Multifamily Investing with Midfield Realty – Complete Successfully Guidance

What is Multifamily Real Estate?

Multifamily real estate refers to residential properties that are shared by multiple households or families. These properties contain at least two separate living units that are either adjacent or stacked. They share common features such as walls, roofs, and systems for heating and cooling. Examples include townhomes, condominiums, apartment complexes, and build-to-rent (BTR) communities. In simple terms, multifamily housing is designed to be occupied by more than one family or household.

Investing in multifamily properties is one of the largest and most straightforward options among the four main types of commercial real estate. Many investors choose this path to diversify their investments. Multifamily properties can generate rental income, expand your investment portfolio, and sometimes offer tax benefits.

If you are looking to add variety to your 60/40 investment mix, multifamily properties might be a good option. Investing in these properties is more accessible than ever. However, like any investment, it comes with its own set of risks and considerations, which will be discussed in detail.

Multifamily Investing Explained:

Investing in multifamily properties, such as apartment buildings or condominiums, involves purchasing buildings designed for multiple tenants. These properties typically have many units, allowing investors to benefit from economies of scale and potentially higher profits.

This article explains the basics of multifamily investing for individual investors and highlights why this type of investment is beneficial compared to traditional stock and bond portfolios:

Cash Flow and Appreciation:

Multifamily investments can offer both steady rental income and potential property value growth.

Diversified Tenant Base:

Unlike single-family home investing or house flipping, multifamily properties benefit from having multiple tenants, which can reduce risk.

Essential and In-Demand:

Compared to other commercial real estate types, multifamily housing Investment is essential, difficult to replace, and often in short supply.

Investing in multifamily properties is a key strategy for those looking to diversify their investments. Multifamily real estate is a significant part of commercial real estate and is often among the easiest for investors to understand. The reasons for its popularity and the fundamental roles of multifamily buildings are clear. Additionally, multifamily real estate is usually one of the most reliable investments compared to others.

This article covers key aspects of investing in multi-unit properties, highlights major benefits, and offers advice for passive real estate investors.

Multifamily Investing Detailed Explained:

Multifamily investing involves purchasing properties that house multiple tenants, such as apartments and condos, with a focus on lease-up and value-add improvements. It is recognized as one of the “core four” categories of commercial real estate investments.

Investors in multifamily properties often aim to enhance their net operating income (NOI) by increasing occupancy rates, raising average rents, or both. Success in multifamily investing also depends on selling the property at a premium, which can be achieved through favorable market trends, property improvements, or a combination of both. Therefore, commercial real estate (CRE) investors typically focus on several key metrics when evaluating a multifamily investment:

Occupancy Rate:

The percentage of units occupied by tenants.

Capitalization Rate (Cap Rate):

A measure of return on investment, calculated as the ratio of net operating income to the property’s current market value.

Sales and Rental Comparisons (Comps):

A review of similar properties in the area to gauge potential income and value.

Market Demand Drivers:

Factors such as population growth, job growth, and other elements that influence demand for rental units.

The performance of multifamily properties is influenced by supply and demand. Limited supply can drive up rents, increase the property’s market value as a multiple of rents, and lead to higher sale prices. Local factors, such as zoning laws and permitting, can affect the supply of multifamily units in a given area. Macroeconomic factors also play a significant role. In the U.S., demand for rental units generally exceeds supply, benefiting multifamily investing. As of 2024, the pipeline for new multifamily developments is strong but expected to decelerate significantly in the coming years, particularly beyond 2025, due to rising interest rates. These rates have caused many new projects to be put on hold.

Overall Meaning of Multifamily Investing

Multifamily real estate stands out as a crucial and often lucrative segment within commercial real estate. Defined by properties designed to accommodate multiple households—such as apartment buildings, condominiums, and townhomes – multifamily housing features shared infrastructure and common areas. This asset class is particularly attractive for investors seeking diversification beyond traditional stock and bond portfolios.

Investing in multifamily properties offers notable advantages, including steady cash flow from rental income, potential for property value appreciation, and a reduced risk profile due to a diversified tenant base. The demand for multifamily housing remains strong due to persistent needs for affordable living spaces, despite fluctuations in the broader real estate market.

With the current construction pipeline slowing down and fewer new projects coming to market, the multifamily sector is poised to benefit from decreased competition and ongoing rental demand. Additionally, multifamily properties are well-positioned to act as a hedge against inflation and economic downturns, further enhancing their appeal.

For investors, understanding key metrics—such as occupancy rates, capitalization rates, and market demand drivers – is essential for making informed investment decisions. Multifamily investing offers a balance of stability and growth potential, making it a compelling option for those looking to diversify their investment portfolios.

Overall, multifamily real estate remains a foundational asset class with strong potential for steady returns and long-term value appreciation, making it a prudent choice for investors in 2024 and beyond.

Multifamily Real Estate Investing vs. Single-Family

When individuals discuss “real estate investing,” they typically mean purchasing and renting single-family homes or flipping them for profit. However, investing in commercial multifamily properties functions in several distinct ways that differ significantly from single-family home investments. It’s crucial for investors to understand these differences when contemplating multifamily properties over single-family homes.

One significant distinction lies in the effect of tenant turnover and vacancies. For single-family homes, the loss of a tenant can significantly diminish or even wipe out your rental income until a new tenant is secured. Conversely, multifamily properties, characterized by multiple units, are better equipped to withstand the impact of vacancies. Even when one unit is vacant, the income generated from the others can still ensure a steady cash flow, rendering multifamily investments generally more robust against tenant turnover.

In essence, multifamily investing gains from a diversified tenant base. With a larger number of units and tenants, and leases expiring at various times, the property is less susceptible to the risk of vacancy. This means that even if some units remain vacant, the income generated from the occupied units can help sustain cash flow, offering greater stability in comparison to single-family investments.

Single-Family vs. Multifamily Investing

Single Family Real Estate

Generally only one tenant
Part of a larger buying pool
Comparatively low upfront costs
Currently extremely low inventory

Multifamily Investing

Can be occupied by multiple tenants
Generates multiple streams of cash flow
Allows for engineering of cash flow through structuring of many leases
Better potential hedge against inflation

Since multifamily properties generate multiple streams of income, they tend to be less volatile than single-family rentals during economic downturns or recessions.

While the upfront costs of multifamily properties are typically higher, they often yield more reliable rental income and cash flow over time.

Even with short-term leases, renting to multiple tenants provides a natural safeguard against inflation. With increased tenant turnover, rental prices can swiftly adapt to prevailing market values, ensuring they remain in step with inflation. Moreover, multifamily operators often “capture” inflation by tying rent increases to the Consumer Price Index (CPI), thereby automatically mitigating the impact of inflation.

Multifamily Investing – A Recession-Resistant Asset Class?

Multifamily real estate investments exhibit resilience during recessions and various economic cycles due to several key factors:

Stability in Demand:

Unlike sectors like retail, office, and hospitality that often suffer during economic downturns, the demand for housing remains steady. The need for a place to live is constant, supporting the resilience of multifamily investments. For example, during the COVID-19 pandemic, many opted to stay in their current homes due to health and economic uncertainties.

Increased Renting During Recessions:

Economic downturns often make it more difficult for individuals to qualify for mortgages as lenders become more stringent in their criteria. This, in turn, leads to an increase in the number of renters, thereby boosting demand for rental apartments. Additionally, financial uncertainty discourages significant purchases such as homes, further expanding the pool of renters.

Performance During Past Recessions:

Historical data indicates that multifamily properties have the ability to recover swiftly following initial downturns. For instance, apartment Real Estate Investment Trusts (REITs) have rebounded and outperformed other commercial real estate asset classes and the S&P 500 in the aftermath of the Great Recession. Furthermore, the U.S. Bureau of Labor Statistics confirms that residential rents typically rise each year, even during recessions, with only a temporary decline observed after the Great Recession.

Adaptability to Economic Changes:

Multifamily investments have demonstrated resilience and adaptability across a range of economic downturns, including financial crises, tech bubbles, and pandemics. During the early 1990s recession, multifamily properties were the sole major property type to see positive rent growth. Similarly, during the economic fallout of the 2020 pandemic, multifamily, along with the industrial and retail sectors, experienced positive rent growth, driven by robust housing demand and government stimulus measures.

Income-Based Valuation:

Multifamily property valuations primarily rely on the income they generate, rather than market conditions. This income-based valuation provides an added layer of resilience, ensuring rental income remains steady even in challenging market conditions.

Looking ahead to 2024, a scenario of a “soft landing” — characterized by a gradual decline in interest rates and inflation without severe economic damage — appears increasingly feasible. However, economic downturns are common following periods of rapid rate increases, such as those experienced between mid-2022 and late-2023. Therefore, multifamily investments might be a timely asset class to consider.

The case for investing in multifamily properties as a recession-resistant asset class is well-supported by historical evidence. This is particularly true during the most severe economic downturn in U.S. history, the Great Financial Collapse. During this period, multifamily real estate outperformed all other asset classes. Even after the initial downturn, multifamily real estate investment trusts (REITs) continued to outperform all other commercial real estate (CRE) asset classes and the S&P 500 throughout the recovery period.

Additionally, delinquency rates on Fannie Mae and Freddie Mac multifamily loans remained below 0.5% for much of the Great Financial Crisis (GFC), never surpassing 1%, even when U.S. unemployment rates exceeded 10%. This low default rate highlights the downside protection of multifamily investments, especially for workforce and non-Class A assets. It demonstrates that multifamily properties, including those with more affordable rent levels, can offer stability and resilience even during severe economic downturns.

Advantages of Investing in Multifamily Properties

Multifamily properties, ranging from duplexes to sprawling apartment complexes, play a crucial role for real estate investors looking to diversify their portfolios. These properties are more than just residential spaces; they are assets that generate revenue and offer greater stability than the volatile stock market.

Why Multifamily?

For accredited investors—those with an annual income over $200K or a net worth exceeding $1M, excluding their primary residence – multifamily investments offer several distinct advantages:

Access to Larger Deals: Accredited investors can participate in larger multifamily projects that may offer higher returns and more significant income potential compared to smaller, single-family investments.
Diversification: Multifamily investments allow accredited investors to diversify their portfolios across multiple units and properties, reducing overall risk and enhancing potential stability.
Income Potential: With multiple rental units, multifamily properties provide multiple streams of rental income, which can lead to more stable and predictable cash flow.
Economies of Scale: Investing in multifamily properties can lead to economies of scale in management and maintenance, making these investments more cost-effective compared to managing several single-family properties individually.
Tax Benefits: Multifamily investments often come with tax advantages, such as depreciation and interest deductions, which can be beneficial for accredited investors looking to optimize their tax situation.
Value Appreciation: Multifamily properties have the potential for significant value appreciation, particularly when improvements are made or when market conditions favor increased rents and property values.

These benefits make multifamily investing an attractive option for accredited investors seeking to enhance their investment portfolios and achieve financial growth.

Multifamily real estate stands as one of the most crucial asset classes, consistently witnessing lower vacancy rates annually. Among all commercial real estate types, multifamily properties serve the most vital role: housing provision. Irrespective of local market conditions or wider economic shifts, the demand for residential spaces remains unwavering.

Is Multifamily Investing a Good Idea in 2024?

In 2024 and beyond, macroeconomic factors are likely to favor multifamily investing. Here are some trends that support this outlook:

High Homeownership Costs: Homeownership is currently more expensive than ever, with single-family homes in short supply and high prices. With economists predicting mortgage rates to stay above 6% in the near term, many potential homebuyers are choosing to remain in rental apartments. Although there is increasing pressure on the multifamily supply, elevated mortgage rates and high home prices will likely expand the rental pool. New multifamily units will take time to meet this growing demand.
Housing Shortfall and Household Formation: The U.S. faces a significant shortfall in housing units, and strong household formation trends are expected to continue. With job figures remaining robust, demand for multifamily units should stay high relative to supply for the foreseeable future.
Inflation Considerations: While inflation has moderated, it is expected to persist for some time. Multifamily properties offer a good hedge against inflation, making them an attractive investment compared to other asset classes.

Given these factors, multifamily investing appears to be a favorable choice in 2024, benefiting from high demand, ongoing housing shortages, and inflation-hedging characteristics.

The multifamily construction pipeline has traditionally been robust, but recent increases in interest rates have shifted the landscape. The Census Bureau predicts a significant year-over-year decline in multifamily starts, coupled with a dwindling supply pipeline in the coming years. This presents a unique opportunity for multifamily investing to bridge the substantial gap in market-rate housing across the United States.

Investing in multifamily properties offers not only a potential financial return but also aligns with social impact objectives. Specifically, investments in workforce housing are in high demand, and any investment in high-density housing is viewed as a positive step towards addressing housing shortages. Therefore, multifamily investing can be a strategy for “doing well by doing good,” merging financial gains with significant contributions to resolving the housing crisis.

The Supply Picture

Investment opportunities in multifamily real estate are significantly influenced by market fundamentals, particularly supply and demand. A reduction in supply typically leads to less competition, making it advantageous for multifamily investors. This trend is expected to continue in the near future.

As of April 2024, the number of new multifamily project starts has hit its lowest point since April 2020, the year the COVID-19 pandemic brought construction to a halt in many regions. This slowdown is primarily attributed to the current state of the capital market conditions, rather than a drop in demand. Elevated interest rates and more stringent balance sheets among mid-sized banks have made securing financing for developers and operators significantly more difficult.

For those adept at navigating the complexities of financing, the resulting decrease in new projects and reduced competition could lead to more appealing investment opportunities.

Current Trends in Multifamily Supply and Cap Rates

In the second quarter of 2024, the construction of new multifamily units saw a modest increase, with around 40,000 units starting, marking a continuation of a downward trend in construction activity. Although there is some worry regarding potential overbuilding within the multifamily sector, the prevailing view is that this issue has predominantly impacted luxury multifamily units over the last ten years. Conversely, there is a significant shortage of workforce and affordable housing units. For further insights into the supply-demand dynamics of multifamily investing, please refer to the latest editions of the Monthly Multiple.

A Brief Note on Multifamily Cap Rates:

According to CBRE research, prime multifamily cap rates averaged 5.06% in the fourth quarter of 2023. This figure represents a 170-basis-point increase from the first quarter of 2022 and surpasses the pre-pandemic average of 2018-2019 by 85 basis points.

In April 2024, CBRE reported that prime multifamily metrics, including cap rates, had experienced their first improvement since the Federal Reserve initiated its interest rate hikes in early 2022.

Looking Ahead: Cap Rates and Opportunities in Multifamily Investing

CBRE forecasts that multifamily cap rates will widen by an additional 25-50 basis points in 2024, potentially bringing the average to around 6%. Higher cap rates generally present opportunities in two key areas:

More Attractive Current Cash Flow Potential: With higher cap rates, investors can expect more favorable cash flow returns on multifamily properties, as the cost of entry may decrease relative to income potential.
Opportunity for Cap Rate Compression: As cap rates widen, there is a potential for “cap rate compression,” where property values can increase for a given level of cash flow. This phenomenon often aligns with changes in interest rates, offering prospects for appreciation in property values as the market adjusts.

These factors could make multifamily investments particularly appealing in 2024, providing both immediate cash flow advantages and long-term value appreciation opportunities.

Conclusion:

In 2024, multifamily investing remains a compelling choice for diversifying investment portfolios and securing reliable returns. Multifamily real estate, including apartment complexes and townhomes, offers significant advantages over single-family investments due to its steady cash flow, reduced risk from tenant turnover, and resilience during economic downturns. Investing in multifamily properties provides opportunities for both immediate income and long-term value appreciation, especially given the current trends of high homeownership costs and a shortage of housing. As the supply of new multifamily units slows and cap rates potentially widen, multifamily investments are positioned to deliver attractive returns and stability in an evolving market.