One of my biggest regrets as a real estate investor was buying a single family house for $1,520,000 in San Francisco in 2005 instead of buying multifamily real estate.
The house was too big for just my wife and I, which meant a lot was wasted. It would have been much better if we bought a duplex or fourplex, lived in one apartment and rented out the other units.
Not only would we have lower living costs, we'd produce higher rents and have a higher return in the process.
Over the 25-year period from 1992 through 2018, multifamily real estate provided the highest average annual total returns (9.75%) of any commercial real estate sector with the second lowest level of volatility (7.75%). This is according to research cited in a 2018 report by CBRE, the world’s largest commercial real estate investment firm.
Let's look at five reasons why investing in multifamily real estate is an attractive investment.
Reasons To Invest In Multifamily Real Estate
1) Strong Demographic Demand For Real Estate By Millennials
According to the US Census Bureau, the national rate of homeownership for the population overall was 64% in 2016, for millennials aged 25 to 29 it was just 31%, and for millennials aged 30 to 34 it was only 45%.
Real estate values have increased at a much higher clip than income since the financial crisis, making purchase affordability a problem. Further, Millennials tend to value mobility and flexibility over the benefits of owning property – much like taking an Uber or Lyft instead of owning a car or adopting Airbnb.
With the sharing economy in full swing, the demand for rentals should be strong.
2) Downsizing By Baby Boomers For A Simpler Life
According to a Forbes report, between 2009 and 2015, the biggest shift from homeownership to renting came from those aged 55 and older (in other words, boomers). More recently, the National Multifamily Housing Council and National Apartment Association cited in a 2017 report that renters aged 55 and above account for more than 30% of rental households.
Older tenants are drawn to renting not because they have difficulty purchasing a home like millennials (they do not), but rather because the right multifamily property can offer hassle-free, amenity-filled luxury living that appeals to this older generation.
My mother is 71 years old and can't stand the 5 bedroom, 3 bathroom house she currently lives in in Oahu with my dad. She complains about cleaning and maintenance all the time. Instead, she wants to live in a one bedroom or two bedroom apartment and leave the house for my family to live and manage.
Related: Why The Housing Market Won't Crash Any Time Soon
3) Shorter-Term Lease Agreements Allow For Faster Rent Increase
Whereas leases of five years or more are standard with other types of commercial real estate (office and retail, for example), multifamily leases are typically just one year. When the economy is booming, there's more flexibility for multifamily landlords to raise rents and capture the good times.
Meanwhile, when the economy is flatlining or falling, rents are still sticky on the way down. During the 2008-2010 financial crisis, I continued to receive the same amount of rent from all my San Francisco and Lake Tahoe rentals due to one year leases. Although my rents remained flat for 2-3 years, that was much better than a 20%+ decline in property values.
When the economy began to recover in 2011, I raised my rents by 10% across the board, and continued to raise them by 10% every two years. Take a look at my rental and mortgage history with one property in San Francisco. Notice how rents continued to stay strong through the crisis.
4) General Increased Demand For Workforce Housing
Workforce housing generally refers to multifamily properties for middle-income households, although it can include families earning anywhere from 60% to 120% of their area’s median income.
These properties are often Class B and Class C apartments that do not have the amenities of the higher-end complexes, and serve people who are being priced out of the market for units in the more attractive buildings. They are located in Gateway Cities with usually faster growth.
The key long-term benefit of investing in workforce housing, according to the 2017 State of the Nation’s Housing study by Harvard Research, comes down to simple supply and demand. As the study found, while construction of high-end Class A properties has increased in recent years, it has fallen for the Class B and C properties. In other words, workforce housing is facing a shortfall of units.
In the decade between 2005 and 2015, the supply of rental housing stock increased by nearly 100% for high-end units, but during that same period the stock of affordable units fell by 2%.
It makes sense that developers have focused on Class A properties due to fatter margins. BMW and Mercedes Benz margins are 2X higher than Toyota and Honda margins, for example. But Toyota and Honda produce much higher volumes.
5) Better Financing Arrangements
Multifamily investments enjoy a preferential mortgage market and better funding terms relative to other types of commercial real estate.
According to 2017 research from Real Capital Analytics, multifamily investors enjoyed better terms for funding than investors in the broader commercial real estate market.
For example, the typical mortgage rate of 4.25% for multifamily was lower than the overall commercial real estate sector, at 4.5%.
Multifamily investors also received higher loan-to-value ratios (67% on average) than the broader pool of commercial real estate investors (who averaged 59%), as well as lower debt-service-coverage ratios (1.25, versus 1.74).
Real Estate Crowdfunding As A Solution
One of the problems with multifamily real estate investments is the cost of entry. To buy a 100+ unit apartment complex will likely costs millions of dollars if not 10s of millions of dollars. As a result, it has been hard for regular people to profit.
Real estate crowdfunding is a solution that allows investors to invest as little as $1,000 in a multifamily REIT like the ones offered by Fundrise. You can also invest a piece of individual multifamily real estate investments on their platform if you particularly like one deal if you are an accredited investor.
With Fundrise, investors can buy directly into a REIT that invests in multifamily real estate property prescreened by their experts, and then leave the day-to-day management responsibilities to the professionals. As a result, you get the benefits of multifamily investment diversification without all the hassle.
Invest On The Best Platforms
Check out my two other favorite real estate crowdfunding platforms.
1) CrowdStreet is based in Portland and connects accredited investors with a broad range of debt and equity commercial real estate investments. CrowdStreet is great because they focus primarily on 18-hour cities (secondary cities) with lower valuations, higher net rental yields, and potentially higher growth.
2) Fundrise, founded in 2012 and is available for non-accredited investors. I’ve worked with Fundrise since the beginning, and they’ve consistently impressed me with their innovation. They are pioneers of the eREIT product. Most recently, they were the first ones to launch an Opportunity Fund in the real estate crowdfunding space to take advantage of new tax laws.
Both are free to sign up and explore. So far, I've invested $810,000 in 18 different commercial real estate projects and am earning a ~15% IRR.
About the Author:
Sam has $810,000 invested in real estate crowdfunding to take advantage of lower valuations and higher net rental yields in non-coastal city real estate. He believes there will be a multi-decade migration away from expensive coastal cities due to technology and the emergency of real estate crowdfunding platforms.
In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $260,000 a year in passive income. He spends time playing tennis, hanging out with family, consulting for leading fintech companies and writing online to help others achieve financial freedom.