During my discussion with investors, the idea of investing during inflationary time was risky. Investors were preferring to stay on the sidelines in favor of higher cash liquidity. Some debated that maybe now wasn’t the best time to invest in multi family. As a general rule, I never judge an investor’s decision to not invest. It’s not for everyone. However, I wanted to explore the argument that investing in Multi Family in these inflationary times was to risky.

In the wise words of Pitbull, “scared money, don’t make money”. Now I am not saying we should be reckless. What I am saying is that part of managing risk is understanding its components. Sometimes when we dissect the risk components, we realize that it isn’t, as risky as we once thought. Unlike stocks and bonds, real estate offers a robust buffer against volatility, an inflation hedge, and a variety of tax benefits. The industry is also benefiting from a supply and demand imbalance, which is producing larger income and cash flows, than with other asset classes.

Let’s examine each of the variables more closely.

Recession:

Apartment occupancy tends to remain stable, during these economic downturns. Renters are disinclined to move to another market; choosing to stay with their employer longer. In essence, why would you leave your current job, if there are less jobs being offered. That proposition seems more risky, if you ask me. There is also a supply/demand imbalance, as interest rates hit new highs, as it makes it more difficult to affords a home, so renters stay renters longer.

Interest Rates:

Among asset classes, apartments have been afforded better rates, than other commercial
assets. Government backed agencies, like Freddie/Fannie, help offer lower rate sheets on
apartments. Although increasing interest rates aren’t preferable, apartments still benefit from better rates than other commercial assets, thus helping keep demand stable. In contrast, single family homes are very sensitive to interest hikes. Higher rates means homes become more unaffordable, causing a renter to continue being a renter.

Inflation:

One of largest benefits of apartment investing is the ability to adjust rental rates to market
conditions. If you think about office space, commercial warehouse, retail, these are all tied up in long terms leases. As inflation increases, an investor is tied to the lease allowable increases. In apartments, these lease agreements can often end at the 12 month mark. This means you can adjust rental rates higher to keep up with inflation. In a recent study, by Real Page, renters were able and willing to pay their rents. As inflation has climbed, renters income has also climbed. This has kept the rent-to-income ratio closer than what anyone would have expected

Liquidity:

What I mean by liquidity is in the ability for lenders to lend. Capital markets have become very stringent in lending with other commercial assets types, like office. In contrast, apartments still have access to lending options. Government back agency debt from Fannie/Freddie has continues to support apartments lending. This has helped keep the apartment market stable, without the dramatics of huge price drops.

Tax Benefits:

This is probably one of the most beneficial aspects of buying apartments real estate. Investment returns host several tax advantages. Depreciation, capital gains deferment through a 1031 exchange, as well as the tax-efficient cash flow to investors, often regarded as a return of capital and decrease of basis before becoming taxable, are just a few of the tax benefits mentioned. The savvy investor will want to take as many of these legally offered tax advantages.

Diversification:

Have I mentioned how the stock market is doing this year? Well, its not good. I have told my friends that you have to have a strong stomach to be in the market this year. Trust me, I know first hand, as I have an allocation in the market. But what is more important is that I don’t stress out about it. My diversification into other classes, like apartments investing has more than offset any instabilities. My apartment portfolio continues to perform and provides gains, even this year. Now, I am not saying go all in, but have a balanced portfolio. I actually believe at some point, having a real estate backed investment offering will become a standard in portfolio management.

Valuations:

This one is a valid concern. In apartment investing, capitalization rate is one of the most
analyzed metrics that determines value. The theory is as interest rates rises, cap rates expand, causing values to decline. While there is some correlation between the two metrics, there also many other variables that move valuation. Consider the flow of funds from private investors, institutions, fund managers, which are all on the sideline right now. This large amount of capital will be deployed sometime in 2023. According to Freddie Mac, apartments are well positioned despite cap rates pressures. The other factor to consider is that apartment values are driven by operating income. As rental income rises, so does the value of the property. Remember my opinion on inflation driving up rental rates? Despite an expansion of cap rates, values will continue to rise on the properties operating income, driven up by rental rates.

Demographics:

Millennials or younger, now comprise about half of the nations population. As millennials grow older, they continue to be renters, while Gen Z is starting to enter the rental market. Remember my opinion on homes becoming more unaffordable? We can expect both these groups to continue being renters for a longer time period.

High Demand, Limited Supply:

There continues to be a lack of supply of living in the US. Apartments starts have largely been focused on higher end class A builds. As a result, Class B/C apartment types are all in demand by renters, depending in the market off course. Inflation, interest rates, and lender constraints have all negatively impacted the ability for new constructions projects to more forward fast, during 2022. Unlike homes, apartments take much longer to deliver to a market.

Affordability (Buying versus Renting):

This fact is interesting. As much as rents have gone up, the affordability of buying a home has gone up by more. The average mortgage payment is now higher than renting in 45 of the 50 largest metro areas. In 2019, this comparison was 22 of 50. As ownership becomes more unattainable, renters will rent for longer periods.

Pandemic Affect:

This was probably one of the most stressful periods of my investing career. I remember the cries to cancel rents, rent freeze, and eviction moratorium. A quarter of my portfolio is in one of the most tenant friendly markets – CA. I, like many investors, feared a large swath of renter refusing to pay rent, while we were stuck having to continue paying the mortgage. The reality turned out to be much different. According to Real Page, rental collection continued to hoover around 95% during the pandemic. My personal portfolio, average slightly better. Meaning almost all of the residents made a concertize effort to pay their rental amounts. Now that this period is behind us, landlords are playing catch-up with rental rates. But even with these increases in rent rates, residents continue to choose to stay in their apartments.

Final thoughts:

I hope this blog was interesting. It went a lot longer than what I tried to do, but I felt the topic was necessary to discuss. Although, there are concerns that we should discuss in investing, sometimes those concerns are shrouded in fear. When we start to understand what the risks are and how those scenario play out, then we become a smarter investor. Need any more convincing about apartment investing in these times? Remember, the 2009 Housing Crash? You’ll be surprised how apartments fared during that period, but that a whole new blog.