Why Invest in Multifamily Real Estate?
Once lumped in with single-family residential, multifamily is now firmly entrenched as one of the four major commercial real estate asset classes – alongside office, retail and industrial. The asset class now accounts for around one quarter of all U.S. commercial real estate investment, and is occupying a growing share of institutional investor’s portfolios. In this article we take a look at the major advantages to investing in multifamily commercial real estate, and why it is a particularly favorable time for the asset class.
Provides built-in hedge against inflation while reducing risk
While office space, industrial and retail properties typically have only one or a small handful of tenants locked into long-term leases, multifamily properties can have tens or even hundreds of diversely-structured rental agreements, with tenants turning over on a rolling basis. This arrangement provides downside-protection by minimizing vacancy exposure during economic downturns. On the other hand, consistent turnover of leases in a multifamily property allows management to gradually ratchet up average rents in accordance with prevailing market rates and commensurate with the rate of inflation.
Multifamily exhibits low volatility
Multifamily has historically been the least volatile of commercial real estate asset classes. The main reasons are fairly straightforward: whereas markets for office, industrial and retail most closely align with micro and macroeconomic trends, multifamily most closely mirrors demographic trends: where people live, how many, and the demographic makeup of populations within a given market or neighborhood. Clearly economic trends and demographic trends are related, but since residential dwelling is the most essential function of the built environment, multifamily will be less impacted by fluctuations or structural shifts in the economy. As a corollary, we could say that multifamily is more resilient through market cycles.
This holds true empirically: over the past few decades multifamily has exhibited less volatility – as expressed by standard deviation from mean return – of any major commercial real estate asset class, while yielding the best risk-adjusted return.
Investing in multifamily amid volatility
A number of social, demographic, and economic factors make multifamily more appealing on the whole than other real estate asset classes for the foreseeable future. In Q2, 2016, homeownership rates in the U.S. (the percentage of all households owning rather than renting their residence) fell to 62.9%, the lowest since 1965, from a pre-recession high of 69.4% in 2004**. Much of this can be attributed to the housing collapse and aftermath: lack of inventory, tight credit, and eroded faith in the merits of homeownership have all resulted in historically high rates of renting. Further, Millennials – those of the age group typically inclined to first-time home-ownership – are starting families later in life, favoring the live-work-play urban areas where homeownership is relatively expensive. While homeownership rates may not remain at historic lows, there’s every indication that demand for multifamily housing will remain strong.
Meanwhile, much about the economic outlook for the next few years remains uncertain. Various policy changes could have vast impacts on retail (particularly in export or import-based businesses and supply chains); on energy, industrial and manufacturing; and/or on economic sectors reliant on office space. However, there are more questions than answers at this point. Macroeconomic shifts to come will certainly impact multifamily. But, for the reasons mentioned above, the asset class should provide a welcome hedge against uncertainty in years to come.
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