Within our article library and our investor guides, we have consistently demonstrated the superiority of multifamily real estate as an investment vehicle.
Our Real Estate vs. The Stock Market guide went through real hard data that proved that real estate is a better bet for your investment dollars.
In our The Pros and Cons of Apartment Building Investing article, we took an in depth look at why investing in multifamily apartments not only provides the best returns of any investment vehicle, it is also by far the best form of real estate for investment.
We also took a look at some of the truly compelling demographic data regarding homeownership rates and a growing population of renters.
Knowing how well multifamily investments perform is only the tip of the iceberg, however. Now we have to actually decide where and how to invest in multifamily assets. There’s a lot of choices to be made when you take the plunge into real estate investment and what markets you choose for investment is similar in importance to choosing what asset type to invest in.
You’ve probably heard the tired real estate cliche of “location, location, location,” but if you’re anything like me, you don’t get much out of it. Okay, the best locations can attract the highest rents and sales prices. Seems kind of obvious, but there’s not much actionable information in realizing that.
We need to take it a step further and start looking at things in terms of renter type, markets, and sub-markets. For beginner investors, there’s often an incorrect assumption that you can only invest in your own backyard. For more experienced investors, you know that most of the top investments are made long distance.
Putting the right property management team in place and practicing sound asset management practices, you can own and operate a property from anywhere.
Check out our 5 Steps to Asset Manage like a Pro for Multifamily Investments and 5 Tips for Working with the Right Property Management Company articles for an in-depth look at these extremely important topics.
When you open the door to investing anywhere, however, it’s very easy to get bogged down by analysis paralysis.
There are so many markets to choose from and so many voices all pulling you in seemingly different directions.
In order to cut through the noise and make any progress, you need to hone in on your approach, even if that means putting the blinders on for a bit and not getting overwhelmed by the many different approaches and opinions out there.
You’ll find many similarities in how the top investors choose the markets they intend to target, but in the end, everyone has a slightly different approach and outlook.
On our Target Markets page, you can see some of the characteristics we look for when selecting a market.
We share many of those selection criteria with other top investors, such as placing extreme importance on job growth, economic diversity, and population growth.
The place where we separate ourselves from the pack, and you can too, is by placing a heavy focus on recession-resistant markets.
These are simply markets that displayed continued growth throughout the most recent recessionary environment. While the cause and nature of every recession is unique, we feel that given the demographic shift towards more permanent renters (as discussed in The Pros and Cons of Apartment Building Investing article), those markets with solid fundamentals can continue to thrive even in the midst of a recession.
Of course, this isn’t just our own opinion – we have some truly compelling data to back up our assertions. In fact, there were a handful of select markets that we are targeting that saw solid rent growth throughout the dog days of the COVID-19 pandemic recession. This was in spite of the fact that there were eviction moratoriums in place, seemingly the worst possible environment for multifamily investment on the surface.
Yet multifamily investments continued to thrive and grow. Don’t you think it might be worth checking into those markets that grew even under cartoonishly unfavorable conditions?
Figure out Who Your Renters Are
The first step to wrapping your head around multifamily investments is understanding who will be renting your units. There are many different reasons that people choose to become renters and there are also many different quality levels of real estate available. For a detailed look, check out our Class A, B, C, and D Multifamily Classes Explained article for an explanation of the different quality and classes of apartment buildings. Despite the fact that there are several tiers of quality level available as a renter, the reality is that most renters fall into lower income brackets.
The graph above shows the income level at which the proportion of families that are renters and the proportion of families that are homeowners is in equilibrium. If your household income falls within the $50,000-$74,999 range, you’re still more likely to be a renter, but you’re almost equally as likely to be a homeowner. Once you reach income brackets above that level, the proportion of homeowners increases drastically. The simple takeaway here is that the majority of renters are lower income.
Why is this important to know? It might seem like common sense when we’re speaking about it in this context, but it’s logical to target the segment of the population that is far more likely to be a renter than a homeowner. Many people could intuitively understand this on paper, but you’d be surprised how logic goes out the window when people are looking at individual deals. The big thing we see is that investors, especially beginners, tend to be enamored with luxury class A investments. Those can be great investments when you purchase them for the right price, but they struggle in a recessionary environment.
Class A Rents Declined During the Recession, but Other Classes Grew
People are drawn to class A investments because they are new, aesthetically pleasing, and have the highest gross rental income. As investors, however, we care more about a property’s net operating income than how high the individual rents are. Due to the high cost of construction, it’s also essentially impossible to build housing suitable for the largest segment of renters.
As we discussed in our Workforce Housing Explained article, in order to make the numbers work for new construction projects that are aimed towards middle or lower class renters, you need a significant amount of subsidy. This falls under the affordable housing domain and is a different animal than traditional multifamily investing.
We discussed this topic in-depth in our How to Develop Affordable Housing article. While we include developing affordable housing as part of our overall investment strategy, it is a much slower-moving form of investment. You do not reap the benefits of your labor immediately.
That’s why we target “natural” workforce housing. These are pre-existing B and C class multifamily assets that usually need renovations to be brought back up to proper working order. This is known as the “value-add” multifamily strategy, where you take an underperforming building, renovate it, then raise the rents to the market level. You can think of this as a slow renovation.
This strategy is popular because it carries low risk while still having large rewards. Because you’re buying a building that’s already occupied and cash flowing, you’ve minimized your risk. You can slowly renovate the building over the course of two years as units turnover without ever having to go through a period of low occupancy.
Most people are looking for assets that are cash-flowing on day one, such as these workforce housing value-add multifamily properties we invest in. These properties provide investors regular cash in their pockets, but also have tremendous long-term upside.
You Get Better Rent Growth and Occupancy from Renters-by-Necessity
Another reason to focus on value-add multifamily rather than luxury new construction multifamily is the resiliency of workforce housing multifamily. As common sense would imply, people who are renters-by-necessity are more motivated to remain tenants as they have no other options.
People who are renters due to lifestyle reasons have more options. It’s easy for them to abandon ship when the seas are rough, whereas your renter-by-necessity tenants will stay with you even in rough waters.
We like this graph because it includes several of our target markets (NC Triad, Indianapolis, and Jacksonville). The first thing you should notice here is that the buildings housing the renter-by-necessity category of tenants experienced rent growth in every market on the list. Remember that this was in the midst of a global recession.
The stronger markets on this list also experienced rent growth within the renter due to lifestyle choices category of tenant. Yet you’ve probably noticed that in the vast majority of markets, the renter-by-necessity category experienced stronger growth. In addition to that, there were also several markets that experienced declining rents for the lifestyle category of tenant, but no market saw rent decreases for renters-by-necessity.
Renter-by-Necessity has Greater Occupancy Levels in a Recession, Too
As you can see from the chart above, multifamily occupancy levels from the renter-by necessity tenant type did not drop over the course of the recession. On the contrary, you saw a continual steady decline from the renter-by-lifestyle choices tenant type.
That’s all well and good, but what about the best markets to invest in? Why are we only focusing on the type of tenant? You’re going to have renters by necessity and renters due to lifestyle choices in pretty much every market. That in and of itself doesn’t help narrow it down.
Yet these discussions are interconnected based on the subject of affordability. People become renters-by-necessity because they can’t afford to purchase a single family home. Similarly, some percentage of those renters-by-necessity will seek greener pastures by moving to a place with a lower cost of living.
Choose Markets with an Affordable Cost of Living
If we’ve decided the most sensible tenant type to target is the renter-by-necessity, we should focus on markets that are attractive to this type of tenant: ones with a lower cost of living. We’re looking for markets that meet all of our other criteria, such as job growth, economic diversity, and population growth, but have managed to remain comparatively affordable.
As you can see from the above chart based on data from U-Haul, people are fleeing overpriced traditional population centers like New York and Los Angeles for more affordable alternatives like Raleigh and Phoenix.
Affordability is ultimately the name of the game when choosing recession-resistant multifamily. You focus on those who are renters because they have no other choice, then search for the major markets with strong fundamentals that are the most affordable and realistic for that type of tenant to live in.
This doesn’t mean you can’t make money in those “out-migration” markets. One segment of our business is developing luxury new construction condominiums in the Boston market. While it’s an overall out-migration market, severe supply shortages for new housing aimed at upper-class young professionals has led to continually rising prices, even throughout the most recent recession.
Yet as you can tell from my explanation, you have to find very specific niches and be very careful when operating in those markets. It requires lots of experience and caution. That’s why the majority of our investments are multifamily investments value-add syndications in those more affordable in-migration markets. These types of investments carry minimal risk due to the abundance of demographic data backing them up.
So Which Markets Should I Invest In?
My goal in writing this article was to teach you how to fish rather than just give you a fish. Setting your sights on the affordability issue and understanding the demographics about just who your potential renters are is far more valuable than just being handed a list of cities to choose from.
That said, I can understand if you want some solid suggestions to hang your hat on rather than just ideas and philosophies. The first place that I would suggest you visit is our Target Markets page, which shows you just which markets we are targeting. They all fit the criteria laid out in this article in one way or another.
I would also just like to take this moment to sing the praises of investing in the Midwest. During the COVID recession, Indianapolis and Kansas City experienced solid rent growth. These are more affordable markets with a lower cost of living, checking all of the boxes we discussed throughout this article. In fact, according to data compiled by real estate research and property management company Yardi Matrix:
“In fact, all Midwest markets had positive year-over year rent growth in November except for the Twin Cities (-0.5%) and Chicago (-3.4%).”
You Should Also Consider Satellite Cities
So what went wrong in Chicago, but went right in all those other Midwestern markets? You guessed it – Chicago is less affordable than its nearby brethren. According to Yardi Matrix:
“In Chicago, the closest gateway market to Indianapolis and Kansas City, the average rent is about 34% more expensive than Kansas City and 32% more expensive than Indianapolis.”
The thing is, when people find that the place they grew up or have lived in for many years has become unaffordable, they don’t always flee halfway across the country. A lot of those long-time residents of today’s unaffordable metros have simply been pushed to neighboring cities. We refer to these markets as “satellite cities.” They’re caught in the orbit of a larger or more prominent city with a greater gravitational pull, but they are also their own markets or submarkets unto themselves.
As you can see from the above chart, when major cities reach the point of unaffordability, their less-expensive neighbors benefit. This effect is amplified during a recession when there is less money to go around and affordability becomes even more important to people. Investing in these markets that are waiting in the wings to pick up the slack from their too-expensive neighbors can be very lucrative in the long term.
CONCLUSION
Focusing on the largest segment of renters and investing in markets they could afford to live will serve you well. Both common sense logic and real hard data suggest that we should be putting our focus on workforce housing in affordable markets. These investments are both lower-risk due to the higher pool of potential renters, but also have more long-term growth potential due to declining rates of homeownership within the population as a whole. Use these principles to choose your investments wisely.
