Real estate is often considered a cyclical investment class, meaning its fortunes can rise and fall along with the cycles of the general economy.
That’s not always true, though. The multifamily sector has some features that can resist or even overcome broader market swings, and, given the current late-cycle market, those features may soon have the opportunity to shine. (article continues below)
Cycling on a Smoother Path
Defensive investments are those that can potentially mitigate the effects of broader market swings. They are typically thought of as involving health care, utilities, and essential consumer products—goods and services that people find it difficult to do without, even when money is tight.
Real estate is generally categorized as a more cyclical investment, along with basic materials, financial services, and “nice-to-have” consumer products. Investments in this sector are often considered to be more sensitive to business cycle peaks and troughs.
The multifamily sector has some features that can resist or even overcome broader market swings. Given the current late-cycle market, those features may soon have the opportunity to shine.
Commercial real estate is typically included in this group because demand for office, retail, and industrial property is usually tied to the health of the broader market. Hotels, too, tend to get squeezed when travel is de-prioritized, as it can be when personal and business budgets are tightened.
But not all real estate acts so cyclically.
Self-storage facilities, for example, are often thought to be less volatile
and cyclical compared to other asset classes. Displaced homeowners who downsized to apartments or smaller homes still needed to store excess household items.
Multifamily apartment complexes are often thought to be a similarly defensive investment. Everyone needs a place to live—even when a drooping economy might cause significant vacancies in other types of commercial properties.
Larger multi-family complexes may offer further stability, since individual vacancies in those properties have a lesser impact on the overall rent roll than they would in smaller office or industrial properties.
The Best Offense is a Good Defense
article a few years ago summarized some strong evidence
It asked Yale University’s Robert Shiller, winner of the Nobel Prize in economics and the co-creator of the Case-Shiller Home Price Index, the question, “Which asset class has performed as well as bonds during U.S. equity bear markets of the past 60 years?”
The answer: residential real estate. Data from Professor Shiller showed that in 14 of the 15 previous U.S. equity bear markets—going back to 1956—the home price index actually rose. The 2008-09 bear market seems to have been an anomaly, and attributable more to idiosyncratic developments such as subprime mortgages and liar loans.
The question: which asset class has performed as well as bonds during U.S. equity bear markets of the past 60 years? The answer: residential real estate.
Other studies have also shown positive results for apartment complexes. Multifamily can be considered a “defensive play,” as noted in a recent report from CBRE, a prominent real estate services firm. The report notes that multifamily is typically less impacted by cyclical downturns than other property types. The report also showed how, using standard deviation as a measure of volatility over a 25-year period ending 2017, retail and multifamily had the lowest levels of volatility in return performance. (article continues below)
Multifamily seems to have shown a favorable track record during most economic downturns. And crowdfunding platforms like RealtyShares now allow investors access to properties like larger multi-family complexes as passive investments—in a convenient and relatively affordable way.
Investors Are “Moving Into” Apartments
The current slowdown in home sales, felt sharply in Western states
, has been attributed to higher mortgage rates and rising prices. The trend seems likely to increase the attractiveness of apartment rentals—and, potentially, of multifamily investments.
As reported in the Wall Street Journal
, the share of people who believe that now is a good time to purchase a home actually fell in July—and the survey, by Fannie Mae, is often thought to be a good indicator of near-term consumer behavior.
The share of people who believe that now is a good time to purchase a home actually fell in July. The survey, by Fannie Mae, is often thought to be a good indicator of near-term consumer behavior.
Investment managers are ramping up their stakes in workforce and affordable housing.
“We are seeing an increasing number of funds raising capital to pursue opportunities in this workforce housing space,” said Peter Rogers
, senior investment consultant at Willis Towers Watson.
Although inner cities had recently been a popular “destination” for real estate investors, many are increasingly looking at properties in suburban or secondary markets. A joint venture between Allstate Investments and Los Angeles-based TruAmerica Multifamily, for example, recently acquired more than 7,600 units of workforce apartments.
The two companies clearly consider workforce housing to be a defensive play. “It goes to the chronic undersupply of affordable housing,” said Mike Moran
, head of commercial real estate investments for Allstate Investments.
“We think that class B multifamily is almost recession-proof,” said Robert E. Hart
, founder, CEO and president of TruAmerica Multifamily. Demand for workforce housing remains steady even in a financial crisis, he continued. Renters might double up, but demand for affordable apartments still exceeds supply.
Other institutional investors have recently followed suit, targeting workforce housing and Class-B value-added multifamily properties. (article continues below)
- New York State Common Retirement Fund ($197.1 billion )
- The California State Teachers' Retirement System ($213.7 billion )
- LEM Capital LP ($6.9 billion)
- Pennsylvania Public School Employees’ Retirement System ($52.7 billion )
Supply and Demand for Multifamily Apartment Buildings
One of the most significant factors affecting the performance of multifamily investments is the housing supply. Happily for investors—and unhappily for renters—the supply of apartments in America’s big cities continues to lag demand.
In the many cities where housing is in short supply, local authorities have discussed additional rent control measures
. But such restrictive price ceilings tend merely to reduce the supply of property to the market, which then exacerbates the price crunch.
One solution is simply to build more housing.
Unfortunately, the bulk of recent development activity has tended to be in high-end Class A properties
with luxury features.
It stands to reason, then, that an investment strategy focusing on Class B properties with light to moderate renovations may offer potential upside. Even after they are renovated, these properties can often provide renters with a valuable alternative to newly constructed properties.
To support such a theory, a recent Marcus & Millichap report claimed that Class B and C vacancy rates would likely continue to be lower
than those of Class A apartment buildings, and would probably climb at a slower rate as well.
“We think that class B multifamily is almost recession-proof.”
It points up a distinctive characteristic of the market for multifamily: Class B and C properties are generally less prone to competition from new supply of competing “product.” One possible explanation is that the unit economics no longer support the construction of such buildings; or perhaps developers are simply seeking higher returns.
Evidence also suggests that there is currently very little in the way of free rent or other concessions being offered on class B properties. In this way, Class B and C properties seem to be well positioned relative to higher-end Class A buildings, where such concessions are frequently offered in response to competition coming from newly constructed complexes. (article continues below)
Multifamily—Defensive and Timely?
Everyone needs a place to live, and larger apartment complexes in particular are often able to weather broader economic downturns. The asset class has historically performed better than other real estate asset classes during equity bear markets, and institutional investors are increasingly appreciative of the sector’s unique characteristics.
Everyone needs a place to live, and larger apartment complexes in particular are often able to weather broader economic downturns.
In addition, the recent rise in housing prices and potential regulatory restrictions on new construction may only serve to increase the possible upside with workforce housing and Class B projects featuring light renovations.
Keep in mind that real estate investments involve risk and are not insured; as such, they run the risk of loss, including the loss of invested capital. Before investing, you should carefully review the offering materials and arrive at a realistic understanding of your own risk profile.