Is Buying an Apartment Building a Good Investment?
The Benefits, Drawbacks, and Alternatives to Apartment Investing
Multifamily and apartment properties have always been a strong investment choice. It doesn’t hurt that many well-known businesspeople have built their fortunes through multifamily real estate. Unlike single-family investment properties, apartment buildings are less prone to vacancy risks and are ideal assets for partnerships or syndication deals.
While homeownership rates have generally been on the rise since 2016 (with the notable exceptions of Q4 2018 and Q1 2019), they’re still not anywhere near their 2004 peak. And, with homeownership rates relatively low and overall housing demand high, apartment rents have continued to increase. Those increases have generally lead to a strong increase in apartment property values over the last several years. And, while values may not necessarily keep increasing at the same rate for years to come, housing demand is currently spiking and expected to stay relatively strong in the future.
However, despite all the upsides of buying an apartment building, doing so should only be done after proper research and preparation. Successful apartment investing requires attention to detail and typically, a much greater time investment than, say, simply owning a portfolio of mutual funds.
Benefits of Apartment Investing
Purchasing or investing in an apartment building has a wide variety of benefits. Some are obvious; others less so. Common benefits include:
- Leverage: Leverage has always been one of the major benefits of investing in real estate compared to other asset classes. What sort of investment provides you the ability to put only 20% to 30% down while repaying the rest over an extended time period? Other than other types of commercial real estate and single-family investment properties, the answer is pretty much nothing. And, with non-recourse apartment loans like the Fannie Mae DUS Loan and the HUD 223(f) loan offering fully-amortizing terms between 30–35 years, certain borrowers may never even need to refinance.
- Partnership/Syndication Opportunities: Unlike other types of investments, multifamily real estate really lends itself towards groups of investors. Investing with one or more partners can easily increase the size and quality of the apartment building you can purchase — but some like to take things further and take part in larger scale apartment syndications. Being the General Partner (GP) for an apartment syndication deal can net you an additional share of the profits above a certain amount (referred to as a promote) while being a Limited Partner (LP) allows you to sit back and enjoy the profits while not actively participating in the management process.
- Rental Cash Flow: Cash flow from rents can be a great source of readily-available income for investors, especially those who are retired. For younger investors, rental cash flow can allow them to pay bills, or, more ideally, re-invest the cash in stocks, bonds, real estate, or other profitable investments.
- Appreciation: In addition to providing monthly cash flow to investors, apartment buildings generally appreciate over the years, along with the overall real estate market. However, unlike single-family homes, apartment building appreciation is more based on the income of the property itself, so rising rents are generally correlated with increased apartment building values. However, investors may be able to accelerate appreciation by purchasing an older property with management issues, and then hiring new management and making upgrades in order to increase rents.
- Supplementary Income Opportunities: While rental income generally makes up the largest portion of an apartment property’s cash flow, supplementary income sources, such as non-resident parking spots, laundry machines, and vending machines can provide a welcome boost to a property’s overall income.
- Tax Benefits: Apartment buildings possess a variety of tax benefits, including allowing owners to take depreciation deductions against their federal income taxes, as well as allowing owners to defer capital gains taxes upon the sale of their property by engaging in a 1031 exchange.
Drawbacks of Apartment Investing
Like any investment, apartment buildings have their drawbacks. These can include:
- Time investment: Buying an apartment building can be a serious time investment. However, after the purchase period is over, many of the daily tasks of apartment ownership can be outsourced to a property management company. For larger portfolios, an asset manager may also be hired to look for ways to increase overall profitability.
- Risk of loss: Unlike a diverse portfolio of stocks or mutual funds, where a borrower is unlikely to lose everything, in the case of a foreclosure, a borrower could lose the property itself, and could even find their own personal assets at risk.
- Liability: Even though lenders generally require borrowers to carry some form of insurance, lawsuits resulting from accidental injuries or crimes occurring on the property can still be costly. Expensive insurance deductibles and additional legal fees can add up, so investors should be aware and take precautions against liability — such as avoiding purchasing apartments in bad areas and getting a comprehensive insurance policy.
- Expenses: While apartment buildings can be a great source of income, operating expenses can still be costly. Major expenses include property management fees, insurance, taxes, and maintenance costs.
- Vacancy issues: While a vacancy in an apartment building is far less disastrous than for a single-family investment property, if the vacancy rate in a building is high (due to poor management, market forces, or other factors), it can seriously impact the property’s income.
Apartment Buildings Compared to Other Investments
To truly determine whether purchasing an apartment building is a good investment for a particular individual, it must be weighed and balanced against other investment options. To do this, we’ve looked at a few factors, including the time investment involved, the liquidity of the investment, the overall investment risk, and the investment’s cash flow potential.
Stocks/Bonds:
- Time investment: Owning an apartment building is generally a much greater time investment than stocks/bonds, provided that you are purchasing the stocks/bonds with a long-term buy and hold strategy (i.e. not actively day-trading).
- Cash flow: In general, apartment buildings provide investors much greater cash flow than stocks — considering the fact that only stocks with dividends provide investors a steady cash flow, and even these (in most cases) are proportionally much smaller than the cash flows from a comparable apartment investment.
- Liquidity: Multifamily real estate is significantly less liquid than stocks and bonds. Instead of just calling your broker (or, more realistically, clicking a few buttons on your online brokerage account), you’ll generally have to hire a commercial real estate broker, and may have to wait several months for the right offer to come through — and several more weeks after that for the deal to close.
- Risk: It’s difficult to quantify the difference, as it depends on the individual situation. While real estate is generally considered safer than the stock market, an over-leveraged, inexperienced investor purchasing an apartment building with a full-recourse loan could take significantly more losses than if they had simply made some subpar stock choices (provided the investor is not buying on margin). On the other hand, purchasing treasury bills or other government bonds is generally far safer than real estate, though potential returns are quite limited.
Non-Apartment Commercial Real Estate
- Time investment: Similar; commercial properties often require more time investment upfront (during the leasing process), as commercial tenants tend to sign significantly larger and longer leases than apartment tenants.
- Cash flow: In theory, similar to apartment buildings, though this depends on individual properties and market conditions.
- Risk: Similar, though apartment properties are generally somewhat less risky from a vacancy standpoint. Demand for residential units is typically considered to be steadier (and less influenced by overall economic conditions) than the demand for commercial real estate. People may shop or eat out less during trying financial times, but they will still need somewhere to live.
- Liquidity: Generally similar to apartment buildings, though selling an office or retail building may be more challenging during poor economic conditions.
Single-Family Investment Properties
- Time investment: Single-family investment properties generally require less time investment than multifamily properties, as they are smaller, require less insurance, and may not require external property management.
- Risk: Overall, single-family homes are generally less risky when it comes to overall liability, but present more of a vacancy risk. If the home is left vacant/unrented for just 1–2 months a year, it can significantly impact an investor’s income; whereas a 10 or 20 unit apartment building presents significantly less vacancy risk (even if a few units remain vacant for 1–2 months each year). In addition, most loans for single-family investment properties are full recourse, which does increase risk if a borrower were to default.
- Liquidity: While it depends on the market, single-family investment properties are generally easier to sell than apartment buildings, due to the much larger market for single-family homes. Instead of selling only to other investors or investment firms, an owner can often sell to an individual or family who plans to use the property as their primary residence.
- Appreciation: In general, single-family homes appreciate faster than apartment buildings due to the larger market demand. While markets fluctuate, appreciation has averaged around 3–5% per year over the last 30 years. As we mentioned previously, apartment building appreciation is more based on income/rent growth.
Hedge Funds and Private Equity:
- Time investment: Significantly less time is required when compared to investing in an apartment building.
- Risk: Varies greatly. Those who invest in a hedge fund or with a private equity firm are placing a significant amount of trust in the investment manager(s), while they will be relying much more on their own hard work and due diligence if they decide to purchase an apartment building.
- Liquidity: Depends. Can sometimes be less than an apartment building; sometimes more. Many hedge funds require an investor to pledge their funds for a minimum of 5–10 years or risk facing significant penalties.
Apartments Buildings Remain an Excellent Investment in 2019
While we may be biased, we believe apartment buildings have historically been an excellent investment, and still remain a good choice for many investors. People will always need a place to live, and, since apartment buildings can be financed, long-term returns can often outpace that of the stock market. Multifamily properties can also provide a good source of cash flow, have several tax benefits, and are a tangible asset that can be passed down from generation to generation to create and maintain familial wealth.
