Over the 25-year period from 1992 through 2017, 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%), according to research cited in a 2018 report by CBRE, the world’s largest commercial real estate investment firm.
This statistic alone should give investors a reason to consider multifamily real estate as a vehicle to diversify their investment portfolios. However, there are several other trends and factors to consider that make multifamily workforce housing a smart investment strategy.
Millennials are Placing Strong Demand on Rental Properties
The U.S. Census Bureau reports that renting represents the most common form of housing for millennials, the largest generation in U.S. history. The national homeownership rate for the population overall was 64% in 2019, for millennials aged 25 to 29 it was just 31%, and for millennials aged 30 to 34 it was only 45%.
The reasons for the high rental demand amongst millennials include steadily rising median home prices putting homeownership out of reach for many people in this generation. Millennials also tend to value mobility and flexibility over the benefits of owning property, and for this reason, they are more likely than previous generations to favor renting.
Baby Boomers are Increasingly Opting to Rent
At the other end of the age spectrum, the baby boomer generation is increasingly opting to rent property over owning a home. 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.
As the Forbes report notes, older tenants are drawn to renting not because they have difficulty purchasing a home like millennials, but rather because the right multifamily property can offer hassle-free, amenity-filled living that appeals to this older generation.
The Data Suggest Increasing Demand for Workforce Housing
Workforce housing generally refers to multifamily properties that appeal to 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 communities with quality amenities, but do not compete effectively with the higher-end complexes. They are often located in suburban settings and appeal to people who are being priced-out of the market for newer units in urban locations.
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, supply has fallen for the Class B market segment.
In other words, workforce housing is facing a shortage of new units (supply).
The Harvard study found, for example, that in the decade between 2005 and 2015, the supply of rental housing stock increased by nearly 100% for high-end units, while at the same time the stock of workforce housing units fell by 2%.
Preferential Investment for Financing
Finally, the data also indicate that multifamily investments enjoy a preferential mortgage market and better financing 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 4.75%. 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).
Benefits of Investing in Multifamily Workforce Housing
Baseline Level of Demand
Regardless of the state of the economy, people need a place to live. This creates a baseline level of demand for most multifamily assets. According to Yardi, the national occupancy rate for stabilized multifamily assets closed calendar year 2019 above 95%.
Diversified Cash Flow
Multifamily properties produce monthly rents, with the risk of default spread among multiple tenants. A single tenant represents a relatively small percentage of overall income, and minor changes in occupancy will not significantly impact cash flow.
Appreciation
Multifamily investments are valued much differently than single family homes. Small changes can create huge increases in value through the use of leverage and “multiples”. When you spread small increases across 50 to 200 tenants at a property it can create significant increases in cash flow, which creates an even bigger increase in value.
Tax Benefits
Multifamily real estate boasts substantial tax advantages that create “tax-advantaged income”. The use of depreciation, cost segregation to accelerate depreciation capture, 1031 exchanges, and self-directed IRAs gives investors some of the most favorable income tax treatments of any asset class.
Principal Paydown
Every month when tenants pay their rent, they pay off a portion of any financing used to purchase the property, thereby creating additional equity in the property via principal paydown of the loan.
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