The premise behind the growth and popularity of the multifamily rental industry is simple – people need a place to live. While the ways in which people work and shop are turning parts of the commercial real estate industry upside down, the durable cash flow and appreciation that apartment properties provide have made this asset class the most attractive real estate investment.
Attitudes about apartment living have shifted dramatically over the past few decades. Once seen as a last resort for many households, apartments are now viewed as a long-term lifestyle by many who value the flexibility and mobility that rental living offers. A quality apartment community now offers a broad array of amenities, including resort-style pool areas, state-of-the-art fitness facilities, resident lounges with Wi-Fi & entertainment, pet parks and much more. The inclusion of these common area amenities results in a community that residents want to call home for longer periods.
Additionally, an increasing population in the U.S. cannot afford to own a home until later in life, fueling demand for multifamily rental properties. The “American Dream” of home ownership is out of reach for many, and the amplified quality of apartment living has made this lifestyle an acceptable alternative.
Supply & Demand Imbalance – Over 4.5 million apartments will be needed by 2030 in the U.S. to meet the demand created by delayed marriages that result in later family growth, a continually aging population and international immigration. Demand continues to outpace supply in recent years, despite elevated construction.
Affordability – Since the last recession, multifamily rents have increased nationally by 3.6% per year on average, while single-family median home prices have increased 6.5% per year, making it increasingly more difficult for Americans to buy homes. COVID-19 has had little impact on for-sale home prices, and we expect that the affordability gap between renting and owning will endure.
Demographic Trends – The large Millennial cohort has a proven propensity towards renting, given the value placed on mobility and flexibility. Most will change jobs frequently in their first 10 years in the job market. Home ownership is typically not a fit with these trends. In addition, a large number of retiring Baby Boomers will become renters, wanting to unburden themselves of the care and maintenance that ownership requires. Many also want the flexibility to move and be close to children and grandchildren.
Advantages vs. Other Real Estate – People need a place to live, creating perpetual demand. While retail and office sectors are facing a changing landscape in which demand drivers are shifting in the wrong direction, the demand for apartments continues to surge. The continuing demand makes multifamily real estate the most attractive real estate asset class over both the short and long term.
COVID-19 Impact & Opportunity – The current pandemic has served to temporarily stall rent increases in most markets across the country. However, most economists are predicting a gradual recovery for much of 2021, followed by outsized growth in 2022. The expected inflation will only drive rents higher over the next couple of years. Currently, debt rates are at or near all-time lows, meaning that owners of multifamily real estate can borrow at unprecedented interest rates, creating immediate cash flow.
Depreciation – Investment real estate can be depreciated, creating taxable loss that can negate some or all taxes associated with cash flow for a period of many years. In many cases, this tax-free cash flow is in the 7% to 10% range, annually.
Workforce Housing typically refers to Class B and C properties developed prior to 2000 in which renters usually earn 60% to 100% of the area median income.
Renters by Necessity – Workforce Housing renters live in apartments because their economic circumstances do not support the notion of owning a home. Many will make renting an apartment their lifestyle for years to come. The great majority of multifamily renters in the U.S. are renters by necessity, with only 15% to 20% of the renter pool able to afford luxury Class A rents. This smaller subset is known as renters by choice because they could afford to purchase a home, if they were so inclined.
Higher Yields – Workforce housing offers higher yields, with class B and C assets trading at cap rates 80 to 130 basis points higher than class A, respectively.
Value-Add Opportunity – Class B & C assets have renovation opportunities in which an attractive return can be derived from additional investment in the asset. A typical scenario consists of renovating and upgrading dated apartment interiors and common areas, creating an opportunity to push rents. The value-add opportunities are highly sought after because they produce outsized investment returns.
Limited New Construction Impact – Class B & C assets are less vulnerable to new construction because they do not compete with the same renters will lease at a Class A community. Instead, B & C properties serve as a more affordable alternative to renters who may be priced out.
Cash Flow & NOI Growth – A large percentage of overall profits are derived from cash flow and NOI growth, creating less dependency on sales proceeds to drive returns.
Laguna Point is research-oriented with respect to making determinations about which markets to target for investment. Employment growth and positive net in-migration are the most important drivers of multifamily demand. We refer to MSA’s possession these drivers as momentum markets. In recent years, many Americans have been moving to states with low tax rates, making local taxation another key factor. In fact, our current portfolio is located almost entirely within states where the local income tax rate is 6% or less (Nevada & Florida are 0%).
Additionally, there has been a demographic shift across much of the country in which households are moving to states with a warmer climate (i.e. the South and West). This movement continues to create significant upward pressure on rents in markets such as Phoenix, Las Vegas, Orlando and Jacksonville, to name a few. While the multifamily industry will continue to benefit from ongoing national trends, our focus on momentum markets and the factors that drive them serves to generate outsized returns for our investors.