By Fred Matera, CIO, Redwood Trust A lack of affordability will lead to near-term weakness,…
by Rachel Adams
The apartment complex market, also known as the multifamily market, has continued to grow steadily and gain exposure amongst investors of all kinds – experienced, novice, foreign, “mom and pop” operators, etc. Even amidst a global pandemic, the multifamily market continues to show areas of growth and stability, despite initial overwhelming fear of significant losses. The resilience of the apartment complex sector during such an unprecedented time demonstrates the demand of investing in this asset class. Acquiring an apartment complex is an excellent investment that allows investors to leverage their income while bringing about unique benefits that are not experienced when owning other types of real estate assets. While there is a wide array of advantages to investing in multifamily buildings, there are also potential hurdles that need to be considered when making any investments. In this blog, I will provide some insight into the “pros” and “cons” of owning an apartment complex.
The “Pros” of an Apartment Complex
As discussed above, there are several advantages to investing in an apartment complex. Some of these “pros” include:
- Residual Rental Income: Owning a stabilized multifamily building allows investors to capture steady cash flow. In comparison to investing in a single-family home as a rental property, apartment complexes can offer a higher return and the opportunity for steady cash flow. Additionally, given the fact that multifamily assets have several units, it avoids the risk of absolute vacancy therefore creating more stability – one tenant, or even a few, vacating their unit(s) will likely cause a smaller fluctuation in the investors’ monthly income than say a single-family home vacancy.
- Supplementary Income: In addition to enjoying steady monthly cash flow via rental income from tenants, apartment complexes also allow investors to gain, in some cases, a substantial amount of passive income by charging for extra amenities and services such as parking (resident and non-resident), laundry machines, pets, gyms, etc.
- Sizeable Tax Benefits: Purchasing apartment complexes, from a tax perspective, is an sound investment. Multifamily investors have the ability to deduct operating expenses and capital expenditures from their income (personal income not associated with the rental asset included), which in turn can give them the benefit of a sizeable tax break. Additionally, investors are able to take depreciation deductions, thus further reducing their taxes owed.
- Ideal for Property Management: It often is not cost effective for investors with one or two single-family homes under their belt to hire a property management company – however having several units under one asset generating income typically allows investors to have enough cash to hire a property manager. With property managers handling day-to-day operations and maintenance of the apartment complex(es), it is just as easy to oversee multiple units in a building as it is one single family home. Hiring a property manager also allows investors to have less daily involvement.
- Capital Appreciation: By having an efficient and competent property management team, investors can expect satisfactory value appreciation. Successful property management can attribute to steady year-over-year increase in rents, as well as a positive reputation of the apartment complex and thus bringing in new tenants and lowering vacancy rates. These factors increase a property’s value, and therefore increasing capital gains when the investor feels it is time to sell.
- Scalability: Multifamily buildings exemplify scalability. Acquiring a multifamily asset allows investors to purchase multiple units within one building at a time, rather than one single property at a time. This acquisition can quickly expand an investors’ real estate portfolio, thus allowing them to grow their individual business and profitability. Furthermore, financing can become simpler for investors as lenders in this space often mainly look at experience and the real estate owned.
The “Cons” of an Apartment Complex
While the benefits of owning an apartment complex are plentiful, it is not without its potential downsides. Here are some various “cons” associated with this investment:
- Time: Acquiring an apartment complex can be a timely investment. A significant amount of time goes into choosing the asset, finding the right financing, and closing on the purchase. While having a property management company to handle the day-to-day operations and general maintenance of the asset saves investors time in daily responsibilities and dealing with tenants directly, investors will need to oversee and confirm the management company is successfully supervising the building and keeping their investment profitable and tenants happy.
- Liquidity: Apartment complexes are not as liquid as other real estate investments – in other words, if the investor needs to cash-out on their investment, it is not so simple. The process of selling a multifamily building can often be a long process – it can take several months for potential buyers to be able to secure financing while closing is often time-sensitive.
- Risk and Liability: While multifamily investments are typically lower risk and higher reward vehicles, with any investment, there is risk involved. Investors need to be sure their assets are resilient and can bounce back from unexpected losses due to mismanagement, natural disasters, etc. While these investors typically have strict and rigorous insurance policies in place to protect them, they can still be held liable for accidents and crimes occurring on the property. They also need to set aside a certain amount in capital reserves to ensure that any costs due to damage, crime or mis-use can be covered.
- Maintenance Expenses: Apartments typically have a high turnover of tenants, and therefore it is common for tenants of a multifamily building to treat their units with less care, compared to a tenant in a single-family home planning to stay long-term. Investors are then generally required to spend more time handling unit turnover and maintenance. Maintenance costs in an apartment complex are typically much higher than those of a single-family rental investment, happen more frequently, and investors are responsible for paying for these common area maintenance costs.
- Tenant Issues: Whether it be paying rent late or not paying at all, breaking complex rules (i.e.: no smoking, not properly disposing of their garbage, etc.), and/or causing damage to their individual units as discussed above, tenants can cause investors headaches. Even long-term tenants with promising credentials can choose to leave the property unexpectedly. In order to better filter tenants, investors can implement tight screening policies, such as requiring references and criminal reports. While this may mitigate some tenant risk, risks remain however, and these processes costs money and additional time.
- Government Regulations: The government has the ability to interfere with housing and landlord-tenant relationships regarding rent control, building ordinances, evictions, environmental regulations, etc. This was very evident during the height of the Coronavirus pandemic, as discussed earlier, in which there were various tenant protections in place under the CARES Act. Investors have to adapt to the changing regulatory environment and have the burden of preparing themselves to endure further health or economic related crises.
Investing in and owning apartment complexes can be extremely beneficial and profitable for a wide range of investors. Having the ability to earn a steady monthly income, receiving ample tax breaks, and growing one’s real estate portfolio are just a few of the mitigants making this type of investment an attractive one. But, like any investment, there are also potential risks that need to be considered. If you are interested in acquiring multifamily real estate, it is crucial that the above factors are measured prior to making any decisions, and that you are prepared to devote a great deal of time and resources to this investment.