Warren Buffett once said, “The first rule of an investment is don’t lose [money]. And the second rule of an investment is don’t forget the first rule.”
Understanding why you are investing in the things you are investing in is crucial. It’s important to invest and diversify your portfolio in a way that will help you get closer to your financial goals and allow you to maintain peace of mind even in a recession. It’s easy to make money in a bull market, but it’s just as critical to not lose money in a bear market or recession.
As an apartment syndicator, I’m a strong advocate for apartment investing. Why?
One major reason – apartments have the highest risk-adjusted returns out of all commercial asset classes.
Aside from the risk adjusted returns, apartments are recession resilient, are a hedge against inflation, and they have a bright economic outlook.
Recession Resiliency
Investments that are resilient during economic downtowns are ones that service a basic need. Apartments satisfy one of those needs.
Consider that everyone has the same basic needs. Everyone needs to have a roof over their head, needs to have a place to sleep, food to eat, water to drink, etc. Affordable housing provides a UNIVERSAL and BASIC need.
Your quality of life is a combination of health, comfort and happiness. Part of your quality of life concerns things that you want, and part of your quality of life are things you can’t live without. American psychologist Abraham Maslow proposed that everyone has a universal tier of “needs”, ranging from deficiency (basic) needs to growth (advanced) needs.
According to Maslow, our initial set of needs—our physiological ones—is what drives us. These include our biological requirements for human survival. This includes air, food, drink, shelter, clothing, warmth, sex, and sleep. If these needs are not met, he proposed that humans cannot operate at their fullest potential.
Figure 1. Maslow’s hierarchy of needs
As these needs become less basic, fewer people share them. But we all share the need for those base-level physical elements mentioned in the list above.
Apartments, clearly, fall under the need for shelter. This is the most basic level of needs that we all have. Investing in something that provides a basic need is an excellent way to protect yourself from volatility in uncertain times.
Hedge Against Inflation
With inflation reaching record levels, multifamily investing is an attractive investment option. As the cost of goods and services required to build, maintain and repair multifamily assets, that cost is going to get passed along to the customer. Relative to numerous other commercial assets, apartments have short term leases. This allows the rising cost to be captured in the form of rising rents. It is the reason why we’re season record-setting rent growth in 2021 and 2022.
Due to inflation and ongoing supply chain issues, housing rents have been rising. Strong demand meets limited supply. With this, investors could allow new leases to capitalize on market rents and meet inflation head on. A key to its effectiveness lies in landlords’ ability to raise rents in markets with low vacancy rates, resulting in outpacing rising inflation and potentially increasing income to investors. This provides protection to apartments performance and evaluation.
In fact, construction costs have outpaced inflation in recent years. High construction costs imply increased replacement costs for buildings, making existing real estate investments more valuable.
Barriers to Home Ownership Are Increasing
Construction & Labor Costs Increase
What alternative do you have to renting? Living in your parents’ basement? Maybe couchsurfing? Realistically, if you’re not renting, your only option is to own. Sounds great in theory; however, there are some very big barriers to home ownership at this moment.
Housing supply, as we previously noted, has a significant impact on how much a housing costs. Couple that with the fact that construction and labor costs are increasing faster than inflation and you have a recipe for a severe demand for housing.
Additionally, affordable housing simply is not the focus of the industry. It clearly doesn’t generate the returns to warrant the effort. Workforce housing demand and supply simply cannot meet the need for the millions of homes required to satiate the growing population.
There’s also the cost of replacement. It simply is not cost-effective to build “affordable” renting space. The increased labor costs associated with construction spiked 2 to 5% in 2021 alone, while the costs of commodities such as lumber and other materials equally increased this year.
The costs associated with construction and labor present unique challenges to building affordable housing, and this further exacerbates the housing inventory shortage. In fact, it is estimated that we’d have to build 5.5.–6.8 million homes to catch up with demand.
Figure 2. Housing prices effect of low inventories. “The State of the Nation’s Housing.” JCHS, 2021, p. 06.
Note: Months of supply measures how long it would take the number of homes on the market to sell at the current rate, where six months is typically considered a balanced market. JCHS tabulations of National Association of Realtors (NAR), Existing Home Sales: S&P CoreLogic Case-Shiller US National Home Price Index.
The history of the housing market demonstrates that there is a massive difference between the supply and demand for the market. And when inflation soars and housing costs rise along with it, thus, the gap will only widen.
The Population Continues to Grow
Did you know that the US population has grown every year for the last 70 years?
Figure 3. Population trend and growth rate over the last 50+ years. “U.S. Population Growth Rate 1950-2021.” Macrotrends, 2021.
The US population continues to grow. As those babies grow and turn into adults, the need for housing increases even more. Additionally, the inventory for homeowners is increasingly limited. An increase in population and a limited inventory of homes result in serious demand for multifamily properties.
To put it simply, as population increases the demand for housing increases the supply however, isn’t keeping up. As a result, home prices are increasing.
Two distinct generations are contributing to this rental demand increase…
More Baby Boomers Renting
While the general view is that the people who rent homes are young, the data shows a different story. The reality is more baby boomers—those who are considered more well established financially—are renting more than ever before.
Boomers, or those in older generations, rent differently than their younger counterparts. For instance, they have different apartment preferences than millennials and are more likely to stay in a single rental for a much longer period of time.
With 70 million boomers looking for housing, many of whom are choosing to rent, it’s easy to see how this has placed increased pressure on multifamily rentals.
More Millennials in the Rental Market
Millennials, too, are consuming multifamily unit vacancies. They also have unique preferences. With many millennials moving out of their parents’ homes in favor of luxury apartments and suburban homes, affordability is still an important concern. This pushes millennials to look into affordable multifamily housing units.
Millennials are currently the largest generation out of today’s population. With over 72 million millennials, this generation is clearly having a significant impact on both the rental and ownership housing markets.
Which is why from a population that is growing and a greater demand for affordable housing to the changes in the cost of labor and commodities, multifamily housing is only going to become a more valuable asset.
What does all of this mean?
In short, demand for renting will increase AND people will rent longer.
Let’s first look at economic vacancy rates. Vacancy rates are a useful metric of a particular market. It can be indicative of market desirability, supply and demand. If a particular market has a low economic vacancy, 2% or lower, it implies that the market is desirable, there is high demand, there is low supply, or a combination of all three.
National rental vacancy rates have been on a downward trend since 2010. Currently, the national vacancy rate has decreased 8.8% over the past 12 months. As of July 2021, the national rental vacancy rate is 6.2%
The market is showing us that there is not enough supply to meet demand. This has an impact on price, which we’ll discuss later.
Figure 4. National rental vacancy in US. “Rental Vacancy in the United States.” FRED, 2021.
In addition to the aforementioned decline in vacancy rates, tenants are now renting longer than ever before. The average renter in the United States stays in a unit for 27.5 months, according to one survey conducted by ResidentRated.com.
Not only that but more US households are also renting than at any other time in the past 50 years, says Pew Research Center Census Bureau data. This increase in renters has happened across all levels of educational backgrounds.
Clearly, rental units are becoming increasingly important for the US housing market.
Figure 5. Historical multifamily turnover in the US. 2020 Multifamily research brief. (n.d.). CBRE
In Q4 of 2019, apartment demands spiked some 11% from just 12 months prior. As the pandemic has raged on, we see employers allowing for more flexible work arrangements. This led to massive migration patterns across the US. This led to variability of demand—some concentrated markets (see NY, CA) experienced less demand and other markets (TX, FL, AZ) experienced spikes in demand.
At a national level, rent prices increased by 30 basis points. The desirable markets experienced rent price growth over 100 basis points!
As the demand for rentals increases, fewer people can save up enough for a down payment to purchase a home, let alone afford the repairs and maintenance that come along with homeownership.
Figure 6. Growth in median price compared to the previous year. “National Rent Growth.” Zumper, 2021.
In Closing
Apartments are a great way to diversify your risk and growth. There are numerous ways to diversify solely within apartment investing, and investing in apartments entail a variety of financial options. You can also diversify by geography, by asset class, and by business plan to balance cash flow markets with appreciating markets.
There are numerous ways to invest in multifamily assets, whether you want to be passive or active in the day-to-day management. While this article provides you with a lot of reasons why apartments are a great asset class to invest in, there are several financial advantages to investing in apartments.
If you are considering passively investing in apartments, check out this free Passive Investors Guide to the Multifamily Universe.