How Investing in Multifamily Properties Reduces Portfolio Volatility

EQUITYMULTIPLE Team  |

Via chotda

This intro comes courtesy of the team at EQUITYMULTIPLE

Not long ago, multifamily was conventionally evaluated alongside single-family residential. More than ever, multifamily is now established as one of the four major commercial real estate sub-asset classes — along with retail, industrial and office. As of Q1 2017, multifamily accounts for around one quarter of all US commercial real estate investment, and is getting more and more love from institutional investors. In this article we take a look why savvy investors allocate meaningful portfolio share to multifamily commercial real estate, and why current macro conditions favor the asset class.

A Built-in Hedge Against Inflation. Reduced Risk

Retail, industrial, and office properties typically have just a small group of tenants locked into long-term leases (and sometimes just one). Multifamily properties, on the other hand, can have tens or even hundreds of diversely-structured rental agreements, with tenants turning over on a rolling basis. This is the basis for programmatic value-engineering of NOI (net operating income). Multifamily investors who engage in active management enjoy downside-protection by minimizing vacancy exposure during economic downturns. On the flip side, consistent turnover of leases in a multifamily property allows management to gradually increase average rents in accordance with prevailing market rates and commensurate with rates of inflation.

Multifamily Exhibits Low Volatility

Multifamily has historically been the least volatile of commercial real estate asset classes. While market equilibria for office, industrial and retail most closely align with micro and macroeconomic trends, multifamily instead moves alongside demographic trends: where people live, how many, qualitative preferences among renters, and the demographic makeup of populations within a given market or neighborhood. Of course, economic and demographic trends are related, but since residential dwelling is the most essential function of the built environment, multifamily will be less impacted by fluctuations or structural shifts in the economy. As a corollary, we could say that multifamily is more resilient through market cycles.

This holds true empirically: over the past few decades multifamily has exhibited less volatility - as expressed by standard deviation from mean return - of any major commercial real estate asset class, while yielding the best risk-adjusted return.

Investing in Multifamily Now, Amid Volatility

As 2017 and a new administration get going, a number of social, demographic, and economic factors make multifamily more appealing on the whole than other real estate asset classes. In Q2, 2016, homeownership 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**. Much of this can be attributed to the housing collapse and aftermath: lack of inventory, tight credit, and eroded faith in the merits of homeownership have all resulted in historically high rates of renting. Further, Millennials - those of the age group typically inclined to first-time home-ownership - are starting families later in life, favoring the live-work-play urban areas where homeownership is relatively expensive. While homeownership rates may not remain at historic lows, there’s every indication that demand for multifamily housing will remain strong.

Meanwhile, much about the economic outlook for the next few years remains uncertain. Various policy changes could have vast impacts on retail (particularly in export or import-based businesses and supply chains); on energy, industrial and manufacturing; and/or on economic sectors reliant on office space. However, there are more questions than answers at this point. Macroeconomic shifts to come will certainly impact multifamily. But, for the reasons mentioned above, the asset class should provide a welcome hedge against uncertainty in years to come.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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