3 Surprising Facts About Multifamily Real Estate You Should Know

Commercial real estate (CRE) has grown immensely over the past 25 years. Today, it even includes properties like server farms powering artificial intelligence and cell towers powering your smartphones.

We at Wide Moat Research really like these 21st-century sectors, but we’re hardly closing the door on more traditional properties. There are good reasons why hotels, retail, and other “old-school” real estate have stood the test of time.

For instance, many investors know the multifamily, or apartment, category has the potential to offer inflation protection. And historically have performed better than many alternatives during recessions. But there’s much, much more to know about these properties than first meets the eye.

In fact, after learning what I’m about to share with you today, I bet multifamily real estate will never look the same.

A Different Level of Diversification

It’s important to understand that each CRE sector has its pros and cons to consider.

Industrial properties, for instance – a category that includes warehouses and distribution facilities – has delivered strong performance in recent years. Of the 11 types of real estate, industrial has been a top 3 performer in most years going back to 2012, The explosion of online shopping and rapid delivery services was already expanding in the 2010s, and they accelerated even faster during the pandemic.

But many industrial parks have a hidden weakness.

It doesn’t matter if the warehouse in question is in Dallas, Texas; Detroit, Michigan; or Denver, Colorado. The most likely and/or largest tenant will be Amazon (AMZN) more than nine out of 10 times.

Not that long ago, in 2012, Amazon was leasing 35.3 million square feet of industrial space. By the end of 2021, that figure had grown to over 370 million.

That rate of growth has slowed in recent years. But Amazon still dominates the market. Add in Walmart and a couple other giant retailers, and the picture is clear: These firms are the industrial real estate market.

That might not sound problematic at first glance considering how enormously powerful and profitable these companies are. But they’re not infallible, and their plans can and do change sometimes. In which case, if they decide to bail from a property or properties, the landlord may have to rely on one of the two or three other major players to come to the rescue.

If they don’t, that landlord is likely in serious trouble.

The multifamily scene, however, is different. A single 80-unit apartment complex usually has more tenant diversification than many billion-dollar industrial properties since every resident represents a separate lease.

Odds are they’re all tied to different jobs across many sectors. And unlike the corporate tenants that lease most commercial real estate, these people live there. They likely won’t move just to save a few bucks, and they may do almost anything to avoid being evicted.

Yet when a tenant does leave, almost anyone is a potential tenant. That often makes them easier to replace. And the landlord may not miss more than a couple of monthly rent payments. One tenant’s abrupt departure may not rock the boat the way it does in other types of commercial real estate.

Subsidized Financing

CRE has presented a tough market for property buyers in the past couple years.

Inflation has helped keep property prices high. Banks have required a lot more money down. And to make matters worse, interest rates for most CRE loans rose sharply from 4.1% in 2017 to 8.5% today.

Notice I said most commercial real estate though.

Just like with home mortgages, the government subsidizes multifamily loans on existing properties. As of March 12, Freddie Mac and Fannie Mae – the two government agencies that originate residential mortgages – offered rates as low as 6.51% on a 15-year term and only 20% down. Or, with more money down and a 10-year term, you can still get a multifamily loan in the 5%-6% range.

That’s about 30% cheaper than the same loan but backed by another property type: a potential advantage the government only offers to multifamily loans.

Strangled Supply Meets Durable Demand

Many companies track the spread, or difference, between what it costs to buy versus rent a home in each area. This kind of service gives us a valuable indicator for current and future demand for apartments.

In Q4 2023, the average spread for the U.S. rose yet again to $1,066. In other words, renting may save you four figures over buying.

Every.

Single.

Month.

Thanks to stubbornly high rates and cautious lenders still focused on last year’s regional banking crisis (which isn’t quite over yet), renting may be more economical. This could be bad if you’re trying to buy a home, but it could be great for multifamily investors.

In December 2023, the occupancy rate for U.S. multifamily was 94.1%. If that sounds exceedingly good, it’s because it is. You have to go all the way back to January 2014 – over 10 years ago – to match it.

In short, nationwide demand for apartments is very strong.

Won’t this change when rates eventually go down and home mortgages are more affordable? Possibly, but some experts don’t think so. And we agree with that assessment since property prices usually rise when rates decline. So while the interest rate may improve, the amount financed may grow proportionately.

Now, the market usually does a great job in balancing supply and demand. Which begs the question: Why hasn’t it worked this time?

Due to a historic spike in inflation, the Federal Reserve increased rates at the fastest pace in 40 years. That made the cost of construction loans and materials increase significantly. This stalled development activity that otherwise would have added supply. And while Freddie Mac and Frannie Mae do offer construction loans, they are much more limited in availability, have stricter requirements, and carry higher interest rates. Most builders are forced to use private lenders and they charge rates as high as 13.8%.

In Conclusion…

Since the Federal Reserve started tracking multifamily real estate prices in the 1980s, prices have only declined twice.

Once was during the Great Recession of 2008-2009. And the only other period? That would be Q4-22 through today. No one knows for sure if prices have bottomed, but there are indications that may be the case.

The phrase “higher for longer” is often used today. It means that interest rates may not go down as quickly as some market participants expect. And maybe they’re right. But it’s hard to predict what the Federal Reserve will do.

Personally, I don’t know if rates will start trending downward next quarter or the one after that. But I do know that average apartment rents in the U.S. have never declined over a 5-year period back to at least 1940.

Occupancy is at decade highs, and supply just isn’t keeping up with demand thanks to those high interest rates and inflation.

Eventually that imbalance will subside, but then so will interest rates. And when interest rates decline, real estate prices tend to go up.

So while I wouldn’t bet one way or the other on interest rates, “higher for longer” apartment rents do seem like a smart wager.

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Nothing in this blog is or should be construed as investment advice or an offer or solicitation of offers of investments. Both Real Estate Investments and Securities offerings are speculative and involve substantial risks. Risks include but are not limited to illiquidity, lack of diversification, complete loss of capital, default risk, and capital call risk. Investments may not achieve their objectives. Investors who cannot afford to lose their entire investment should not invest in such offerings. Consult with your legal and investment professionals prior to making any investment decisions. All Securities are offered through North Capital Private Securities, Member FINRA/SIPC.

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