In case you haven’t heard, America’s Social Security and retirement planning system is outdated. It was never designed for today’s reality. There are several reasons why this has happened. One of those reasons is that life expectancy has increased dramatically since the 1900’s. Thankfully, men and women are living 30+ years longer today and healthcare costs are rising way faster than inflation. Because of this, it is extremely important that we make adjustments to our investment and retirement portfolios to even come close to living the life of our dreams in our golden years.
My goal with this blog post is to help you to see that you must expand your investment portfolios beyond stocks and bonds. When your true stock market returns are adjusted for inflation, they are just too low for the average investor to get ahead. So what is the answer? As investors, we must understand the magic of compounding returns as well as seek higher yielding investments for our portfolio.
$100 for 30 years at 2% return = $182
$100 for 30 years at 10% return = $1984
$100 for 30 years at 18% return = $21,270
This math shows an exponential growth curve when you are invested in assets with annualized returns above 10%. Being diligent to find investments with higher returns and tremendous tax benefits will drastically change your quality of life after your working years.
To get these types of returns, many investors have turned to multifamily real estate. The term multifamily means 5+ units. However, to really get the advantage of true economies of scale you want to focus on properties with 150 units or more. One of the reasons multifamily real estate is so attractive to investors is because properties with 5+ units are valued based on Net Operating Income and not based on comparables like residential or single family properties. This is important because the owner of a multifamily asset is able to force appreciation by simply increasing income and decreasing expenses. A simple $25 increase in rent on a 200 unit apartment complex will increase the value of that property by >$850K depending on the exit cap rate for the market.
Another advantage of multifamily real estate is that the loans for these assets are based on the property’s Net Operating Income and occupancy rate and not on the buyer’s income or credit score. This gives many that would not otherwise qualify to purchase a multi-million dollar property the ability to do so. The lenders scrutinize each multifamily property in great detail protecting not only them, but both the buyer and his/her investors in the deal as well.
After the great recession of 2008, investors realized that the values of multifamily were less volatile than single family real estate. Unlike residential, the multifamily asset class did not decline sharply because the value of these assets are based on income. When people lost their homes, they still needed a place to live and therefore turned to apartments. As a result, multifamily rents fluctuated less than home prices.
The returns on multifamily properties correspond with the asset class and the risk level of the investment. There are four different asset classes and risk levels. Class A properties have the most affluent tenants paying above average rents. The buildings are newer and have higher quality finishes, more amenities with little to no deferred maintenance in great locations. Although less risky, these properties have lower cash flow and returns for investors. Class B properties are competing for a wide range of tenants that pay an average monthly rent for the area. They are somewhat older properties and there is some deferred maintenance. These properties have adequate amenities with better cash flow and higher returns. The exit buyers are both institutional and private. Class C properties are much older and located in less than desirable neighborhoods. They are always needing renovations and updating. They have lower rents and are typically mismanaged creating amazing value-add opportunities for the savvy investor. For this reason, there is a higher cash flow and great upside. Class D properties are in very rough areas and something we suggest that you stay away from as an investor.
Another thing that is driving long term demand for Multifamily properties is the increase in the renter pool. Only half of all renters say that they want to become homeowners in the next 5 years even if they qualify for a mortgage. Some of this is driven by the millennial lifestyle choices and the fact that the baby boomer generation is beginning to downsize and looking to urban apartments for convenient services and easy access to amenities.
All of these things suggest that the multifamily market has a good decade of demand. The purchase of these multimillion dollar assets are not as far out of reach as you might think. Group buying through syndication governed by the Security Exchange Commision has made this possible for many sophisticated and accredited investors. Let's discuss how this works.
A syndication team of active investors finds an asset, contracts to purchase, performs all due diligence on the asset, organizes the investment offering, and then offers the opportunity to their pre-screened investors and then proceeds to manage the property until the sale. Passive investors can invest as individuals, using their self-directed retirement plans, family trusts or entities. The investors then invest varying amounts and receive a prorated equity share of the cash flow and value gained over the investment period. The key principles/general partners that found and put together the deal will receive a share of the cash flow and profits and a small management fee.
The syndication team will assign an asset manager and a property management company to run the property so the passive investors have zero involvement in the day to day headaches. Cash flows are disbursed on a monthly or quarterly basis to the investors, who receive their preferred returns before the management team is paid. Double digit annual returns are common in the multifamily syndication space making it very appealing to investors. This is possible because of cash flow and forced appreciation through increasing income and lowering expenses.
If I haven’t convinced you already, some other reasons to invest in multifamily assets include the fact that the professional management’s ability to use sales, cost and profit metrics drastically lowers risk and decreases the role of the passive investors. This is not typically the case with single family investments. Multifamily assets have protection against inflation. The value of multifamily and all other real assets increase with inflation. Real cash, on the other hand, will decrease in value from inflation. With the FED printing trillions of dollars out of thin air, this is something every investor needs to think about.
Lastly, my favorite benefit is the tremendous tax advantages. Multifamily properties are able to take advantage of the depreciation on the building and equipment essentially offsetting some or all of the income taxes from the properties cash flow. Last but not least, multifamily properties have economies of scale on their side. These benefits include vacancy impact, marketing more efficient, repairs and maintenance is more cost effective, etc.
The advantages of adding multifamily syndication to your portfolio are obvious to the sophisticated investor. We would love to help you diversify your portfolio by educating you on this amazing asset class. We are currently underwriting multiple deals and would like to add you to our preferred investor list. Give us a call today!