Multifamily property is a defensive countercyclical investment and I'll share with you why in this detailed post. As an investor in multifamily properties for a decade, I've seen this type of investment significantly outperform during economic downturns.
Defensive investments are those that can potentially mitigate the effects of broader market swings. They are typically thought of as involving health care, utilities, and essential consumer products—goods and services that people find it difficult to do without, even when money is tight.
Defensive investments tend to go down less than other investments in its category. Or they may actually go up, depending on the nature of the investment. In other words, defensive investments generally outperform its closest benchmarks.
Real estate is generally categorized as a more cyclical investment, along with basic materials, financial services, and consumer discretionary. In other words, when times are good, real estate goes up an vice versa.
However, the multifamily sector has some features that can resist or even overcome broader market swings.
Focusing on defensive investments now seems to be a good idea.
Why Multifamily Property Is A Defensive Countercyclical Investment
Multifamily apartment complexes are often thought to be a similarly defensive investment. Everyone needs a place to live—even when a drooping economy might cause significant vacancies in other types of commercial properties.
In addition to multifamily properties, self-storage facilities, are also often thought to be less volatile and cyclical compared to other asset classes. Displaced homeowners who downsized to apartments or smaller homes still needed to store excess household items.
Larger multi-family complexes may offer further stability. Individual vacancies in those properties have a lesser impact on the overall rent roll than they would in smaller office or industrial properties.
Commercial real estate such as office, retail, and industrial property is usually tied to the health of the broader market. Thus, they are NOT considered defensive investments. Hotels, too, tend to get squeezed when travel is de-prioritized, as it can be when personal and business budgets are tightened.
Which Asset Class Performs Well During Bear Markets
A Barron’s article a few years ago summarized some strong evidence.
It asked Yale University’s Robert Shiller, winner of the Nobel Prize in economics and the co-creator of the Case-Shiller Home Price Index, the question, “Which asset class has performed as well as bonds during U.S. equity bear markets of the past 60 years?”
The answer: multifamily real estate. Data from Professor Shiller showed that in 14 of the 15 previous U.S. equity bear markets—going back to 1956—the home price index actually rose. The 2008-09 bear market seems to have been an anomaly. It was attributable more to subprime mortgages, NINJA loans, extreme banker and borrower greed.
Other studies have also shown positive results for apartment complexes. Multifamily can be considered a “defensive play,” as noted by CBRE, a prominent real estate services firm.
Its report notes that multifamily is typically less impacted by cyclical downturns than other property types. It also showed how, using standard deviation as a measure of volatility over a 25-year period ending 2017, retail and multifamily had the lowest levels of volatility in return performance.
Average Annual Return by Property Type
Multifamily seems to have shown a favorable track record during most economic downturns with a LOWER standard deviation (volatility) than Hotel, Industrial (the highest), Office (second highest), and Retail (even lower).
Crowdfunding platforms like Fundrise now allow investors access to properties like larger multi-family complexes. They do so in a convenient and relatively affordable way as passive investments.
Individual Investors Have Become Smarter
The current slowdown in home sales, felt sharply in Western states, has been attributed to higher mortgage rates and rising prices. The trend increases the attractiveness of apartment rentals—and, potentially, of multifamily investments.
If you want to buy property, you may remember the residential housing meltdown that destroyed the financial lives of millions of Americans. As a result, you’re likely cautious about leveraging up.
Instead, the best strategy to consider is to rent until prices soften further. Check out the 2023 Housing Price predictions to get my thoughts on when a buying opportunity could emerge.
It usually takes 2-5 years for the downward real estate cycle to completely play out. For example, real estate started weakening around the end of 2006/early 2007. It wasn't until 2012 when real estate prices started taking off again, or 5 years.
Smart real estate investors will embark on a strategy I call BURL: Buy Utility, Rent Luxury. Investors will do the math and wisely rent expensive property while buying inexpensive properties with high cap rates in places like the heartland of America.
Institutional Money Is Investing In Apartment Complexes
Investment managers are ramping up their stakes in workforce and affordable housing. “We are seeing an increasing number of funds raising capital to pursue opportunities in this workforce housing space,” said Peter Rogers, senior investment consultant at Willis Towers Watson.
“We think that class B multifamily is almost recession-proof,” said Robert E. Hart, founder, CEO and president of TruAmerica Multifamily. Demand for workforce housing remains steady even in a financial crisis, he continued. Renters might double up, but demand for affordable apartments still exceeds supply.
Other institutional investors followed suit, targeting workforce housing and Class-B value-added multifamily properties.
- New York State Common Retirement Fund ($197.1 billion )
- The California State Teachers' Retirement System ($213.7 billion )
- LEM Capital LP ($6.9 billion)
- Pennsylvania Public School Employees’ Retirement System ($52.7 billion )
Supply Lags Demand For Multifamily Apartment Buildings
One of the most significant factors affecting the performance of multifamily investments is the UNDER supply of housing. This is great for landlords, but not so good for renters.
In many cities, such as San Francisco, NYC, Seattle, Los Angeles, and Portland, housing is in short supply. And local authorities have discussed additional rent control measures. But such restrictive price ceilings tend merely to reduce the supply of property to the market. This then exacerbates the price crunch.
One solution is simply to build more housing. Unfortunately, the bulk of recent development activity has tended to be in high-end Class A properties with luxury features. Think about all those luxury rentals being build in Manhattan or San Francisco. Further, getting any property built in notoriously Not In My Backyard areas like the SF Bay Area is troublesome for developers. Again, great for landlords.
Class B And C Multifamily Investment Opportunities
An investment strategy focusing on Class B properties with light to moderate renovations may offer potential upside. Even after they are renovated, these properties can often provide renters with a valuable alternative to newly constructed properties.
Class B and C properties are generally less prone to competition from new supply of competing “product.” One possible explanation is that the unit economics no longer support the construction of such buildings. Or perhaps developers are simply seeking higher returns.
Evidence also suggests that there is currently very little in the way of free rent or other concessions being offered on class B properties. In this way, Class B and C properties seem to be well positioned relative to higher-end Class A buildings, where such concessions are frequently offered in response to competition coming from newly constructed complexes.
The best place to buy Class B mutlifamily properties is therefore in Tier 2 cities in the heartland of America where valuations are much lower and cap rates are much higher.
Explore Multifamily Investment Property
Everyone needs a place to live, and larger apartment complexes in particular are often able to weather broader economic downturns. The asset class has historically performed better than other real estate asset classes during equity bear markets, and institutional investors are increasingly appreciative of the sector’s unique characteristics.
One of my real estate investment regrets was buying a $1.525M single family home in San Francisco for just my girlfriend and I at the time rather than buying a duplex or a four-plex. It would have been much more cost efficient for us to live in a 1,000 sqft apartment and rent out the others, than assume an entire building. We would have made a lot more money in the long run as well.
But I'm not complaining, since I ended up selling the single family house for $2.74M in 2017 and redeploying $550,000 of the assets into real estate crowdfunding. It feels great to earn a 4X-5X higher net rental yield without having to do ANY of the property management. My risk exposure is much lower as well ($2.74M down to $550K), but with potentially an EQUAL income stream amount.
The Best Real Estate Marketplaces
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 available for accredited investors and 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 of these platforms are the oldest and largest real estate crowdfunding platforms today. They have the best marketplaces and the strongest underwriting of deals. Sign up and take a look around as it’s free.
As always, do your own due diligence and only investment in what you understand. I’ve personally got $810,000 invested across 18 different commercial real estate projects around the country. My current internal rate of return is about 15% since 2016.
About the Author:
Sam started Financial Samurai in 2009 as a way to make sense of the financial crisis. He proceeded to spend the next 13 years after attending The College of William & Mary and UC Berkeley for b-school working at Goldman Sachs and Credit Suisse. He owns properties in San Francisco, Lake Tahoe, and Honolulu and has $810,000 invested in real estate crowdfunding.
In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $300,000 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.