Investment triggers may feel harder to pull in 2022 due to persistent inflation. Real estate with multiple dwellings is a good choice.
2 Nov 2022
Many investors struggle in an inflationary atmosphere since making any form of investment can seem like a riskier proposition. There are countless questions. Where are our dollars best positioned to serve our long-term financial goals in the face of rising interest rates, declining returns, and recession fears? Should I maintain this money in a more liquid state in case inflation gets out of control? Or what assets are more secure at a time when the economy is changing so quickly all around us?
Many people find commercial real estate investing to be particularly intimidating, and this is especially true in times of economic uncertainty. Is it a wise time to invest in commercial real estate right now? has been asked in countless financial advisory offices this year.
Our data suggest that the answer is affirmative, particularly in the case of multifamily. Unlike stocks and bonds, real estate offers a robust inflation hedge, a strong defensive approach against market volatility, and a variety of tax benefits (especially in 2022). The industry is also currently gaining from a fundamental supply and demand imbalance, which is producing larger income and cash flows than are possible with other asset classes. Let's examine each of the various variables more closely.
Recession
There are many benefits to investing in multifamily real estate during a recession. Due to the withdrawal of lenders and equity partners as well as the delay in new home deliveries, there is a limited supply of both rental and for-sale housing. Demand rises as new renters enter the market and existing renters are priced out of homeownership by skyrocketing housing prices and interest rates. Due to tenants' reluctance to move and their decision to stay in their rental homes longer than they otherwise would, apartment occupancy rates also tend to hold steady during economic downturns.
Rates of interest
Both situations of stable and rising interest rates are expected to be favorable for apartment performance. Due to the federal backing of multifamily mortgages from Fannie Mae and Freddie Mac, which result in a lower risk premium than privately sourced mortgages, financing rates for apartments have historically been lower than those for other forms of commercial property. Indeed, during the past ten years, apartments have benefited from financing rates that have been more than 48 basis points cheaper than those for commercial property, according to Real Capital Analytics. Particularly if the increase in rates is brought on by rising inflation, as is currently happening, apartment investors may benefit from the loss of demand produced by higher interest rates. The current inventory of homes is declining as the cost of building new products and the cost of purchasing old ones rises.
Inflation
By providing the chance to reset lease rates as frequently as every 12 months, as opposed to every three to ten years for other property types, multifamily investments can act as a hedge against inflation. Managers now have the freedom to quickly adjust pricing to satisfy demand or lower escalating operational expenses.
Historically, the cost of renting an apartment has tended to rise faster than inflation. However, the likelihood of raising rents will vary depending on how cost-constrained each market is, so having solid local knowledge and being selective in your acquisitions is crucial.
A recent analysis by RealPage revealed that the vast majority of tenants were able and willing to make their rent payments. Renters' salaries have increased along with rents due to inflation reaching a 40-year high. Due to this, Rent-to-income ratios are far lower than commonly believed and do not significantly affect the affordability of apartments.
Beyond the sharp rise in rents, apartment investors stand to gain. At Hamilton Zanze, the nationwide portfolio of the company's multifamily properties accounts for about 40% of the company's revenue. Even though rents are rising faster than inflation, our net operating income (NOI) and cash flow would still rise if revenue and expenses increased at the same rate.
Liquidity
Currently, liquidity is the main characteristic that set liquidity
Currently, liquidity is the main characteristic that sets multifamily apart from other forms of commercial real estate. It has become extremely challenging to obtain a loan for an office building, for example, because the financial markets have essentially frozen up. We anticipate that these properties will be in a great deal of distress, which could present chances for astute investors. In contrast, there is plenty of liquidity for apartment purchases since government-backed lenders like Fannie Mae and Freddie Mac are stepping up to support the nation's residential mortgage finance system, as is their mandate. Apartments have therefore avoided the sharp decline in asset prices that we are currently witnessing with other kinds of commercial real estate.
tax advantages (especially in 2022)
Depreciation (especially with bonus depreciation through cost segregation), capital gains deferral through 1031 exchanges, as well as the tax-efficient cash flow to investors, considered a return of capital and reduction of basis before becoming taxable, all help to increase total returns on real estate investments.
To take advantage of bonus depreciation, which allows buyers to deduct 100% of qualified property through December 2022, shrewd investors will want to move promptly in the fourth quarter. This benefit will gradually decline each year starting with acquisitions in 2023 and will be phased out in 2026.
diversity of holdings
It's important to keep in mind that portfolio diversity is crucial in unpredictable economic times as the world gradually emerges from COVID and investors get ready for whatever lies next. Apartment complexes can be a reliable alternative asset class for a well-built portfolio, and to an increasing number of investors, the sector is becoming acknowledged as a "fourth asset class" and a viable alternative to conventional assets like equities and bonds.
Valuations
What is happening with valuations is a further concern for investors at the moment.
More so than changes in interest rates, capital flows have a significant impact on capitalization rates (and consequently asset values). "The relationship between multifamily and office cap rates and interest rates is weak, however, the relationship with the flow of money is the major driving force," claims Dr. Peter Linneman.
Cap rates have increased by 10–20 percent recently as a result of the rise in interest rates, which has forced many funds and private equity companies to stay out of the market. Although a significant amount of equity has to be invested in apartment buildings, we anticipate that transaction activity will increase once more in the first quarter of 2023. As capital flows back into the market.
Trends in demographics
The homeownership rate is still far lower than it was during the last recession, and current demographic trends still favor renting. The majority of renters are typically between the ages of 20 and 34, and their numbers are continually growing. In actuality, the millennial generation and younger currently make up more than half of the country's entire population.
Although millennials are living longer, many of them still rent, either out of habit or as a result of rising housing costs and heavy student loan debt. The rental housing industry has now welcomed Gen Z, which will have a big impact in the years to come. Baby boomers also continue to be a big source of apartment demand due to lifestyle changes and downsizing.
Gap in affordability
Home prices have increased even more quickly than rentals in recent years. Renting is still, for the most part, a much more cheap alternative than buying. In 45 of the 50 largest U.S. metros, up from 22 in 2019, mortgage payments are more than rent, according to current Zillow statistics. Typical monthly rent in the United States has increased by more than three times since July 2019 to $2,031, crossing the $2,000 mark for the first time this year.
For many would-be homeowners, renting is still the most economical choice because there are still many obstacles to becoming a homeowner, which will probably be the case for some time.
Conclusion
In conclusion, there are a number of strong arguments for why this specific period of time is excellent for multifamily real estate investments. The multifamily market will continue to benefit from historical demand spanning several generations, a meager supply of new homes, demographic and lifestyle trends that favor renting, and financial benefits for both investors and renters. To put it bluntly, now is a terrific time to be a landlord in whatever capacity that may be possible.