.”
—HUD & US Census
Related: 4 Ways Technology is Shaking Up Commercial Real Estate (& Why Multifamily Will Pull Ahead)
Echo Boomers are largely disenfranchised with the concept of homeownership. They’ve watched their friends and parents lose their homes in the recent recession. After many grew up believing a home was the cornerstone of their investment portfolio, they watched this “fact” dissolve into a myth before their very eyes.
Gen Y-ers want a more flexible lifestyle. They are less likely to stay in one job, one home, or one city. Why lock oneself into a 30-year contract to a seemingly overpriced home and forego the flexibility to pick and move for a better job or new friends next year? Access to public transportation is better from many multifamily properties, and even a car means insurance, repairs, gridlocked traffic, and environmental consequences.
A study by GoBankingRates found that “62% of Americans have less than $1,000 in their savings accounts and a third of those under-savers have no savings account at all. The most frequently selected amount that people say they have in savings is zero. 28% selected this answer. Even worse, the next-most-common answer is ‘I don’t have a savings account,’ selected by one in five people (20.7%).”
Millennials also carry a record debt load. Student debt is at an alarming level, and this generation doesn’t appear to place a big value on saving up money. This would have mattered little in purchasing a home a decade ago, but the crash has tightened lending restrictions back toward the historical norm. Nevertheless, this generation’s saving and debt trends are anything but the norm.
Excerpts from Forbes article:
“With Millennials facing an unemployment rate of more than 8% and $1 trillion in student loan debt, they’re increasingly renting instead of buying homes. In fact, the true home ownership rate for 18-34 year-olds has fallen to a new low: 13.2%. But finances aren’t the only reason for the dip in homeownership. Millennials are recognizing the many benefits of renting — including reasons that have nothing to do with money.”
The article goes on to detail benefits in the following categories:
- Love of Amenities
- Love of Community
- Love of Flexibility
- Love of Convenience
“The ultimate benefit of renting may arise from the flexibility of leaving for any reason, especially career reasons. Millennials tend to change jobs three times more often than their older counterparts and stay with the same employer for just three years on average, according to the U.S. Bureau of Labor Statistics. Renting instead of buying makes transferring to a new or better job much simpler. Some leases may even include a termination clause that specifies acceptable reasons for early termination, such as a job transfer that is more than 50 miles away. In some cases, the tenant may not be liable for any payment if the unit is re-rented within a particular time period.”
Multifamily Demographic Driver #3: U.S. Immigration Continues to Grow
As a group, U.S. immigrants, regardless of source location or socioeconomics, rent more often than they own and rent for longer periods of time.
A Harvard housing study said, “About half of all immigrants are renters, including 74 percent of those under age 35.”
Check out this graph showing the effect that immigration is having on the U.S. population. Assuming that immigrants continue to prefer renting at a higher percentage than non-immigrants, it will be hard to overestimate the impact of this powerful driver.
This study states, “Immigrants can also have a lower access to the housing and credit markets. They lack information on these markets and they may suffer from discrimination affecting not only the screening of housing units but also the type of mortgage and insurance made available to them. Even if some immigrants access homeownership, they may be more vulnerable to adverse economic shocks that could make them default on their mortgage and force them to resell their dwelling.
…staying in the rental sector can be a choice for some immigrants who prefer to make financial transfers to their family in their home country or accumulate wealth to purchase a dwelling in their home country after return migration.”
Conclusion: This is Big. Really Big.
I was thoroughly convinced by the demographics that the multifamily business had a sound future. The numbers show a strength and undeniable length that should go on long after my lifetime.
I was now a serial entrepreneur converted to a multifamily investor and syndicator. I would never go back.
So how about you? Are you convinced?
Feel free to agree or disagree—let me know your thoughts below!