There is no denying that the coronavirus has altered life as we know it. Everyone everywhere has had to make some form of concession. Governments, big corporations, and institutions in various sectors halted their plans, while individuals have taken shelter in their homes. This pause disrupted the economy and pushed our country into a recession. In the face of this reality, the big question real estate enthusiasts ask is, “multifamily housing still a viable investment after the pandemic?”
Based on forecasts and past performance, multifamily housing performs decently during the recession. In the Great Recession of 2008-2011 multifamily default rates barely hit 0.9% vs almost 5% for single family housing. In this latest cycle, multifamily is holding its own against hotels, restaurants, retail and office space and is expected to perform well post-pandemic. This article will look at six practical reasons why the multifamily property class is one of the most robust asset classes before, during and after the pandemic.
Six reasons why multifamily housing will remain a viable investment after the pandemic
1- Multi-family housing is a basic need
Housing is and will always be a fundamental human need. According to Abraham Maslow’s hierarchy of needs, shelter is a base level need. It is almost as important as food. Although demand and rent can rise and fall or become stagnant, the reality is that there will always be a demand for multi-housing property.
A recent study by the National Multifamily Housing Council supports this statement. According to the NMHC survey of 11.4 million units of legally managed properties across the country, 93.3% of multifamily apartment households paid rent as of May 27, and 89.2% of tenants paid rent in April. These trends have continued to hold and collections across our portfolio are north of 92% through the end of 2020.
This statistic lends credence to the fact that rent may fluctuate, but demand always remains. Contrastingly, other commercial property types (offices, industrial, retail, hospitality) saw a sharp decline in rents. Rent collections held at 75% in March but fell to 47% in April and 44% in May.
In summary, people will always need a place to stay regardless of the economic conditions. Moreover, the cost of renting a multi-family apartment fits an average budget. This makes investment in multi-family housing a smart choice even in poor economic conditions.
2- Multifamily loans are available, interest rates are lower than ever, creating an inflation hedge
Although the pandemic has made lenders adopt a stricter standard for loan-to-value ratios and most lenders have introduced a “Covid reserve” to prevent forbearance risk, interest rates remain dramatically low. The US 10 year treasury rate fell to levels unseen in decades, falling to below 0.6% in March and August of 2020. This rate has recovered and crossed the 1% threshold in the early days of 2021. The fact remains that interest rates are incredibly low. We are closing on a transaction in the coming weeks and our interest rate is going to be less than 3% fixed for 30 years! Just two years ago we were paying interest rates of 5% and higher. While pricing is relatively higher than a few years ago this difference in interest rate directly benefits investors. This is also a tremendous inflation hedge as debt is secured at a fixed rate for many years while rents adjust upwards with inflation over time.
3- Economies of scale and risk diversification (lower beta) vs single family
In terms of cost reduction and profit maximization, a multifamily property is more affordable to manage and offers a higher risk adjusted return. The overall management and maintenance costs are distributed among many tenants. The pandemic has affected millions of people. Having many tenants diversifies the owner or landlord’s risk. Some tenants may run into difficulties and it is in the landlord’s interest to work with them. People are people and when you treat someone with respect and fairly that is not forgotten. Most renters understand that they need a roof over their heads and the majority continue to pay rent on time. This has contributed to rent collection rates in excess of 90% on average across the industry.
4- Tax advantaged asset
The importance of tax relief has never been more important than now. The government considers multifamily properties essential for the well-being of US citizens. Multifamily properties fulfill the government’s responsibility of creating adequate housing for citizens. The government encourages multifamily property ownership through various tax laws and incentives. Notably, the depreciation tax law that allows homeowners to deduct a calculated amount of money generated from rent to cover for depreciation of property value. Under the current tax law, multifamily homeowners are allowed to take a percentage of the rental income to finance debt. There are several ways to leverage tax deductions, incentives, and grants provided by the government for multifamily property owners. The key here is that when comparing the multifamily asset class to other potential investments taxes are often not in the conversation and they should be. Multifamily is a tax advantaged asset class vs many others which are not, particularly stocks.
5- Cash flow potential
Add cash flow potential to the reasons why investing in multifamily post-pandemic is a smart decision. Many investments grow over time but do not have a significant cash flow component to them. Multifamily assets have both of these components. It is not uncommon for the right apartment building complex if operated well to generate anywhere between 5% and 10% in annual cash flow which is distributed to investors in the form of a dividend. As noted earlier rents tend to go up over time and savvy operators strives to keep expenses growing at a rate lower than the rate of rent growth, further increasing cash flow over time. There may also be options to add several amenities to increase the positive cash flow. For example, you can open a laundromat, etc. The amenities should be suited to the demography in the property. For example, if the families have pets or kids, you can offer a pet walking service or babysitting service.
6- Asset value protection and forced appreciation
A multifamily property has better insulation from price swings or market changes compared to a single-family property. The reason is that multifamily assets are valued like businesses. The value of an apartment complex is a function of how much profit or net operating income (NOI) it generates. The owners have the ability to influence the NOI and by extension the value of the property by performing upgrades to make the property nicer and in turn commanding higher rents. By executing such improvements owners have the ability to essentially force the appreciation of their asset. For this reason multifamily assets tend to appreciate over time and are more resilient to economic downturns than other forms of investments. The bottom line is that owners or operators can improve the value of a multifamily property by adding amenities to increase income and drive down expenses. While there are market cycles in all asset classes in this case the market does not entirely determine the value of the multifamily property.
Multifamily assets will remain stable during and after the pandemic for the reasons stated above and more. Despite the volatility in other asset classes, and because of the imperfections in the market, there are still opportunities to get into great multifamily properties and position yourself for the economic rebound. Multifamily is a relatively low-risk, slow and steady, long-term investment that is one of the best ways to build generational wealth in America. The vaccines are being rolled out. The government is committed to stimulating the economy aggressively with the latest $1.9 trillion proposal. 2021 will likely not get us totally out of the woods but at some point in the next 24 months the economy will be in a better place. Make sure you find a way to participate in the upside.
At Cape Sierra Capital we invest in multifamily assets and provide our investors an above average risk-adjusted returns. For more insight on this topic download our e-book The Personal Cash Flow Formula. Start participating in the benefits of investing passively in multifamily syndications.