Investing in multi-family properties such as apartment complexes can provide a pathway to passive wealth generation that bypasses the volatility of stock market movements.
“Multifamily has been one of the most attractive and desirable types of investment property for investors during the current cycle,” said Russ Moroz, senior vice president of investments at Marcus & Millichap.
Its popularity, Moroz says, can largely be attributed to the perceived stability of the housing market and the steady growth in demand and rental rates for multi-unit buildings.
Multifamily investing offers several obvious advantages, beyond those associated with renting single-family homes.
Raphael Sidelsky, chief investment officer at W5 Group in New York, says those advantages include a strong risk-return profile, cash flow and capital appreciation. Multi-family dwellings are also benefiting from falling homeownership rates, a trend that Sidelsky says is likely to persist for the foreseeable future.
For the first-time real estate investor, the challenge is deciding what approach to take in this area of real estate investing. There are three main options for investing in multi-family properties:
- Direct ownership.
- Real estate crowdfunding.
- Multifamily REITs.
Robert Rahmanian, director and co-founder of Real New York, advocates owning multifamily rentals directly over other avenues of investment.
“Maybe it’s because I’m an active investor and I like to roll up my sleeves and really be part of investing,” Rahmanian says. “It means making decisions about renovations, seeing income and expenses, and overall feeling in control.”
This extends to the option of buying an apartment building or duplex solo or in partnership with other investment seekers. Moroz says this structure provides greater control over owning, repositioning, or selling a multi-unit property as they see fit.
The most daunting aspects of direct ownership include selecting a suitable property, finding reliable tenants, and overseeing property maintenance. Buying a turnkey property can be a way to minimize some of these challenges. In a turnkey property, the tenants and a professional management company are usually already in place, which means that a stable cash flow is already generated.
Securing financing for the purchase can present another challenge, though Moroz says that shouldn’t be a deterrent.
“Multifamily investment property financing is more favorable than any other type of product, largely due to competition from Fannie Mae and Freddie Mac,” he says. “These government-sponsored companies often offer rates and terms that are better than what investors can get from conventional funding sources.”
Real estate crowdfunding
Real estate crowdfunding may appeal to someone looking for multi-level, multi-family investments.
First, there is the ability to access a diverse range of properties that have been thoroughly vetted by the platform. It is possible to invest in multiple markets across the country, instead of concentrating land ownership in the investor’s local geographic area.
Investment minimums can be much lower than buying an apartment building outright, which is an advantage for the novice investor. Some real estate crowdfunding platforms like Fundrise, for example, set the minimum investment at $500. Others like RealtyMogul set the bar slightly higher at $1,000.
All of the tax advantages associated with owning a rental property, minus the management requirements or costs associated with direct ownership, also apply to crowdfunded investments.
“Crowdfunding is great because it gives you access and exposure to markets outside of your own, and now you have the opportunity to invest with a general partner who hopefully has a proven track record,” Rahmanian says.
The trade-offs are liquidity and control. Crowdfunded real estate investments often have a multi-year holding period, tying up investors’ money in the meantime. The person investing also has no say in the management of the property.
“I strongly believe in seeing, walking and touching the investment you buy daily or weekly and from there you can analyze a spreadsheet and execute at the highest level,” says Rahmanian.
Crowdfunding, by nature, does not allow this.
Real estate investment trusts own a collection of properties, providing investors with diversification and dividend income in one tax-efficient package. Companies like Equity Residential (ticker: EQR) and Avalonbay Communities (AVB) focus their holdings on apartment communities and multi-family rentals.
“For individual investors, apartment REITs are a great way to invest that offers diversification, high-caliber management, current income, and none of the headaches of actual ownership,” says Sidelsky.
An apartment-focused REIT can also offer greater liquidity compared to real estate crowdfunding because REITs can be bought and sold as needed to fit a portfolio.
Rahmanian says these REITs can appeal to the passive investor looking to time the real estate market at scale.
“You have REITs that operate in the United States and around the world and I find it interesting to invest when you think the real estate market is going up and short when you think we are at the end of a cycle or that something is going to disrupt the market,” he says.
The key thing to keep in mind when investing in multi-family REITs is to look at the underlying properties, rather than just focusing on the dividend yield. Assessing the fundamentals of the underlying investments and the real estate markets in which they are focused can help investors choose apartment REITs that match their risk profile and performance expectations.
Also keep in mind that dividends paid by a REIT are taxed as ordinary income.
Moroz says investors should realize that the current cycle has been historically long for growth and understand what that means from a multifamily investing perspective.
“We’re probably in the latter part and as such they should be more careful when buying properties with underwriting based on the same rental growth assumptions we’ve had for the past nine years,” says -he.
In most markets, rent growth has been above average historically, but in many submarkets wages have not kept pace with rising rental rates. This could pose a challenge to the sustainability of further rental growth in these markets.
Sidelsky notes that it’s also important to keep the balance between supply and demand in mind, avoiding areas where available multi-family rentals exceed demand. This could create a situation where rental rates stagnate or vacancy rates remain high.
Finally, analyze the numbers for any apartment or multi-family rental investment to make sure the deal makes sense.