Today Theo and Travis will be making a case for multifamily real estate as an asset class. This episode builds on previous episodes of the Actively Passive podcast that covered various industry reports and showcased in-depth information about the multifamily market.
This time, Theo and Travis are explaining why multifamily real estate is a great choice for passive investment in 2021. And while there are many nuances for each market and specific deals, some common indicators show how profitable and secure the multifamily asset class investments can currently be.
We also have a Syndication School series about the “How To’s” of apartment syndications, and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening!
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TRANSCRIPTION
Theo Hicks: Hello Best Ever listeners and welcome back to another edition of the Actively Passive Investing Show. As always, I’m your co-host, Theo Hicks, with Travis Watts. Travis, how are you doing?
Travis Watts: Hey, Theo, doing great.
Theo Hicks: Well, thank you again for joining us today. Best Ever listeners, thank you for joining us as well. Today we’re going to give you a Case For Multifamily Real Estate in 2021. There is a question mark in the title, but for me it’s an exclamation point. The Case For Multifamily Real Estate in 2021.
Travis and I have done a few Actively Passive Investing Shows in the past on very detailed, in-depth, well-researched multifamily reports, commercial real estate reports, going over a lot of stats and data on specifically why there is a strong demand for multifamily; some of the forecasts for commercial real estate in general, but also multifamily for 2021 and beyond. So based off of our backgrounds, as well as our reading of those reports, we kind of threw together a list of different points that support investing in multifamily, specifically in 2021 and beyond. A lot of these metrics will kind of give you an idea of what types of metrics indicate a demand for multifamily, what types of metrics show that a certain asset class is going to be strong; how do you know that a certain asset class is going to be strong. So those are the things we’re going to talk about today. We’re gonna be keeping it pretty high level. If you want to check out some more detailed analysis, again, check out some of our other Active Passive Investing Shows. There are also lots of different really solid real estate reports out there that you can find as well.
Travis Watts: Absolutely, Theo. I think for me anyway, the purpose of this particular show episode is that, to your point, we’re hugely going really in-depth on something very specific. What are the top 10 markets for 2021, or how does a cap rate work, or whatever it is… The way I envisioned this is I’m sitting at a table, I’m introduced to somebody I don’t know, they say, “What do you do?” and I say “I invest in apartments” and they say, “Oh, really? Tell me more. Why would you do that?” So this is just kind of that high level, I’m kind of making the case for why I do what I do. So it’s just kind of some general thoughts.
I’ll kick it off with something that we talked about several episodes back, I can’t remember which one it was, but it’s about cash flow strategies. I’m such a huge advocate for investing in things that produce passive income, or cash flow, or dividends, or interest… And personally, part of my criteria is on a monthly frequency. And the reason is because when I have a whole portfolio stacked up with monthly-paying, cashflow-producing assets, yes, I’m living on a portion of it, but then anything I’m not using, I’m able to quickly reinvest into other assets that produce even more cash flow. Therefore, what’s important about that, that little circle of life right there, is the way I see it, I’m reducing my risk.
So let’s say I have to go out there in the world and I have to earn an income, and I pay my taxes, and I’m left with my net amount of cash. Well, I take that cash and I initially put it into some real estate, let’s say. So that in my mind is where I’m taking the most risk. In fact, all the risk, that first investment. But as that investment starts kicking off more cash flow and more income, and I take that and then buy another asset over here, then I’m taking significantly less risk. Because even if that new investment that I just made over here falls apart or goes to zero, or whatever happens, I still have my initial piece of real estate. So I still, in my mind anyway – I’m sure some people probably don’t agree with this – but it’s almost like I’ve taken no risk on the last investment that I made, because I still have everything that I started with, hopefully, and then some.
So that’s the primary reason. We’re going to get into a lot more in this episode, reasons for multifamily, and apartments, etc. But at the top of my list, it’s all about cash flow and passive income. I’ll leave it at that.
Theo Hicks: Yes. Like all transactions, it’s all about supply and demand. So for real estate, for multifamily, I like looking at supply as two different things – it’s the people, and then the properties. People need to live somewhere, every person needs a place to live, so how many units are there for people to live in? So as the number of people goes up, if the units stay the same, then demand for those units is going to go up. If the people stay the same, but the units go up, then the demand for those units is going to go down. When the demand goes up or down, that impacts the amount of rent that can be charged. It’s kind of a simple calculation.
When it comes to determining where supply is at, there are places you can see the number of units constructed. Those are kind of good to understand compared to the previous year, but I really like the absorption rate, because that basically tells you over a certain period of time, there are this many available units; what percentage of those units have been occupied? That doesn’t really tell you how many years are being constructed, but it kind of shows you what the demand is for the units.
So obviously, an increasing absorption rate indicates that there are less units than there are people. If it’s going down, then there are more units than there are people. [unintelligible [00:08:28].11] real estate reports – you’ve probably heard this before, it’s the affordable housing crisis. There’s a very limited supply of affordable housing because of the costs to make multifamily, and the amount of rents you can get. All the new construction is going to be A class, because it costs a lot to develop the property, so you need to get a lot of rent in order to cover all those costs. So it doesn’t financially make a lot of sense to do new development for C class or B class properties. It’s usually going to be an A class range in really nice markets.
Since the supply of B class, C class, affordable housing isn’t really going up –it might even be going down, because they’re getting fixed up and brought to a higher level– but the number of people that need that housing, especially now because of the current recession that we’re in, that is a big plus for multifamily, from a supply and demand perspective. This is kind of reflected in the rent growth.
I just did a blog post a few weeks ago about the rent growth forecast. The 10 markets where rents are going to grow the most in 2021. What you realize when you read these things is that these are all, again, forecasts, and it could be higher, it could be lower… But when you look at 2020 rent growth, and then 2021 forecasted rent growth, they’re not in these massive, big markets.
The market that grew the most in 2020 was Boise, Idaho, of all places. So they’re not these A class markets, they’re these secondary and tertiary markets. On the one hand, you can see that okay, there’s a lack of affordable housing, and then in these areas, the rents are going up. So if you are a passive investor, you might want to consider looking at, again, these value-add type plays, where they’re buying the C class, B class properties, in areas that have experienced rent growth, that has beaten the national averages over the past five years, and is projected to continue to beat the national average over the next five to 10 years, and investing in those places. You can still do well investing in new development deals and things like that, but at minimum, you’re always going to have this demand for these affordable housing until something changes where it becomes really cheap to build again.
Travis Watts: Absolutely, Theo, great points. Two other things I was just thinking about is — I want to give a different kind of spin on what everybody’s pretty familiar with, which is the appreciation aspect of real estate, and the depreciation aspect. But I want to take it a step further and paint a different picture.
A lot of people think of appreciation in the sense that, “Oh, I’m going to buy this property – whatever the property is, single-family, multifamily, etc. – and I’m going to sit on it for numerous years. Hopefully, the market is just going to lift the value, and (to your point) supply and demand, and one day, it’s going to be worth more.” As we all know, our grandparents and what they paid for their single-family homes way back when, $20,000 for a house that today is $500,000. Well, that’s certainly one way to look at appreciation. The problem with that is markets don’t always just go straight up. As you know, what about 2008, ’09 and ’10? Sometimes markets go down. So solely relying on just market conditions for appreciation, I think, is a mistake. This is why I invest in value-add properties, because we are forcing the appreciation. We are buying something that’s already at a discount because it has some problems; we’re fixing those problems, we are raising the rents.
The whole name of the game in multifamily is net operating income. We either have to increase revenues and/or cut expenses. And then your NOI (net operating income) goes up, and then your property is more valuable. A lot of single-family investors don’t necessarily think about it that way, because NOI really is almost irrelevant in the single-family space; it’s more based around the comps in your area.
So that’s one thing to think about with appreciation. The good thing about real estate, generally speaking, is that it’s kind of an inflation hedge. So if you believe the Fed and their projections that inflation is 2%, then theoretically your property is going up approximately 2%. Either you can raise your rents 2%, or the cost of materials to build goes up 2% a year… So yeah, in theory, over time, the property’s worth more. But guess what? It’s gotten eaten up too with inflation, so maybe it’s really not worth anything more.
So something to think about there is, think about it like buying a stock. If you could find a really solid company that, for whatever reason, just had a big dip, because the whole market went down, like we saw last year in March and April… If you’re able to pick that stock up at a 30% discount and it recovers, now you have a 30% buffer. So the market could collapse again 30%, but you still wouldn’t be losing any money. You’d be at breakeven at that point. That’s just how I like to invest, and a different way to think about appreciation.
Now for depreciation, this is where we get into taxes, and Theo and I certainly aren’t CPAs or tax professionals, so certainly seek out your own licensed advice on this… But real estate has some tremendous tax advantages with bonus depreciation, with cost segregation studies that you can do, mostly applicable in the multifamily space… But the bottom line is, to the point of my first topic when I was talking about reinvesting cash flow and then lowering risk – well, if I’m not having to pay 35 plus percent in taxes on my cash flow each year, because I have more depreciation than I have cash flow, then I’m able to reinvest that cash flow over and over again, where otherwise I wouldn’t be able to.
If you ever look at these compound interest charts – I’m sure most of us nerds out there, myself definitely included, are always running these calculations of the phenomenon of compounding. But if you ever throw in the equation of, assume that you paid 35% tax, it’s incredible. We’re talking over time, millions and millions of millions of dollars in difference, just because you were paying taxes along the way. It’s certainly a killer of returns, hands down.
So another reason I invest in real estate in general, single-family, multifamily syndications, etc, is the tax advantages and the fact that I can keep rolling that forward, and that they’re tax-favored. If I’m holding a property, let’s say longer than 12 months, now it becomes a long-term capital gain, which is tax-favored, as compared to just getting interest in the bank, for example, something like that, which goes into your ordinary bracket up to 40% plus, that kind of thing. So those are two more high-level thoughts I just thought of.
Theo Hicks: A quick follow-up on the appreciation. I think I brought this up a few times on the show, but I really liked his thought process… It’s from the first webinar that we did for the Best Ever conference. They’re talking about should you buy or should you sell, or should you hold in 2021. It was a tax specialist, and she was saying something changes in the tax code. It’s going to, in a sense, impact all investments very similarly. Some might be impacted, more or less; everyone’s going to be in the same boat. So are you just going to stop investing period, or are you just going to find the best investment for the time being?
I think we’ve talked about this [unintelligible [00:15:41].26] maybe you don’t get 10% returns, but you’ll get 5% returns when everything else is going to be zero or negative. So when you’re talking about appreciation, it kind of triggers my thought process… Because like, look, even if that cap rate part of the equation makes it so that values go down — and it’s not just real estate value is going to go down and everything else is going to be completely [unintelligible [00:15:57].28] The stock market is probably going to go down too, other investments are going to go down too.
So when you have that other metric of the forced appreciation, you can offset and maybe even completely overcome any dips in the market by forcing that appreciation up. And then it’s even better if you’re investing with a company that is very conservative with their underwriting and even assume that in five years from now we’re expecting the market to be worse than it is now, so that if it’s not, then the value is appreciated even more.
We’re talking about the case for multifamily, and when you’re investing in these value-add force appreciation type deals, and the markets doing really well, then you’re going to do even better, if the market is not doing very well, then you’re really better than what you do if you’re investing in something else that was completely reliant on the market that’s not doing very well.
We have other points, too – the back-end buyers. Last week we talked a lot about the exit strategy. Who’s going to buy multifamily? Right now, I know Travis has talked about this a lot, but the returns on other investments are either really low or not very stable. A lot of these big hedge funds are buying real estate, they’re buying stabilized, turnkey, low headache real estate in order to get that 5% consistent return that they can’t really get anywhere else. So when you are investing, again, with value-add, or really investing with anyone who plans on stabilizing the property, which I don’t know why they wouldn’t stabilize the property, then you can have confidence that on the back end an institution is going to buy this property from them.
Travis Watts: I was just going to caveat one thing that you mentioned that’s critical for everybody listening to understand – when you’re saying a 5% return, we’re talking about an unlevered return. We’re talking about institutional capital, buying an apartment community with no debt, no leverage. That’s what a cap rate is, essentially, when you’re buying at a five cap. So these institutional players, just to clarify your point Theo, are looking around and saying, “Treasuries are paying 1%, and bonds are paying 2%. So hey, 5% sounds pretty good.” And if you’re not using any leverage or debt, you’re taking a lot less risk, therefore this may be pretty comparable to buying a bond or a treasury, at least in my opinion. So that’s kind of their perspective from an institutional standpoint. This is a pretty high-yielding asset without taking on a lot of risks, if we’re not going to lever it up with debt.
Theo Hicks: Thanks for clarifying that. So because of a demand from these institutions for that type of real estate, then not only can you benefit from what we talked about already – the cash flow, the appreciation, the tax benefits, the cash and the rent growth, the demand and the supply – we can also have confidence that once they sell this thing, someone’s going to buy it. They might say, “Oh, well, who’s going to buy this thing on the back end if the market is not doing very well, the market takes a dip?” If it’s going to perform better and be a lower risk than other investments, institutions aren’t just going to do nothing and just sit with their money; they’re going to invest in something. And this is going to be one of their better options, especially now.
And then from your perspective, to even reduce your risk even more – because whenever you do research on some of these real estate reports, you’ll see the national average for everything. Some things are better than the national average, some are less than the national average, and then if you get to look at, say, 2019 data forecasts and then what actually happened in 2020, maybe some that were supposed to be the national average didn’t, maybe ones that were not supposed to beat the national average did it… It’s kind of hard to be perfect, especially in 2020, especially. So a good way to minimize risk even more, is to diversify across multiple markets. So possibly invest in some primary markets, but then also do some tertiary markets and some secondary markets. That way, they might not necessarily do as well if you had put all your eggs in one basket and we’re right, but you aren’t going to do as bad if you put all your eggs in one basket and we’re wrong. Diversifying across these different types of markets that have different pros and cons can help you participate in the national average, and hopefully outperform that. But since you’re in multiple places, then if something happens to not perform how it’s opposed to, then the ones that did pull you back up and make sure that you’re keeping your capital, and it’s growing, and you’re making that cash flow.
Travis Watts: As part of the beauty of being a limited partner, I highly value diversification. It’s a lot of the reason why I left doing single-family investing, where I had a portfolio of single-family homes, into multifamily, is so I could pull that equity out and I could redistribute it in smaller amounts nationwide, in markets where I was kind of placing a bet on, with operators who, quite frankly, are doing things a lot better than I was. So I’m huge on that, absolutely. We covered the top 10 markets, as you pointed out, a couple of episodes ago. So in theory I was able to liquidate those single-family homes and go put 25K here, and 50K here, and 75K there, and spread that across those top 10 markets, give or take. So great points, Theo.
Another thing, since we’re talking about single-family and multifamily, is the safety of your capital. So this is something I got really uncomfortable with. Let’s take an example of a single-family house rental and multifamily asset, both leveraged, meaning that we have mortgages or debt on apples to apples that way.
So with a single-family homes, the ones that I used to own, when I had a renter in them, and I was getting the rent payments on time and in full, I may have been a few 100 bucks cashflow-positive every month. But anytime a tenant moved out or didn’t pay me rent, not only did I not get the few 100 bucks, I went severely negative, because I still had property tax, insurance, and HOAs in my mortgage payment. So I might have been $1,000 underwater. So that 300, 300, 300, 300 just goes away if in month number five I don’t collect a rent payment, for whatever reason… In addition to all the maintenance issues that pop up with roofs, and HVAC systems, etc. A lot of times my cash flow was wiped out for the entire year, just because of an unforeseen whatever, that kind of thing.
So I got to thinking about risk, and I thought, “Man, if I had five properties, and even three of those I wasn’t getting rent for whatever reason – maybe a flood, tornado, or just a coincidence – I might be in pretty bad shape.” I don’t have thousands of dollars per month to cover in expenses. and I certainly didn’t have enough cash flow from my other properties to cover that.
So in multifamily, let’s use a 100 unit apartment building just as an example. A lot of times you can find these and underwrite these properties at, let’s call it, a 60% breakeven occupancy, just to use simple numbers again. That means out of my 100 units, I could have 40 tenants not paying rent or not occupying the units, and I’m still at a break-even. I’m not losing money, I’m at break-even on the property in terms of cash flow. So to me, that’s really about safety and risk reduction, and it’s a big reason I really like multifamily, which is obviously the topic that we’re covering here.
In addition to the last thing – I know I already covered it a little bit, but the inflation hedge of “We can bump rents based on what the inflation rate is”, the materials get more expensive to build these types of products, therefore our product becomes more valuable… So it’s a huge topic right now, Theo, and everybody listening, if you haven’t been tuning in, the Fed is just pumping trillions of dollars into the system. We’re going to see inflation. I don’t know what percentage, I’m not that smart, I don’t know how that’s really going to pan out…And hopefully, it doesn’t end up as hyperinflation, like we’ve seen in Venezuela, or back in Germany in the 20s and 30s, or Zimbabwe… But I do think this 2% inflation is perhaps a little bit of a joke, looking forward to the next decade.
So you want to be in something, in my opinion, that’s an inflation hedge. And if you’re leveraging, like we’re talking about, if you have a mortgage and debt, you are locking in today’s dollars in that debt, and then paying them off with cheaper dollars. The more we inflate and the purchasing power goes down, the more money we have to pay off that pre-existing debt. So all in all, big fan of real estate in general, but multifamily, for those reasons.
Theo Hicks: Yes. And then to kind of close and summarize… The thing to think about here isn’t, “Is me passive investing in multifamily going to help me double my money in a certain amount of years, or get 15% annualized return?” I think the better approach is to compare it to everything else.
I’ve kind of said this multiple times in the show, but unless you’re just going to keep your money in the bank or under your mattress, you’re going to invest it in something. So what is the best vehicle to invest in? What is the ideal vehicle to invest in when the market is doing well, or when the market is not doing really well, or when you think the market is not doing very well, or you think it’s doing very well… The point of all these things is to say “Hey, look. These are all the different things that multifamily has going for it that allow it to obviously perform really well when the markets doing well, but most things do well. But what happens when it’s not performing well?” What happens if there’s a dip, or as we talked about inflation, or a recession, the stock market crashes, or whatever… People are going to need a place to live, and you’re going to need a place to invest your money. So those two things being true, real estate is a very good place to park your money.
We’ve also kind of went specifically why we think that multifamily is one of the best places in real estate to park your money, especially when it comes to single-family, especially if you’re passively investing. Actively investing is a different story. We’re talking about passively investing, what should you passively invest in… And Travis kind of went over specifically his story about single-family homes versus multifamily. There are a lot more advantages to that as well. We do have a couple of blog posts comparing single-family and multifamily at joefairless.com; just type in SFR versus multifamily on there and that will come up. But that’s how I approached this, is “Look, you’ve got to invest in something. What should you invest in? Multifamily, and here’s why.”
Travis Watts: I’m glad that you brought that up. Again, you brought up looking at the surrounding options. I did an episode on our show a few episodes back, just solo, about what kinds of things in our market today are yielding approximately a 2% return, or a four, or a six, or an eight, or a 10. Just giving examples to think about. Not suggesting all of these will always produce this kind of cash flow, but it’s something to think about. I’m still bullish on multifamily, for the reasons we talked about. Mostly because institutional capital is looking around saying, “Well, 1% over here,” “2% over there,” or “Oh, 5% over here.”
So think about this – a lot of people have trouble wrapping their heads around where cap rates are today in real estate in general. Let’s say nationwide they’re around 5%, on average. Let’s say that they go to 2%. Your immediate thought might be “Oh, well, I’m out. If it’s a two cap, that’s crazy. I’m not investing in real estate.” What if you look around and the bank is at negative interest rates, you’re having to pay the bank to store your money, and bonds are negative, and what if there’s no such thing as yield, except for real estate that yields a 2% return? That’s probably going to be your best option then. You’re going to want to make any kind of return whatsoever. You always have to be matching it up against the surrounding options.
In another scenario, let’s say that cap rates are 2% on multifamily, but municipal bonds are 4%, which would be a crazy world. But if that were the case, maybe that’s a better option to place your capital, because you might get a tax-free yield at a higher interest rate, and these kinds of things.
So you always have to be kind of looking at the landscape and understanding what Main Street investors are looking for and chasing, and institutional, and from our last episode, understanding what the exit strategy is, who are you likely going to be selling to. Anyway, with single-family, that’s going to be individuals. That’s going to be Main Street people. With a 500 unit apartment building, that’s probably going to be an institutional buyer more than likely. So things to think about, those are my final thoughts
Theo Hicks: I like that, looking at what are these big institutions doing, and then assuming that they know what they’re doing; they have some information that they’re basing the decisions on when they’re investing hundreds and billions of dollars. It kind of reminded me of something we talked about a while back when we were talking about how to analyze the GPs market; something else that you do as well, like, “Okay, if a Fortune 500 company is moving to this market, they have a big team who’s analyzing the entire country to say where should we move our corporate headquarters, based off of a variety of metrics.” So if you’ve got a bunch of Fortune 500 companies going somewhere, or you’ve got some big Fortune 500 company buying a bunch of real estate somewhere, they’re probably onto something. You can use that as a guide, where to invest market-wise.
Same thing here – what are the institutions doing? Are they investing in multifamily? Are they investing in bonds? Are they investing in the stock market? What are they doing? Then figuring out why they’re making that decision. They’re not just randomly investing in multifamily; they’re doing it for a specific reason. So that’s another way to guide you to where to test things out. Anything else you want to mention, Travis, before we sign off?
Travis Watts: No, I think that’s it. All in all, to conclude, I’m still bullish on multifamily for 2021, and looking forward, I’m still investing. I did more deals personally in 2020 than I’ve ever done in any given year, and we’ll see how this year pans out. That’s my opinion on it, for what that’s worth… That’s all I got.
Theo Hicks: Perfect. Thank you as always, Travis, for joining us today. Best Ever listeners, thank you for tuning in. One last thing to mention before we sign off – we are doing a new shorter segment on YouTube. We’re calling it the 60 Second Question. So you submit your Actively Passive Investing questions if you’re watching on YouTube in the comment section below. If you’re listening to the podcast, you can just email me directly at theo@joefairless.com, and Travis and I will read your question and your name, and then we’ll answer it in 60 seconds or less. We’ve got a couple of videos already up on our YouTube channel, so make sure you check that out. If you want to have your question featured, again, email me at theo@joefairless.com.
Again, thank you for tuning in. Best Ever listeners have a Best Ever day and we’ll talk to you tomorrow.
Travis Watts: Thanks, Theo. Thanks, everybody.
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