5 Minute Read
It’s not surprising that many individual investors have been unnerved by the equity-market volatility and economic uncertainty that has come with the COVID-19 pandemic.
While the new environment is unlikely to significantly change the immediate recommendations of financial advisors — most of whom focus on long-term diversification and prudent risk management — today’s climate is likely to prompt a renewed look at investment alternatives. Since true alternatives are largely uncorrelated to equity markets and offer the potential for higher risk-adjusted returns than many credit market investments, alternatives can provide investors with the income and stability they are seeking at this time. One alternative, the multifamily sector of the residential real estate market, may merit your consideration. Here’s why:
Reason #1: Multifamily housing is a true alternative investment.
The promise of alternatives is low correlation to equity markets. Both recent and past experience has shown that many alternative investments move in sync with equities in times of crisis. This is even true for most real estate investments, particularly those held in the form of REITs. Currently, travel- and tourism-related real estate has been adversely affected by the coronavirus, as have the office and industrial/manufacturing sectors, which are suffering due to pandemic’s economic fallout. Because shelter is a basic human need, and because rental multifamily housing provides affordable shelter for a wide swath of average Americans, returns from the asset class are relatively consistent despite swings in the economy or markets. History has demonstrated that lessees pay their monthly rent, even if slightly lowered or forgiven for short periods, whatever the economic climate. Much of the money that individuals of modest means will receive from the CARES Act and other recent federal relief and stimulus programs is likely to go toward rent in multifamily properties. For investors in such properties, this translates into returns that are generally predictable and secure, and largely uncorrelated to what’s happening in equity and fixed-income markets. promise of alternatives is low correlation to equity markets. Both recent and past experience has shown that many alternative investments move in sync with equities in times of crisis. This is even true for most real estate investments, particularly those held in the form of REITs. Currently, travel- and tourism-related real estate has been adversely affected by the coronavirus, as have the office and industrial/manufacturing sectors, which are suffering due to pandemic’s economic fallout. Because shelter is a basic human need, and because rental multifamily housing provides affordable shelter for a wide swath of average Americans, returns from the asset class are relatively consistent despite swings in the economy or markets. History has demonstrated that lessees pay their monthly rent, even if slightly lowered or forgiven for short periods, whatever the economic climate. Much of the money that individuals of modest means will receive from the CARES Act and other recent federal relief and stimulus programs is likely to go toward rent in multifamily properties. For investors in such properties, this translates into returns that are generally predictable and secure, and largely uncorrelated to what’s happening in equity and fixed-income markets.
Reason #2: Favorable rental market conditions.
Several long-term demographic and economic factors underpin the current strong demand for multifamily housing. The first involves the preferences and circumstances of millennials, an age cohort as large as the baby boomers. Millennials have taken on more student debt than older generations, making it more difficult to accumulate the down payment required to buy a home. They also tend to prefer renting to buying. Second, slowly rising wages over the past several decades have not kept pace with the rising prices of homes, which makes home-buying less affordable. Finally, the absence of speculative building due to strict lending guidelines in the post-crisis period means that demand and supply for multifamily residential housing is in balance. In an odd way, the COVID-19 pandemic has added stability to the market as moving is prohibited in many jurisdictions and both owners and tenants prefer to maintain the status quo, even if some adjustments to rent payments must be worked out due to economic hardship.
“If this bear market presages trouble among borrowers leading to rising defaults and tighter credit standards, there will be many opportunities for nimble, well-capitalized owners and investors in multifamily housing.”
Reason #3: A source of income in a yield-starved world.
For investors in retirement or those seeking income, record low fixed-income returns have unleashed a desperate hunt for yield that often means taking on excessive credit risk and/or excessive duration risk should interest rates rise. Multifamily residential real estate offers reasonable returns that by today’s credit-market choices seem lofty. In addition, because private multifamily investments tend to have five-to-seven-year terms, investors capture the liquidity premium inherent in direct real estate investments. As for duration, if interest rates were to rise in tandem with inflation, rents also would rise, increasing nominal returns.
Reason #4: Value of tax treatment.
Direct investment real estate continues to offer favorable tax benefits through the deductibility of mortgage interest and property taxes, as well as depreciation. The federal caps on state-income tax deductibility for many investors in high-tax states, as well as baby boomers’ often higher-than-expected retirement incomes due to required minimum distributions from qualified accounts, can make the after-tax returns of multifamily residential real estate particularly attractive. Unlike REIT’s, direct real estate investments allows for tax losses based on equity ownership and depreciation reduces ordinary income allocated to investors.
Reason #5: Opportunities that come with bear markets.
If this bear market presages trouble among borrowers leading to rising defaults and tighter credit standards, there will be many opportunities for nimble, well-capitalized owners and investors in multifamily housing. Since it will be the capital structure of multifamily properties, not their economic viability, which will be troubled, experienced owner/operators and investors with dry powder will be able to make acquisitions and investments under very favorable terms. For clients of registered investment advisers, therefore, this could be an excellent time to consider an investment in multifamily residential real estate.
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Forum Investment Group is a private real estate investment firm with expertise and emphasis on generating current income and long-term value creation by accessing unique real estate acquisition, development and debt investment opportunities across the capital stack and real estate cycles. Since 2007 we’ve invested more than $2 billion in real estate and built a successful track record of high-performance investments, earning the trust of our investors and partners.
Darren Fisk is the Founding Partner at Forum Capital Advisors – a boutique alternative investment firm focused on real estate investments across the capital stack and throughout the economic cycle.