Why Invest In Apartments

Population and Demographic Shifts

The U.S. population is projected to grow to almost 80 million people by year 2060. Demand drivers such as immigration growth, delaying of family formation and the aging population of the baby boomers will continue to increase demand for apartment homes with the United States needing over 4.6 Million apartment homes by 2030.

 

With tighter home mortgage lending standards, there are fewer people able to qualify to purchase a home of their own increasing the pool of renters. And with a weak jobs market and slow (if any) real wage growth, saving up for a down payment is a slow, if not impossible task for many. The result is more people are renting. As for those former homeowners who lost their homes during the Great Recession, they too have joined the renter population In Q2 of 2016 home-ownership rates in the US (the percentage of all households owning rather than renting their residence) fell to 62.9% the lowest since 1965 from a pre-recession high of 69.4% in 2004.

 

Apartments Are Resilient

Once lumped in with single-family residential, multifamily (aka apartment buildings) is now firmly entrenched as one of the four major commercial real estate asset classes alongside office, retail and industrial. The asset class now accounts for around one-quarter of all US commercial real estate investment and is occupying a growing share of institutional investor’s portfolios. Coming out of the 2008 Great Recession, multi-family properties (i e apartments) became one of the most popular asset classes.

 

As a result, multi-family recovered faster and has performed better than most other real estate investment niches over the last several years. However, long before the Great Recession, multi-family properties had been a staple for both individual investors and institutions like REITs and insurance companies. For individual investors, owning income-producing residential real estate is a proven way to create financial freedom. It’s a timeless asset that serves an essential human need, so it’s in demand in both good times and bad. There are several reasons why multifamily is considered by many to be “best in class” within the investment real estate world both for investors in the property AND investors in the paper (the mortgages that fund the property).

HOUSING AN ENDURING UNIVERSAL NEED

Not everyone works in an office, belongs to a health club, eats in a restaurant, stays in a hotel, operates a factory or stores their personal treasures in a storage bay. But EVERYONE needs a place to sleep at night. And because most people prefer walls and a roof, housing will always be a basic need for everyone.

There are nearly 80 million of these children of the baby boomers, and they’re starting life with student debt, little savings and little desire to buy a home. They saw many of their parents lose equity, and in some cases, lose homes during the crash. They’re in no hurry to buy and are happy to rent. Millennials are expected to outnumber Baby Boomers for the first time in 2019. These 20-35-year-old’s typically are starting families later in life, favoring the live-work-play urban areas where home-ownership is relatively expensive. While home-ownership rates may not remain at historic lows, there’s every indication that demand for multifamily housing will remain strong. Even empty nester Baby Boomers factor into the mix. For those who don’t have adult children or elderly parents moving in with them, downsizing from a home into an easier to care for an apartment is a way to free up equity for investment and simplify their lives. Add to this a population that is growing through immigration often on the lower end of the pay scale and it’s clear there are more and more people needing affordable housing apartments to meet this need. The momentum of the market is underlying the strength of multi-family investing, New jobs, new construction, new infrastructure, and beneficial tax and business climates drive the momentum.

Cash Flow Creates Equity 

This is one of the most important distinctions between houses and apartments. It’s also one of the most important concepts to understand as an apartment investor. Single-family valuation is based on competing properties of similar size, age, and quality construction that have been sold recently in the same submarket. While a house may be bid up by a homeowner to a price far in excess of what rents will support, that can almost never happen with an apartment.

 

In other words, value is a product of income. The more income, the more valuable. So even though investors may bid more for the same income (causing the ROI or cap rate to fall, just like bonds), there’s far less pure speculation in apartments. Apartment investors and lenders are VERY fixated on positive cash flow.

How We Increase Value

Apartment operators can typically raise their rents once per year as leases expire, subject to local market conditions. As rents increase, the value of the property increases with it. As mentioned, apartments are valued off of a multiple of net operating income: ( is Gross Rents Received fewer Expenses). The NOI is what is used to make your mortgage payments. As in any business, lowering expenses and increasing income will increase your net operating income. Something as simple as moving the trash bill from the landlord to the tenant can increase the value of your investment by several thousands of dollars.

 

This is because a small increase in income per unit can be a substantial amount for an entire complex. Even more exciting is that an increase of income can lead to a substantial increase in equity ( For example, if you own a 50 unit apartment building and you increase the income (without incurring any additional expense) by $20/M per unit, you have created an extra $1000 per month. At a 10% cap rate, you have created an additional $120,000 in value. A small movement to income can have a large impact to value.

Tax Benefits

Depreciation expense is one of the few gifts the government gives us. It’s essentially a noncash expense apartment owners use to shelter their income and reduce their tax bill. Apartments are considered residential and enjoy a slightly faster depreciation schedule than commercial properties 27 vs 39 years).

 

This means more deduction per year to offset the income tax on your positive cash flow. With large apartments, you are also able to perform an engineering accounting study called “Cost Segregation”. A Cost Segregation study consists of having a team of engineers to determine the useful life of various components of the apartment. For example, the doors of the apartment may only have a 5-year timeline so you can depreciate their value on a faster schedule.

This breaks up the total value of the apartment into either 5, 7, 15 or 27.5 years, allowing you to depreciate much more each year. Currently, the government also is incentivizing apartment owners with Bonus Depreciation, allowing all of the 5, 7, 15-year schedules to be depreciated 100% in year ONE! This alone has been attracting many high net worth investors to multifamily The bottom line is less tax and more after-tax income.

The Magic of Compounding

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