3 ways to add value in multifamily real estate

By executing a value-add strategy, many investors have been able to increase returns on their multifamily investments. Value-add investments generally target assets that have existing cash flow, but also offer the upside potential of increasing that cash flow through repositioning and implementing improvements to the property. As a result, the property can command higher rents, attract quality tenants, increase tenant satisfaction/retention as well as increase operating efficiencies.

According to the Yardi Matrix report, U.S. multifamily rents grew 3.2% year-over-year from May 2018 to May 2019 (see chart below). Multifamily operators typically increase rents, but in addition they can achieve an even higher rent premium in assets that have room for improvements.

In multifamily real estate, there are many ways an operator can reposition the property and create value. These includes adding value in the form of interior renovations, exterior improvements to the property, and amenities to achieve higher marketability and resident comfort. Strategic improvements can turn an under-performing asset into a high-performing asset. Such enhancements include interior unit renovations with upgraded appliances, cabinets, flooring, lighting and plumbing fixtures, depending upon the market and level of upgrades warranted. Upgraded community amenities often include an expanded fitness center, outdoor entertainment areas , and clubhouse modernization. Once the operator has successfully executed the value-add program, the property should yield a rent premium in addition to the standard rent growth in the market. Successful value-add opportunities offer cash flow throughout the hold period and capital appreciation at sale.

Lloyd Jones’ top three recommendations can be grouped into: interior renovations, curb appeal, and upgraded amenities
1. Interior renovations: Upgrading the units themselves typically involves new cabinetry or appliances and perhaps better flooring. This adds value while aiding in keeping turnover low because these changes directly enhance the quality of life of each resident. At the same time, these energy efficient, maintenance-reducing improvements often decrease the operating expenses of the property.

2. Curb appeal: Not only could improving the landscape of the building please the tenants, but it is likely to catch the attention of potential new residents as well.

3. Upgraded amenities: This can result from enhancing existing amenities such as pools or gyms, or creating new amenities like a dog park or Amazon package locker system. Such changes will offer residents benefits that are typically difficult to access in other types of housing.

Renters often oppose sometimes resist rent hikes. They have many choices in multifamily housing so it is crucial for operators to implement strategies that provide unique or in-demand amenities for which residents are willing to pay premium rents. Without resident satisfaction, there are no fruitful yields for the investment.

The changing landscape of urbanization

U.S. cities such as New York, Chicago, and Los Angeles have long been acclaimed as the cities that support the most opportunity and excitement for young professionals. Today 2.6% of the U.S. population lives in NYC, 1.2% in LA, 0.8% in Chicago. Although these numbers demonstrate how large the cities are, surprisingly each city has seen its population shrink over this past year (see chart below).

Since 2017, NYC’s population has dropped by half a point per year. According to the US Census Bureau, LA’s population dropped -.13% from 2017 to 2018. The US Census Bureau also states that Chicago’s population declined for the fourth year in a row for 2018 (see chart below).

Economists, reporters, and other experts list hundreds of potential reasons to explain this shrinkage, but the four biggest recurring themes are: quality of life, housing options, jobs, and taxes. Residents of these cities are heading elsewhere because the factors that once drove them to these large cities can now be accessed more easily in other locations, and usually at a lower price. 

The New York Times’ April article “Is New York City’s ‘Remarkable Growth Story’ Ending?” speculates that the migration from NYC is caused by the appeal of less expensive and warmer cities in the Southeast. The Financial Times and CNBC reports that part of the moves from NYC and LA can be contributed attributed to significant rent increases.  

Although the net migration may cause concern in NYC, LA, and Chicago, the population influx in southeastern and southwestern cities highlights the idea that benefits such as quality of life, housing options, jobs, and taxes are increasing in emerging cities in Florida, Texas, Arizona and others.

Thoughts on the looming recession

Since the Fed announced its rate cut on July 31st, talks of recession have consumed the markets. With the pending Fed meeting on September 17th, it is largely expected that a consecutive rate cut will follow. A continuation of rate cuts would indicate that the Fed believes the US economy is contracting, and thus we are more likely to be closer to the looming recession.

According to Economist John Mauldin, “Lower asset prices aren’t the result of a recession. They cause the recession. That’s because access to credit drives consumer spending and business investment. Take it away and they decline. Recession follows. The last credit crisis came from subprime mortgages. Those are getting problematic again. But I think today’s bigger risk is the sheer amount of corporate debt, especially high-yield bonds.”

Economists such as Mauldin are pointing to the high levels of corporate debt as the cause of the next recession, or in other words, the “bubble”. Bubbles occur when the market prices an asset above it’s true value. For investors seeking yield but wanting to avoid the risk of investing in corporate debt, real estate investments are a suitable option.

Real estate investments, particularly multifamily, are often recession-proof investments.  Multifamily real estate is recession-proof because during down markets renters have largely proven to maintain their rents. Such housing doesn’t carry the risk of other classes such as single family. The charts below show the percentage change in the prior year for rental and for sale houses from 2008 to 2018. As illustrated below, during the recession of 2008, rental vacancies dropped less than 1% in the following year while housing vacancies decreased by 10%. 

The Fed’s next meeting may indicate how quickly the looming recession could occur, but sophisticated investors will position themselves to be prepared in advance. 

The 4 key areas that are shaking up the senior housing industry

10,000 baby boomers are retiring daily. Similar to the previous generation, baby boomers will be downsizing and seeking a new style of living, but their preferences will be extraordinarily different than that of their predecessors.

4 key areas will shape the way in which baby boomers will retire:

1.Technology: contrary to the generations before, baby boomers have access to modern technology that will influence how they spend their retirement. Wearables, home devices like Amazon’s Alexa or Google’s Echo, and  tablets are helping seniors stay connected while improving their lives.

2. Well-being: fitness regimes and nutritious lifestyles are growing trends that are desired by seniors. Facilities that incorporate classes and offer a means to stay fit and healthy will help slow down aging and be more sought after as a result.

3. Personalized care: another way in which the baby boomers will be differentiated from the generations before will be the ways in which they are cared for. The boomers will expect personalized care and concierge style services to meet their needs, and they will not tolerate the condescending way in which many have been treated in senior living facilities.

4. Community: According to the Pew Research Center, the number of adults living alone has been steadily declining since 1990.  PRC also states that older adults who live alone are less likely to be financially comfortable, have contact with friends or family, and spend time on hobbies (see sample chart below). Given these statistics, it is more important than ever that senior living offer a community-based lifestyle to keep older adults vibrant, happy, and engaged.

The shift in American status symbols

Throughout recent history, a mark of American status was the spacious home with the plush yard and picket fence. Young couples and growing families strove for this style of living to exemplify their status and enjoy what may be perceived as the American dream.

Today, the home with the picket fence is no longer a goal for many. Most millenials and the new era of young families are opting for flexibility, mobility, maintenance-free lifestyle which can be found in multifamily. As mentioned in last week’s blog, We are living in a rental economy, 82% of renters affirmed that renting is the affordable option, and this trend is only growing.

Earlier this year, the WSJ confirmed in their article A Growing Problem in Real Estate: Too Many Too Big Houses that “Large, high-end homes across the Sunbelt are sitting on the market, enduring deep price cuts to sell.” The same homes that were once sought after as a status symbol are no longer regarded as such. The article goes on to state that “Now, many boomers are discovering that these large, high-maintenance houses no longer fit their needs as they grow older, but younger people aren’t buying them.”

According to Fannie Mae’s report, The Coming Exodus of Older Homeowners, boomers’ homeownership is projected to decrease by nearly 30 million over the next couple of decades (see chart below). Across all demographics, we are witnessing a shift toward more practical living, multifamily. 

We are living in a rental economy

A few weeks ago the WSJ reported that “U.S. homeownership rate fell for a second straight quarter, as high prices and limited starter-home inventory are steering more households toward renting.”  This coupled with the fact that home prices rose over the last 2 decades while wages have remained stagnant (see chart below) confirms that we are living in a rental economy.

Although the economics of wages, home prices, and supply drive many hopeful homeowners into renting, others prefer renting for mobile flexibility, lack of debt, and access to amenities and advantages that they may not otherwise have in a single family home.

In Freddie Mac’s recent survey of renters and homeowners, 82% of renters stated that renting is more affordable for them (see chart below). This percentage has steadily increased from 69% in January 2016, further affirming the idea that the rental economy is here to stay.

How are institutional investors reacting to the rate cut?

Less than two weeks ago, the U.S. Federal Reserve announced its first rate cut since 2008. This decision surprised few given the uncertainty in the economy and global trade tensions. What did perhaps surprise many was the effect that the Fed’s decision had on the bond markets. Since the Fed’s announcement on July 31, the 10-year treasury yield has dropped from 2.02 to 1.73. But what does this mean for investors’ portfolios?

According to Economist John Mauldin, “the longer an inverted yield curve persists and the deeper it gets, the higher the probability of recession within the next 9–15 months.” Mauldin predicts a flight of capital toward high-yield junk bonds. Such assets may be able to provide yield, but at what cost?

The safest yield-producing investment during such tumultuous times is multifamily real estate. We have been specializing in multifamily real estate for 40 years because during down markets, it is the most resilient asset class (see Figure 1 below from CBRE Research).

We are already witnessing some of the most high profile investment firms, such as Iconiq Capital, buying up apartment buildings throughout major US cities (Source: WSJ). The timing of these investments demonstrates where the smart money is headed to prepare for our next economic cycle, and that is multifamily real estate.

What does Florida’s booming population growth mean for investing in Florida real estate?

The sunshine state’s population is soaring as more and more Americans are migrating south. It may be the beautiful weather and landscape, the favorable taxes, or the growing job market, but this appears to be a trend that is here to stay.

According to the Demographic Estimating Conference, Florida’s population will surpass 22 million residents by 2022. Florida is already the nation’s third most populous state behind California and Texas. For many, this increased growth is exciting as it brings about opportunity for the state, but it begs the question if the current housing supply in Florida real estate can meet this increasing demand.

Forbes reports that from 2010-2016, on average there were 114,744 new households per year, but only 57,952 new housing units. With the surge of population growth that we are witnessing in 2019, this disparity will only increase. Given this lack of availability, now is the ideal time to invest in Florida real estate that is so sought after to meet the swelling demand.

New households, families in Florida FIGURE 4 FROM STALEY, MILLSAP, AND NASTASI (2019)

Why is real estate the #1 long-term investment for Americans?

It’s no secret that real estate has been, is, and will continue to be a popular choice of investment. As individuals take a more holistic approach to their portfolio planning, real estate investments are receiving a bigger piece of the pie to add diversification and cash flow.

That said, it still came as a surprise to many (but not us), when a nationwide Bankrate survey revealed this month that real estate is Americans’ favorite long-term investment. With rate cuts and swinging volatility, too much uncertainty lies in traditional markets. Real estate investments may offer stability, cash flow, and the gratification of owning a tangible asset that when properly managed over the long term, can bring about capital appreciation.

As investors shape their portfolio with a long-term approach, real estate investment becomes the necessary choice to offer value that is becoming more difficult to find elsewhere.