PropCo Sector Spotlight: Multifamily
Authors: Daniel Fetner, Ryan Freedman & Adam Donahue
In our last piece, we examined two distinct approaches to sourcing and executing PropCo investment strategies. In the second approach, we start with a high-conviction real estate thesis. Next, we begin to layer in OpCo technologies in conjunction with expanding our portfolio. This is an analysis that requires a deep understanding of traditional real estate investing.
Our team’s collective experience in real estate private equity has allowed us to witness and participate in numerous macroeconomic cycles over the last several decades. Throughout this time, we have formed a variety of internal views on common topics such as asset class, geography, underwriting, hold period, and debt.
For the purposes of this post, we are going to spotlight the multifamily sector and answer two main questions.
First of all, why has multifamily proven to be a safe and reliable investment historically?
Second, should investors be thinking about multifamily at this stage of the cycle?
Multifamily: It’s Boring, But It Works
It’s common to stroll through a city like New York and hypothesize about how much profit the owners of the skyscraper office buildings or the glamorous hotels must be turning over each year. While these assets may be considered some of the most “desirable” real estate to own and are certainly capable of producing strong returns, they are not always going to offer the most consistent profit or the best risk-adjusted returns. In the midst of these large-flashy buildings, it’s easy to overlook the 220-unit garden-style apartment just over the bridge in New Jersey, or the mid-sized apartment complex in Queens, both of which offer equally good, if not better investment profiles.
To better understand why so many of the largest institutional investors consistently deploy capital into multifamily, let’s look at a few of the benefits:
- Stability: People always need somewhere to live, regardless of economic conditions. In many instances, living in an apartment is more efficient and practical vs. purchasing a home for the average consumer.
- Consistent Cash Flow: Compare the reliability and occupant diversification of a well-occupied apartment complex to that of a seasonal hotel or office building levered to one or two large tenants.
- More Attractive Financing: Similar to the point above, banks generally find the diversified tenant base less risky vs. a more concentrated single-family or office asset for example.
- Tax Benefits: Investors are generally entitled to their pro-rata share of asset depreciation, which, in most cases, offsets the income tax on their yield.
- Hedge Against Inflation: Apartments with yearly leases can adjust their rent to keep pace with rising inflation. This has held true as rent has kept pace or outpaced inflation over the last 30 years.
Multifamily Today
We know that this asset class has done well historically, and will likely perform well in the future, but given all of the uncertainty in the economy today, should investors sit on the sidelines or begin to sharpen their pencils on multifamily?
As of late, there have been only a small number of asset sales, relatively speaking. It’s worth noting this as investors try to determine exactly where cap rates are, and when it makes sense to begin to deploy capital. Limited sales equate to limited price discovery, but here’s what we do know:
The Concerns
- Interest Rates Are Up: This makes financing more difficult.
- Supply is Up: A number of new apartment buildings have come online in the last few years.
- Consolidation: Many consumers that spread out during COVID are now forced to live with others.
The Positives
- What’s the Alternative? Home prices are unaffordable, so debt is unattainable. For most people, multifamily is the only option.
- Spreads: The 10-year to-cap rate spread is only 50–100bps. In comparison, the spread was 250 bps in 2019. As this starts to widen, look for more institutional capital to flow into multifamily.
- Cap Rates: Cap rates have started to widen a bit. To the extent more expansion happens, this will fuel investment.
- Interest Rates: All eyes are on the Federal Reserve. Those with an opportunistic view believe the 10-year will eventually settle in closer to ~3%, which would make financing much more attractive.
Back to PropCo/OpCo
As you can see, we are fundamentally bullish on multifamily as a long-term asset class and are evaluating conditions daily as we begin to think through our 2023 capital deployment strategy in this sector, as well as others.
We’ve discussed many of the “traditional” features that make multifamily such a compelling offering. While these all hold true, we believe the most exciting opportunity for value creation comes in the form of applying technology to drive efficiency, innovation, and growth in this already-proven sector.
Please Reach Out!
If you’re an entrepreneur considering a PropCo-OpCo structure or an institution exploring the PropCo space, please reach out as we’d love to speak with you. Daniel@alpaca.vc + Ryan@alpaca.vc
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