The Undeniable Multifamily Trend

Have you ever heard that saying, “the trend is your friend”? If you have, you already have a leg up when it comes to investing in the multifamily space. We’re going to take some time in this blog to explore the demographic trends in apartment dwellers. After all, these dwellers will make or break your investment and it is therefore incumbent upon us to know what we’re getting ourselves into!

Fortunately, you have picked an outstanding asset class in terms of immediate, medium to long-term upward trends. You could even go so far as to say that multifamily is here to stay. The Baby Boomers, Gen Xers (yours truly), the Echo Boomers, immigrants and single head of household groups are all part of the wave of customers that will fill multifamily apartments for years and years to come.

There are several long-term trends working to bolster the multifamily market and they revolve around what each generation is going through as they grow up, get jobs, mature and retire. Let’s start with the Baby Boomers. Sometimes discounted as a driving force, this group is returning to the apartment market in force after buying houses and raising families in their younger years and there are about 77 million of them. Between 2009 and 2025, it is estimated that this group will grow an astounding 76% (see credits below).

As if this weren’t a strong trend in and of itself, the Echo Boomers (or Millennials, or Generation Y) are coming. Actually, they’re here and more are coming. Grandsons and granddaughters of Baby Boomers, this group is even larger than their forefathers. Born in the period between 1980 and the early 2000s, this 80 million population generation plays a significant role how multifamily projects are used, designed and built in today’s market. As the age of the rental population declines, we’re witnessing first-hand the Echo Boomers entering the multifamily market in a dominant way.

Several additional factors surrounding Echo Boomers spell good news for those considering multifamily investment. First, the rent-buy math still favors apartments. When that math will turn corner we don’t know, but until then, apartment dwelling makes fiscal sense. Next, the Echo Boomers have been tackled by a weak job market (necessitating the need for mobility), slow economic growth and high student debt, each factor conspiring favor renting in the near and mid-term. Finally, this generation (and likely future generations) are less interested, generally speaking, with leaving a large footprint. More Eco-conscious than their predecessors, living close to city center in a smaller dwelling, with amenities suitable for the tech savvy is what this group is all about.

Look out beyond city center and out into the burbs, another trend in multifamily demographics is emerging: the immigrant population. Immigrants and their families, searching for large, three-bedroom apartments in safe neighborhoods and good schools is driving the suburban multifamily market in much the same fashion that Echo Boomers are driving the urban multifamily market. This bodes well for the apartment investor whether they are interested in a garden-style complex or a high-rise apartment building.

Each of these groups is adding fuel to a strong multifamily market. Some say the strongest market since the Depression. And although in recent months, some investors have shied away from apartment investing owing to a perceived oversupply of multifamily units, demand has kept pace. This is not a surprise either. Given the confluence of particularly the Baby Boomers, the immigrant population and the Echo Boomers, the upward trend we are witnessing in the multifamily segment is supported in the short, medium and long-term. This is good news for multifamily investors.
Credit for certain facts outlined in this blog are due to the following articles:

http://www.multihousingnews.com/news/national/the-effects-of-demographics-on-the-apartment-industry/1004029460.html

http://www.cnbc.com/id/101773495

CRE Value and the CAP Rate Impact

You remember our friend CAP rate? CAP rate is defined as the unlevered return you can expect to receive on a commercial real estate asset investment. CAP rates vary by asset type, asset class and location. CAP rates also vary over time according to supply and demand.

For instance: CAP rates will likely not be the same for an office building situated in a major metropolitan downtown area and a suburban apartment complex. A suburban apartment complex in one part of the country will not have the same CAP rate as an identical suburban apartment complex in another part of the country. The same office building and suburban apartment complexes may have a different CAP rate next quarter or next year or ten years from now. The point is that CAP rates change.

Let’s look at how CAP rates impact the value of our commercial real estate first. You may know that the value of a piece of commercial real estate is typically calculated like this:

Net Operating Income / CAP Rate = Value of the asset

Let’s take an easy example. Suppose your multifamily property has a NOI of $100,000. The going CAP rate for your class of property in your market right now is 10%. This 10% CAP rate says you will earn a 10% return on your invested dollars if you purchased this asset using all of your own cash.

Calculating the value of the asset using the formula above looks like this:

$100,000 / 10% = $1,000,000

So, if you purchased your multifamily building for $1,000,000 using all of your own cash, you would receive $100,000 per year or 10% return on your investment.

Using the formula above, let’s look at the impact of a changing CAP rate on the value of your apartment building.

At a 5 CAP (a CAP rate of 5%), your property would be worth:

$100,000 / 5% = $2,000,000

At an 8 CAP (a CAP rate of 8%), your property would be worth:

$100,000 / 8% = $1,250,000

You get the idea. And you can see that a varying CAP rate can impact your acquisition costs as well as the value of your investment over the life of your hold period. Finally, CAP rate can affect the timing of any financing events during the hold and the price you are able to demand on disposition. Whether it’s an industrial building, a strip mall or an office park, it pays to pay attention to CAP rate.

Don’t Lay an Egg When Selecting a Multifamily Property!

Just for the sake of argument, let’s assume you’ve decided that commercial real estate is for you.  You’ve decided that investing in commercial real estate, and particularly multifamily property is the way to go to secure your retirement (and I would agree!).  You’ve decided as well that you are capable enough and educated enough to act as an active investor on your apartment investment, and for now, you’ll forego the passive investing route.  Surely, you think, if you can invest passively, why not invest actively for greater returns? Apartment buildings are, after all, just many little houses put together and that really isn’t that much different from your own house, right?  You’re excited and you can’t wait to get started!

It’s Easter Sunday tomorrow, and in the spirit of the holiday, let’s work on growing your nest egg, not laying a doozy that will crush your dreams of retirement.  Following this one simple guideline will stop you from making perhaps a multi-thousand dollar mistake.  When people get excited to begin a new project, a great many people do what seems logical in this day and age — they go to the internet.  This does seem to make sense.  After all, when you want to begin shopping for a new house, the internet is a great place to start — you can investigate new cities, new neighborhoods, neighborhood schools, local businesses, new houses for sale, resale houses up on the block, comparable prices and more.

When people first launch their search for multifamily apartment buildings (particularly 5 or more units), one website normally attracts most of the attention:  Loopnet.  Now, there is absolutely nothing wrong with Loopnet.  Here is the distinction you must keep in mind as you peruse those seemingly fantastic investments for sale on Loopnet — unlike residential real estate, there is no central listing service like the MLS for commercial real estate.  Let me say that one again:  Loopnet is not an MLS system for commercial real estate.  Not only does this apply to Loopnet, this is also applicable to any other website that lists apartment complexes and commercial real estate for sale.

Well, okay you say.  No big deal.  So you only get a portion of the listings — big whoop.  Here’s why this is important.  Loopnet and all of the other commercial real estate listing websites get these listings generally speaking, at the end of their sales life cycle.  What does that mean?  What it typically means that commercial real estate brokers have shopped this listing to everyone on their buyers list, shopped the listing to other brokers in their firm and their buyers lists, shopped the listing to others in their network and found no takers.  This means that many, many pairs of eyes have reviewed the property, reviewed the offering memorandum (a multi-page marketing brochure on the property), reviewed the actual financial performance and have determined the property doesn’t meet their investment criteria.

Of course you can argue that their investment criteria may be different from your criteria.  You have found a great deal and are perfectly willing to put your hard-earned dollars to work on this project, but consider this:  the number of reviewers on your find may be in the hundreds!  Hundreds.  You may want to consider carefully why each of those reviewers said ‘no’ to your great investment.

Don’t let your hunt for a nest egg investment turn your retirement into scrambled eggs (sorry, I couldn’t resist).  Consider carefully those ‘can’t miss’ multifamily investments you find online.

Happy Easter!

Pop Quiz: What does a 5-plex, your doc’s office and a Hilton hotel have in common?

If you guessed that each of these can be defined as commercial real estate, congrats — you have scored 100% on today’s quiz!  If the answer didn’t quite spring to mind, this blog entry is for you — please continue reading.

There are just a couple of broad categories used in discussing and transacting real estate — residential and commercial real estate.  Residential is the most intuitive, generally describing single-family housing and multifamily housing of 2-4 units (duplex, triplex and quadplex).  Commercial real estate is any property that is used for commercial purposes, and is much broader in scope and encompasses several, perhaps unapparent, property types discussed below.

Commercial real estate is everywhere.  In the course of a day, you can encounter several examples of commercial real estate:  in the morning before work, you stop at the gas station for some gas for your commute into work.  Gas station – check.  You decide that to make it through your morning meetings, you’ll need some coffee, so you take the most convenient drive-thru at Starbucks.  Starbucks – check.  You get on the stop and go freeway, passing a movie house, a shopping mall and your favorite baseball team’s stadium.  You guessed it:  each one of these is considered commercial real estate.  An hour and a half later, you arrive at your office building to begin your day when your secretary tells you that you are scheduled to be in conference at a downtown hotel.  As you have no doubt figured out, the building where you and your co-workers spend vast numbers of hours of your lives and the hotel where you are supposed to be this morning, are both great examples of commercial real estate.

Commercial real estate can be divided into a few categories for ease of discussion and focus:  retail, industrial, land, office, leisure and multifamily.

• Retail property consists of just what you imagine it to be:  property that hosts retail stores.  Examples would be: the Home Depot, Macy’s, Payless Shoe Source, et al.
• Industrial property consists primarily of factory, research and development, manufacturing, warehousing and distribution centers.  Distribution centers, for example, are generally located outside of major metro areas where there is space to house inventory that may be called upon by metro area stores.  You may be familiar with one of the more popular research and development parks in the U.S., The Triangle in North Carolina.
• Land zoned for commercial use is considered commercial property.  Land designated as farm land is considered commercial real estate.  Even land that is raw and undeveloped could be considered commercial real estate.
• Office buildings with no special equipment, but suitable for administrative tasks is commercial real estate.  You may encounter some distinctions within the office category, like medical office space.
• Leisure real estate is really several, and quite varied property types.  Hotels, resorts, golf courses, stadiums, etc. are considered commercial real estate.  In fact, thinking back to the definition of commercial real estate posted above, each of these property types is most assuredly in existence for a “commercial purpose”.
• Multifamily property is shared residential apartment-style or townhouse-style living.  We think of this form of commercial real estate in terms of a 5-plex all of the way up to complexes with more than 500 units!  These buildings can be very old with few amenities, or brand new with state-of-the-art technology and attractions.  Multifamily buildings all can be sub-categorized into garden-style, mid-rise and high-rise depending on the density of apartments built on the parcel of land on which they sit.  They can be situated on many acres with open space and parks, or on a downtown city block.

This is a short list with just a few examples.  I’m sure that if you sit down and think about it, you could come up with many, many more examples of commercial real estate on your own.  Commercial real estate touches our lives everyday.  We will explore in much more detail how we, as investors with an eye on securing our financial future, can help our friends and neighbors live more comfortably, derive more convenience in their neighborhoods and enjoy more fully their hard-earned time off through our commercial real estate investments.