The Pros and Cons of Apartment Building Investing The Pros and Cons of Apartment Building Investing | Winterspring Capital

The Pros and Cons of Apartment Building Investing

The Pros and Cons of Apartment Building Investing

The Pros and Cons of Apartment Building Investing

There’s a reason that everyone seems to find their way to real estate investing sooner or later.

Whether you’ve already made a lot of money and are looking to preserve and grow it, or you’re an up-and-coming real estate professional, everyone is drawn to this industry because of the tremendous wealth that can and has been built through rental property investments.

Once you’ve decided that you want to get involved in real estate investing, the next step is to decide how.

You need to decide both on the method of investment and the asset class you would like to invest in.

Do you want to be an active investor or a passive investor?

In our 4 Proven Methods to Invest in Apartment Buildings article, we discussed the most common ways to invest in multifamily real estate.

The good news is, whether you want to be a full time real estate professional as an active investor, or you want to be a passive investor in a real estate syndication that doesn’t have to do any work (beyond judging new opportunities!), there are options for you.

When I first got into the industry, I was always drawn to apartment buildings. The case for multifamily property investing seemed clear to me: people will always need a place to live, even in a recessionary environment.

It is also relatable. Most people have lived in an apartment at some point in their lives and understand the basic picture of how an apartment is supposed to run as a business.

When you’re talking about office, retail, or self storage, for example, they’re not quite as intuitive for the average person.

Apartments, on the other hand, are kind of hard to misunderstand: you need bedrooms, a kitchen, bathrooms, and living space.

The water needs to run and the utilities need to be operational. Leases are typically on a yearly basis and follow guidelines and rules pretty much everyone is familiar with.

Apartments being a great place to invest was just my gut feeling, though. You might be similar to how I was back then – you intuitively understand the business case for multifamily investment, but lack the experience or data to give you confidence about your assumptions.

In this article, we’re going to dive deep into the pros and cons of apartment building investing.

We’re also going to provide some compelling data that demonstrates why multifamily is the superior real estate asset class for your investment dollars.

Explaining Multifamily Properties

The Pros and Cons of Apartment Building Investing

I told you we were going to get into the data, so rather than bury the lead, let’s open with this: apartment investing returns knock the pants off of the other real estate asset classes. 

If you’re anything like me, the first place your eyes gazed on this chart was the mean return. 

We’re pleased to see that apartments are the king of that domain, but you should also pay attention to the Sharpe Ratio as well. 

The Sharpe Ratio is a method for calculating risk-adjusted returns. 

The higher the number, the more secure each dollar invested is. 

Apartments stand head and shoulders above the rest on a risk-adjusted basis.  So what exactly counts as an apartment building?

All exclusively residential properties other than single families are multifamily properties. 

As the name implies, these are buildings that are inhabited by “multiple” families. 

This includes small duplexes with only two units, all the way up to 500+ unit complexes.  

The term “apartment building” is synonymous with a larger multifamily property like we typically invest in. 

It’s kind of a grey area, but the technical definition of an apartment building is a multi-story building with three or more residences included. 

This would not include duplexes, making multifamily the more all-encompassing phrase.

I still like to use the phrase “apartment building investing” in our educational materials because it is a much more familiar phrase to the average person. 

In addition, I tend to think of apartment buildings as large multifamily properties, which is what our company invests in.

Smaller multifamily properties, like three unit triple deckers, are a common feature of the existing housing stock in many parts of the United States, especially on the East Coast. 

They make up an important part of the “missing middle” workforce housing that is severely under-supplied. 

If you’re looking to be an active investor and are willing to be a full-time landlord, these smaller properties are a great place to get started investing.

One popular method for investing in smaller multifamily properties that many people are taking advantage of is called “house hacking.” 

The owners leverage favorable financing with little money down through FHA loans, occupy one of the units, renovate, rent out the other units, and then refinance.  

This is a great method for younger and ambitious people with limited access to capital, but are willing to put in some hard labor in order to build some sweat equity. 

Beware that this is pretty much as labor-intensive as real estate can get.  If you’re trying to invest in real estate on a more passive basis, look elsewhere.  

You can also invest in these smaller multifamily properties as a traditional landlord. 

Just keep in mind that due to the low number of units, you’re likely not going to have the scale necessary to outsource maintenance and other landlord responsibilities. 

If you go down that path, you have to be willing to accept some property management as part of the package.

I would like to make the case for larger multifamily properties as the safer bet for investment. 

All multifamily above 5 units counts as a form of commercial property and is financed differently than smaller multifamily properties and single families. 

I wouldn’t stop there, though – I really start to like multifamily once you’re getting above 50 units, at a minimum.  

To give you an idea why; when you’re renting out a three family triple decker, a single vacancy means your gross rents dropped by 33%. 

Two vacancies, and you’re wondering if you can pay the bills that month.  With larger multifamily apartments, you have the scale to shrug off vacancies. 

There’s no bad timing and luck that could derail you so thoroughly. 

Combine this with the fact that larger multifamily properties have the scale necessary to hire best-in-class property managers, and it seems almost obvious that bigger is better in the apartment world. 

We’re not done yet, though:

The Pros and Cons of Apartment Building Investing

Large multifamily has a bunch of intrinsic benefits due to its scale, but it doesn’t stop there. 

We’ve also seen significantly stronger rent growth in larger multifamily buildings in the past fifteen years than in smaller multifamily. 

That said, any form of multifamily is a good bet for investment, so long as you are buying the asset for the right price.  

If you’re looking to be the head of the show as an active investor, then large multifamily might simply be unrealistic for you due to the cost. 

If you’re interested in being a passive investor and don’t have time to be a full-time landlord, then smaller multifamily obviously is not for you. 

You have to choose the strategy that fits best for your situation.

The Pros of Apartment Building Investing

Diversity of Investment Options:

Multifamily is a very broad category with many different types of investments included underneath its umbrella. 

As we mentioned earlier, smaller active investors can target those “missing middle” triple decker style multifamilies, whereas a passive investor could invest in a syndication for a much larger, 100+ unit apartment complex. 

There’s even subcategories of subcategories. 

Take senior housing, for example. 

It is a form of a multifamily investment that has several different subtypes of its own, from the assisted living model to the more well-known retirement home.  

Demographic Trends:

The Pros and Cons of Apartment Building Investing

Complementing the variety of options available to invest in multifamily real estate are the demographic trends that seem destined to ensure the continued dominance of multifamily in the real estate sector. 

Pictured above are three possible scenarios for the homeownership rate in the United States by the year 2050. 

As the chart shows, even the most optimistic scenario for the homeownership rate shows a substantial decrease by 2050. 

This means millions of new renter households, making the future bright for multifamily investing.

Construction Undersupply:

The Pros and Cons of Apartment Building Investing

Making matters worse, we’ve been in a construction drought for several years and the pace of construction cannot keep pace with the growth in households. 

Proper levels of construction should outpace the household growth rate to allow for turnover, which hasn’t happened for many years now. 

This severe supply shortage means multifamily properties will become increasingly in-demand in the long term.

Rising Population of Renters:

The Pros and Cons of Apartment Building Investing

There are many forces that are coalescing to create these demographic shifts, but let’s focus in on one of the bigger ones to get an idea of how this will impact the sector in the future. 

Purchasing a home has traditionally been one of the steps a couple takes after getting married.  

This is for both cultural reasons as well as practical ones. 

It is much easier to afford and maintain a home as a married couple. 

As the age that people get married continues to be pushed backwards, people are spending more time in apartments during their 20’s and 30’s, increasing the pool of renters dramatically.

Many Ways to Invest

As we alluded to earlier, you can get involved in multifamily investing on either a passive or active basis. 

As an active investor, you could buy a building by yourself or form a partnership with other investors. 

As a passive investor, you could invest into a real estate syndication or fund, which does not require you to do any work. 

You can even invest in REITs as a passive investor, which do not come with the tax and other unique benefits of a syndication, but are more liquid due to you purchasing and selling shares of the company, rather than the individual assets.

Historic Appreciation:

The value of multifamily real estate can go up or down in the short term, but it tends to appreciate over the long term.  Historical trends in the United States have shown a gradual increase in value over time that suggest if you’re into multifamily investing for the long term, you will benefit from appreciation over time.

Stability: 

The Pros and Cons of Apartment Building Investing

One of the greatest strengths of multifamily investments is stability

Compare the difference in delinquency rates for single family and multifamily loans during the great recession. 

You can see why multifamily is considered a safer investment when you see how the great recession was basically just a blip on the multifamily delinquency radar! 

The truth is, in a recessionary environment, multifamily continues to perform strongly as former homeowners become renters by necessity.

Regular Cash Flow:

This one’s a little obvious, but needs to be stated. 

Perhaps the biggest draw to investing in apartment buildings is the stable source of cash flow. 

For the vast majority of multifamily properties, the tenants pay their rent every month, providing regular cash flow. 

The high demand for housing also guarantees you can quickly turn over units as the leases expire and keep the flow of cash pumping without a hitch (assuming you are buying in sensible markets).

Scale:

Even for an active investor that enjoys the grind and is doing well, you’re eventually going to hit a wall if you’re only buying single family rental properties. 

Simply searching for enough deals to keep growing your portfolio becomes burdensome. 

With multifamily real estate, you can invest at different size levels that fit your needs and experience.  

For a passive investor, you get instant access to the benefits of scale by investing with a real estate syndication. 

For an active investor, a common pathway is starting with a few small multifamily acquisitions and then making the jump to buildings with higher unit counts.

Tax Benefits

If you ask certain people, we saved the best for last! 

In our
5 Tax Advantages Passive Real Estate Investors Need to Know article, we really dug in deep to some of the great benefits you’ll get as a real estate investor. 

Some of the highlights include the ability to reduce property related expenses (including interest!) from your taxable income, 1031 exchanges, and depreciation. 

1031 exchanges are a government-sanctioned method of selling real estate whereby you are legally bound to identify and re-invest the proceeds from the sale into another real estate investment. 

If you follow all of the rules, you don’t have to pay any taxes on the sale.  

Depreciation is the ability to claim that your investment has decreased in value due to the normal effects of aging. 

This is based on the value of the building and results in extreme tax savings. 

When combined with cost segregation studies and what is known as bonus depreciation, investors can accelerate and multiply everything that’s good about depreciation. 

Check out the article for a more in-depth look.

The Cons of Apartment Building Investing

Apartment buildings are my favorite asset class of real estate to invest in and the backbone of our company’s investment and development portfolio. 

That said, it’s not all peaches and cream and there are some real drawbacks you need to consider first:

Price:

The largest barrier to entry into the apartment investing world is simply the price of purchasing a multifamily asset. 

Even if you’re looking to purchase a smaller multifamily property, you’re looking at price tags in the high hundreds of thousands to low millions in many parts of the country. 

Investing passively in a real estate syndication is actually a more affordable option for many people. 

The minimum investment for most syndications is around $50,000.

Sourcing Deals:

There are less individual investors looking to purchase large multifamily properties, but they are more experienced, dedicate more time to scouting out new acquisitions, and are more dependent on finding and acquiring new assets as they are full time real estate professionals and that is how they make a living.  

As a result, finding deals at a certain level becomes more competitive in a different way than the “100 people showed up at the open house” style of competitive you see with single family houses. 

Brokers and sellers don’t want to waste their time with unproven investors and it’s easy to feel like you’re shut out from an exclusive club. 

Often, you need to have experience like we do and a track record you can point to before brokers start sending you off-market opportunities or sellers give you the time of day when you approach them for a direct sale.

Hands-On:

Compared to the other real estate asset classes, multifamily is a very hands-on investment. 

Your property management company may be the one who takes care of the day-to-day concerns, but the existence of those concerns is what we’re focusing on here. 

There is more activity, things to monitor, tenant communication, and typically maintenance involved with multifamily properties. 

As an owner, this eventually translates to increased asset management duties, as there are typically more moving parts (bills, problems, unit turnover) that need to be watched over financially.

Conclusion

Isn’t it nice when the data and your instincts are in alignment?  It makes intuitive sense that apartment buildings would be a sensible place to invest your money and this is borne out by the data we have on the subject. 

If you’re considering getting involved in real estate investing, there’s typically no finer option than multifamily housing. 

The demographic trends and supply shortage we discussed in this article suggest that multifamily will only become increasingly attractive as an investment option in the coming years. 

Whether you want to get down in the trenches as an active investor landlord or you want to passively invest in a real estate syndication with no work to do on your end, apartment buildings are a great choice that has served us well for years.

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The Pros and Cons of Apartment Building Investing
The Pros and Cons of Apartment Building Investing
The Pros and Cons of Apartment Building Investing
The Pros and Cons of Apartment Building Investing