By Bernard Pierson
Investing in apartments can be a great way to diversify, generate income, enjoy tax benefits, and create equity through appreciation. All these benefits can be achieved through other means; although not exactly as apartments do, so the question we all have, especially if you are newer to the industry is: is it worth it?
As with many things in life, the answer is, you guessed it: It depends. It will depend on what your goals are, what your risk tolerance is, and what you are looking to achieve. There are many ways to invest in apartment buildings. These include investing in a REIT, investing in a private fund, being part of a joint venture, buying your own building, and investing in a syndication. I will compare the latter two.
First, let’s look at how apartments have historically fared in general terms. I am a fan of economist Dr. Peter Linneman, founding chairman of Wharton’s Real Estate Department. I follow his market outlooks and read his quarterly letter. In his Fall 2021 letter, Dr. Linneman does an outstanding analysis on commercial real estate performance as measured by NCREIF, the leading income producing real estate performance index. Going back to 1978, he studied commercial real estate performance, as measured by NCREIF, on any 10 year hold period. On average, across all asset classes, any 10-year period would have yielded an 8.3% return. How did apartments do? They did the best with an average return of 9.4% over any 10-year hold period. Apartments have also been the least risky as measured by standard deviation at 2.1%, compared to 2.6% across all asset classes. Finally, the worst 10-year performance during that period would still have yielded 6.1%, whereas the industry average would have gone as low as 4%. And finally, if you were to choose the best 10-year period, apartments would have yielded 14.6% versus 13.3%. Past performance does not predict the future, but history is all we have to make our best attempt. Apartments outperformed all other asset classes, be it on average, on the worst 10 year period, or on the best 10 year period, all while having the least risk.
To make things better, this is an unlevered analysis! That means no debt. Now consider that apartments have the best debt terms out there. Why? Because of Fannie and Freddie. We can start seeing that with debt, apartments would have had superior positive leverage. Don’t get me wrong, all other real estate asset classes are great, and they all have their place, but historically, apartments have been solid!
So, if you are still with me, you are likely interested in getting some sort of exposure to apartment investing. And I haven’t even touched on the other benefits which include magnified returns using leverage, consistent cash-flow, and tax benefits. So, is apartment investing worth it? For most investors, yes! If the investor can invest with a longer-term mindset (five years or more) and can give up liquidity in the meantime, yes. Now, is it worth going out and buying your own building, or is it better to invest with an experienced operator? Again, it depends.
Buying your own building can have several advantages. To start, you will have more control over the deal. You will decide when to buy, when to refinance, when to sell, what your business plan is, what financing you want, and how you want to manage your property. This is all great, but there are also downsides. For starters, if you don’t have experience, you will quickly learn that although this is a simple business, it is not easy. Experience and education cannot be replaced. For instance, without proper experience, you may underestimate your expenses or overestimate your revenue. Also, with little experience and a limited balance sheet, financing may be difficult to obtain, or terms may not be the best. Lastly, unless you have significant capital, or access to capital, you will not have access to larger deals that may offer better economies of scale.
What is the alternative? Invest with an experienced operator. You will typically do this by investing in a syndication. Essentially, a syndication is the pooling of resources for a common goal. The common goal here is financial growth with multifamily properties, and the pooled resources include capital and experience. An experienced operator will have relationships with brokers and will know how to find and acquire good deals. An experienced operator will also be good at optimizing the operation of the property. And finally, an experienced operator will have access to great financing terms. The best part? You can now be part of a larger, institutional quality deal with limited funds. Sometimes as little as $500, but to be realistic, the number will be closer to $25,000 on the low end.
If you have little or no capital to invest, investing in a syndication may not be your best option. However, don’t let this be a limiting factor. There are plenty of ways to bring value in multifamily investing. Going into detail would be beyond the scope of this article, but think deal finding, being boots on the ground, helping with management, and raising capital. There are tons of resources available for free to learn more on how to become involved. I would start off by reading through the Jake & Gino blog.
How do you choose? Ask yourself the following questions:
- Do I have the time?
- Do I want to invest in my backyard?
- Do I want to manage tenants?
- Do I want to learn how to underwrite and identify deals?
If the answer to these questions is YES, then consider investing in your own buildings. Also consider partnering with experienced operators and find ways to bring value. If the answer is NO to most or all these questions, or if you want a truly passive experience and still want to invest, find an operator you trust and consider investing as a limited partner in their syndication. You will still have to learn to vet the operator and the deal which will require some degree of apartment investing education, but this will be marginal when compared to the experience required to be a good operator.
So, is apartment investing worth it? If you got this far in the reading, the answer is PROBABLY. I wouldn’t recommend investing your last $50,000 into a syndication, but if you have savings and want to get started, learn about syndications, learn about apartment investing, and start off with a syndication. Otherwise, there are still plenty of ways to bring value and be part of a deal. Just know you have several ways of getting involved and find the one that works for you.
Equiti Partners | Managing Partner