The S&P is down by 25%, year-to-date, at the time of writing this article (Ouch!). One thing is clear: Wall Street’s most prominent strategists didn’t see this year’s selloff coming. If the experts didn’t expect this drop, what do you think an everyday retail investor thought of the year 2022?
Imagine that you’re about to retire in 2023 and ~25% of your portfolio is wiped out by a whopping 25%! That reduces the number of years that one can live off of retirement funds. This is one of the reasons why people over 65 go back to the workforce to recoup their losses.
To give some frame of reference, the S&P500 currently sits at $3577 at the time of writing. Big firms such as Morgan Stanley, Goldman Sachs, and UBS predict that the price will range from $3800-$4200 in 2023. Do you know where the S&P500 was in December 2021? It was $4796! So we’re still expecting to be lower than 2021 levels.
So what else is out there? This brings up the topic of alternative investments. More retail investors (you and me!) are discovering other asset classes that could yield greater returns. These are asset classes such as self-storage, assisted living, mineral rights, and apartments. Needless to say, this is an investment, thus it comes with its own risks. Working with a capable and trusted team can mitigate that.
We discovered the power of syndication in 2021. Syndication is a process where there is an active team that will manage the asset. Then, they pull money from other passive investors and they buy the assets altogether. The active team runs the asset for 3 to 5 years, and then sells the asset. Then, all investors split the profits from rental income and property appreciation. In late 2021, we moved a big part of my retirement account from stocks to apartment buildings. I can tell you firsthand that my portfolio decreased by less than 5% rather than a 25% drop in the S&P 500.
The question now is why should one an apartment building out of the plethora of other options?
Today we’re going to talk about the three reasons why apartments are a “solid” investment – both figuratively and literally.
1. Housing Shortage, especially in certain states
A July 2022 study stated that the US is short by 3.8 million homes – both places to rent and places to own. With rising interest rates, home affordability is slipping away from many Americans. This drives higher demand for affordable housing options. Pre-pandemic the cost to own versus renting a property is $300. Post-pandemic, that number is now $1000 according to a study by Marcus and Millichap. Moreover, people are migrating from coastal states like California and New York. They are moving to tax-friendly, job-friendly, and affordable states like Texas Arizona Florida Georgia Tennessee, and the Carolinas. Please see the table below for the full list. States highlighted in blue represent more people moving in. States highlighted in yellow and orange represent more people moving out.
Population growth is another critical factor for the growth of your investment property. The higher the population growth the higher demand for housing. The metropolitan that will see the highest population gain is Houston at 500,000 people in the next 5 years. See the table below.
Lastly, you have to look at housing affordability. People move to more affordable states where they can stretch their dollars as the cost of goods goes up. The heat map below shows the affordability by county.
It is best to consider all these factors before you acquire your next property.
2. Tax Advantages
You are essentially buying four things when you buy an apartment building. You’re paying for the land, the building, the building components, and property upgrades. All these except land is a depreciable asset. In 2017 the tax cuts and jobs act added a tax incentive called bonus depreciation. It states that all the components in the property that has a depreciation life of less than 20 years can be depreciated in year 1. What this means is that investors will have a massive loss (on paper) in the first year that they can use to offset their passive income stream. The year 2022 is the last year when you can have up to 100% bonus depreciation. It then it steps down by 20% per year until it goes away in 2026. These losses are going to show up in your schedule K-1 that you give to your accountant. So imanyve many properties, each property will have their own schedule K-1. Investors use this depreciation loss to offset any of their passive income streams. And this loss will stay in perpetuity until you consume it, making it like a piggy bank.
3. Solid Investments
A multifamily property is a tangible asset. You can drive by it, feel it, see the transformation over time, (and hopefully not smell it). Multifamily renovations happen in different stages. The first area of renovation is the mechanical components and roofing. These are the high-ticket items that ensure your property runs well. A roof is one of the most expensive things to replace in apartment buildings. Singled roofs last somewhere around the 20-year mark. So make sure that roof replacement is accounted for when needed. The next phase of the renovation happens on the exterior. This includes wall sidings, staires, foundation, security cameras, lights, gates, etc,. This is a crucial next step as it creates an initial appeal when a potential tenant walks into the property. The last phase involves the interior of the property. This includes changing the carpet, ceiling fans, backsplash, appliances, etc,. These are things that will make the tenant’s living conditions feel more comfortable. The goal of renovating these items is to generate more income. This aspect is called “forced appreciation”. This improves the quality of living, to increase rent. Conversely, organic appreciation is the increase in a property value due to external factors.
One last important factor about investing in apartments is the human relationship with your sponsor. Passive investors have the ability to reach out and ask the sponsors directly. A good sponsor will respond within 24 hours. You also know the team that manages your asset and find out their track record in the business. When was the last time you got an answer from your stock’s board members?
Conclusion:
45% of Americans hold stocks, making it the most common asset available. However, there are other alternatives that can yield higher returns and lower risks. These assets are typically in real estate. One thing to keep in mind is real estate is a medium-to-long-term investment. You cannot expect to invest in one property and make millions of dollars the next year. Those do happen albeit few and far between. If you invest in real estate like a multifamily property, expect to hold it for five years or more. It may take longer to yield a profit although you can trust me on this, it’s well worth the wait.
Until next time! Onward and upward!
Sources:
https://www.jchs.harvard.edu/blog/domestic-migration-drove-state-and-local-population-change-2021
https://oregoneconomicanalysis.files.wordpress.com/2017/02/ruralaffmap15.png