Inherent Structural Benefits
Multifamily real estate offers several advantages compared to other commercial real estate asset classes such as office, industrial and retail:
- Demand is more consistent since people always need a place to live, and in a post-COVID world also work.
- Multifamily offers a more diverse and dependable income stream, since revenue is generated from a much larger tenant pool compared to other asset classes with a single-digit tenant base.
- The debt and equity capital market is very deep and liquid and is bolstered by government-backed lending programs such as Fannie Mae and Freddie Mac.
- Unlike office, retail and industrial where significant capital expenditures are required to attract and maintain tenants, capex in multifamily housing is more discretionary and smaller and has a higher ROI, translating into a higher rent premium.
- Leases typically have a one-year lease term and as such rents reset annually, which provides a superior hedge on inflation versus commercial properties with longer five-to-ten-year leases.
- More tax-advantaged with a shorter depreciable life of 27.5 years compared to 39 years.
Superior Risk-Adjusted Returns
Given these advantages, multifamily real estate investments tend to have a lower risk profile than other commercial real estate asset classes, and on a risk-adjusted basis offer a superior absolute return. In assessing opportunities and evaluating risk, there are a few areas to consider in addition to the standard risk factors present when investing in illiquid real estate:
- Acquiring existing product below replacement cost is a more conservative strategy versus ground-up development.
- As with any investment strategy, diversification within the multifamily portfolio—across locations, property types and tenant demographics—can help mitigate risk and maximize long-term returns.
- Focusing on landlord-friendly markets, especially in the Southeast and Midwest, is another good way to manage risk. In these places, steady population and job growth are driven by an attractive economic policy that incentivizes businesses to operate, which keeps demand for rental properties high.
- Keep leverage well-balanced and avoid over-leveraged deals.
On The Horizon
Looking ahead, investors can anticipate more opportunities in the multifamily market. Although we have yet to see a significant amount of distress in the market, we expect good-quality assets to become available as more loans come due in the next few years.
In addition, elevated rates have caused buyers and sellers to sit on the sidelines as the bid-ask spread has been wide. We believe that interest rates will likely be cut in the next few months, which will drive sellers into the market, and with a lower borrowing rate, investment opportunities will look more attractive to potential buyers. To capitalize on this opportunity, investors should continue to watch market trends, assess managers diligently and determine their own investment preferences.
The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
