Multifamily Real Estate And Diversification: Taking A Long-Term Approach To Investing
With an eventful year thus far led by geopolitical events, high inflation and rising interest rates, investing in real estate might be the last topic on one’s mind. The current global uncertainty affects local communities and opportunities for growth. Given the current environment, investors must be prudent when making investment decisions by putting pressure on identifying viable opportunities with appropriate risk/reward ratios. By analyzing alternative diversification benefits, fundamental demand drivers and long-term value appreciation, investors can make well-versed decisions when it comes to wealth preservation. As an alternative investment, real estate is a long-term approach that can be fruitful despite economic turbulence.
Diversification Benefits
Diversification has the ability to improve returns and mitigate risk through stabilizing results. Each asset class has characteristics that will react differently to the different environments that occur over time. Through exposure to different assets, investors are able to reduce asset-class risk while navigating through business cycles.
Multifamily real estate is an alternative investment, giving investors exposure to opportunities outside of the public equity and debt markets. Historically, only a small percentage of individuals diversified into alternative investments, while a larger percentage of endowments and pensions managed their portfolio diversification with alternative exposure. Within real estate alternative investment allocations, multifamily has been a safe haven for many investors as rent growth has historically outpaced inflation. I’ve seen this firsthand as the CEO of a company that specializes in multifamily property.
In theory, the diversification from this investment strategy should stabilize returns in an inflationary environment through rental growth outperformance and real asset appreciation. Rental growth drives property revenue, which in turn expands net operating income, producing a higher cash yield for multifamily investors. The acceleration of rental rates is supported by strong labor market fundamentals, wage inflation and an undersupplied housing market.
Rising construction costs have increased the replacement cost for future residential supply additions. As construction costs escalate, the median home price for single-family gets higher. This issue is compounded in a rising interest rate environment, as higher mortgage rates make home ownership unattainable for some buyers. Barriers to entry for single-family home ownership will likely fuel apartment demand growth and multifamily valuations as Gen-Z and Gen Alpha add to the rental base of millennials. Median home price acceleration has also been a function of real asset inflation.
The personal consumption expenditures price index is at a 40-year high, and there is ample uncertainty about how quickly and sustainably the Fed will continue to increase rates and modify its balance sheet policy. Year-to-date, the Federal Funds rate has increased at a rate not witnessed since the early 1980s. Generally, multifamily has moderate to strong performance during challenging economic environments, with the exception of 2008 through 2010. As inflationary price pressures persist in a rising interest rate environment, I suggest investors think about long-term investments instead of attempting to time the market.
Long-Term Value Appreciation
The goal of long-term multifamily investing is to preserve wealth in tangible, tax-advantaged yielding assets that should experience significant value appreciation over time. Ultimately, what is invested today should be worth more in the future. Overall, I’ve observed multifamily investments averaged over a 10% annual return over the last 10 years, outperforming riskier real estate assets. During this time, private real estate investments experienced substantially lower volatility than the public markets. An example of this would be viewing the public market’s reaction during Covid-19. Public markets experienced substantial volatility, while the market for private real estate transactions remained relatively stable.
While there are many benefits to investing in multifamily, there are still some drawbacks. All investments carry some risk, but it is critical to vet these opportunities based on the likelihood of these risks. Multifamily investments are not as liquid as public market investments and therefore carry liquidity risk. Additionally, multifamily direct investing is not diversified. The investor is responsible for their diversification among real estate private investments. Finally, the local economy can also affect the value and distributions from a multifamily investment. These factors must be carefully analyzed before investing.
Accredited investors looking for diversification opportunities in the private real estate market often look to a direct investment model as it can give more control over investment location and deal structure, permitting an investor to accurately diversify their portfolio. (Disclosure: My company uses this model.) It’s important to focus on identifying well-located properties—this can help investors find opportunities that sustain their value over time. Long-term multifamily investments can often generate superior risk-adjusted returns when purchased correctly in the right location. A deal-by-deal structure affords investors the flexibility to act aggressively when the opportunity warrants. Direct syndication models can also offer accredited investors diversification opportunities into the private real estate market through self-selected investments. Therefore, each investment stands on its own merits, and investors select the properties that best complement their existing portfolio.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.