The How of Multifamily
Real Estate Investing
I believe that the best way for most busy individuals to invest in real estate is passive commercial multifamily. Having said that, let’s go through the four different ways anyone can invest in real estate.
Option#1 – Active Residential Real Estate
Many real estate investors begin and end their career here. We all know someone who has done this and as a consequence offers their stern admonition against managing “tenants and toilets.” While there is truth that active management of real estate is not suited for everyone, it can be lucrative when done skillfully.
These investors should pick a business strategy and work with a team to implement it. Are you going to fix and flip distressed properties, focus on vacation rentals, deal exclusively with low-income government subsidized housing, provide student housing, senior housing, or some other strategy?
Due to the lack of economies of scale with residential real estate, the cash-flow can be small and inconsistent. Often times, the real wealth building power of residential comes from appreciation or paying off the loan. For all of the frustrations that can come with residential real estate, the IRS does allow one incredible tax break. Under certain circumstances with very specific requirements, the active investor can qualify for real estate professional status. This allows depreciation from the rental properties to be taken against earned income and therefore reduce the owner’s overall tax burden.
As I alluded to previously, active residential real estate is the entry point for most beginning real estate investors. Many people know this and avoid real estate investing all together given their already busy lifestyles. What many don’t know is that there are other options.
Option #2 – Passive Residential Real Estate
For years, many investors would buy a property, hire a property manager, bury their head in the sand and hope for good results. These investors felt like a property manager could insulate them from the headaches that come with being a landlord. Good property managers can definitely buffer some of the time commitment involved with residential real estate.
However, be aware that a good residential property manager is hard to find. Most charge 8% – 10% of gross income for management. That means if you are renting your single family house for $800 a month, the manager makes $80. This small amount of money will not sustain their business or put food on the table.
Consequently, residential property managers need to manage in bulk to make a decent living. That leaves them with little time to look after your property. Good residential managers do exist, but it is rare to find someone who will take care of your property as well as you would.
Option #3 – Active Commercial Real Estate
Small strip malls, office buildings, and multifamily properties are in the range of the individual accredited investor. To secure larger buildings, most people will have to form partnerships with other investors. These multi-million dollar properties may come with multi-million dollar down payments. Larger properties also come with more economies of scale that allow for better cash-flow than residential real estate. Managing commercial property is serious business. I highly recommend you become an advanced learner before attempting to become an active commercial real estate investor.
Market and submarket analysis along with a sound business plan is just as crucial as picking a quality property that will provide ample cash-flow and appreciation over time. Previous management experience is desirable and may make the difference as to whether or not you will qualify for commercial lending.
Option #4 – Passive Commercial Real Estate
Realizing that the vast majority of medium and large commercial properties are owned by businesses and partnerships means that passive investing is commonplace in the commercial real estate space. This can be a very attractive option for busy individuals. Large partnerships formed to invest in commercial real estate are known as syndicates. There are numerous private real estate investment companies who specialize in various classes of commercial real estate and syndicate these types of deals.
These private real estate investment companies should have systems in place for acquisitions and operations. They should have a team that will consist at a minimum of a real estate attorney, an SEC attorney, CPA, real estate brokers, commercial real estate lender, and a property management company. They bring with them the expertise to manage the property and can qualify for an array of commercial lending including commercial banks, government sponsored entity (GSE), commercial mortgage-backed security (CMBS), and life insurance originations.
There are a range of ways these companies can take ownership:
Limited partnerships and limited liability companies are the most common ownership structures used by private real estate investment companies. It is standard for the real estate company to be the general partner while
the investors are limited partners. Delaware Statutory Trusts are gaining popularity in this space and largely replacing the old Tenant in Common (TIC) structure. TICs have fallen out of favor due to the requirement that all investors must qualify on the loan.
When you invest passively in commercial real estate through syndication, you are by definition a fractional owner. Instead of whole ownership of the property, you own a percentage of the property based on your initial capital investment and the entire amount of the raise.
Keep in mind that when you are investing this way, you are investing in the syndicator as much as you are investing in the property. Just as any wise investor would perform due diligence on a property prior to investing, strict due diligence should also be completed on any private real estate investment company prior to investing with them.
How long have they been in business? What is their track record of performance? What is the background of the upper level management? Is there any pending legal action against them? Have they ever lost a project? Do they have references? Do you like them personally? Do they have the same business/ethics framework as you?
These are just some of the questions that need to be answered before considering investments in this type of structure. When evaluating any private real estate investment company, make sure you verify their track record. Stay away from companies that do not have a track record for consistent distributions of yield and double-digit overall returns.
REITs – The Margarine of Real Estate Investing
This report would not be complete without some mention of REITs.
Just like real estate, butter has been around for thousands of years. Sometime in the 1800’s someone decided that there was a need for something that looked like butter, tasted similar to butter, but wasn’t butter. Along came margarine. Real estate investment trusts (REITs) are the margarine of the real estate investing world.
Let me show you why. NAREIT, the National Association of Real Estate Investment Trusts, answers the question “What is a REIT?” in the following way:
A REIT, or Real Estate Investment Trust, is a type of real estate company modeled after mutual funds. REITs were created by Congress in 1960
to give all Americans – not just the affluent – the opportunity to invest in income producing real estate in a manner similar to how many Americans invest in stocks and bonds through mutual funds.
Income-producing real estate refers to land and the improvements on it – such as apartments, offices or hotels. REITs may invest in the properties themselves, generating income through the collection of rent or they may invest in mortgages or mortgage securities tied to the properties, helping to finance the properties and generating interest income.
REITs have a higher degree of volatility and fewer tax advantages than direct ownership of physical real estate.
While REITs typically own real estate, investors in REITs do not. REITs are paper assets that represent interest in a company that owns and operates income producing properties. In essence they are real estate flavored stock. As such, REITs can be highly correlated with the stock market and experience high degrees of volatility.
When discussing REITs, you encounter the following terminology – public, private, traded, and non-traded.
Public REITs can be designated as non-traded or traded depending on whether or not they are traded on a stock exchange. Since traded REITs are traded on the stock exchange, they enjoy a high degree of liquidity just like any other stock.
Unfortunately, traded REITs tend to follow the economic cycles and can closely correlate with the stock market. This can lead to a higher degree of volatility than what is usually seen with physical real estate – without the tax advantages.
Private REITs and non-traded public REITs are not traded on an exchange. These are usually offered to accredited investors through broker-dealer networks. These REITs are illiquid and generally have high fees. They have been plagued with transparency issues as well as conflicts of interest.
Valuation of this stock is difficult and can be misleading to the investor. Due diligence is very important as the quality of non-traded REITs can vary widely.
How will you retire?
In summary, I would recommend that everyone consider owning direct fractional investments in commercial multifamily real estate.
Commercial multifamily real estate is passive, inflation resistant, evergreen, tax-advantaged, and may provide cash and equity returns.
For those whose portfolio is paper asset heavy, real estate can provide some needed diversification and stability.3 For those who are looking for better yield without having to sacrifice growth, real estate might be right for you. For those looking to decrease their exposure to high volatility investments, real estate may be the way to go.
Every accredited investor should take a look at this asset class and see if it is right for them. Keep in mind that real estate can provide attractive yield in the form of cash-flow as well as longer-term growth in the form of appreciation and amortization. Real estate is also highly tax-advantaged and can be an excellent hedge against inflation.
Realizing that I could gain access to these multi-million dollar properties without having to become a landlord has made all of the difference in the world to my financial success. 37th Parallel Properties is a private real estate acquisitions and asset management firm based in Richmond, Virginia. Our focus is B-grade multifamily real estate in the best markets in the country. While past performance may not be correlated to future results, every asset we own is profitable for our investor and our track record speaks for itself.
To gain access to our deal flow, there is a brief qualifying process. This process ensures that there is a good match between the investor’s goals and our offerings. Additionally, all investors must be accredited. You are accredited if you meet at least one of the following three criteria:
Next Steps
To learn more about how you can benefit from this asset class, schedule a 15-minute phone consultation today.
Don’t hesitate as the consultation is complimentary and there is No Cost and No Obligation to you. We welcome the opportunity to assist you in reaching your financial goals.
References & Sources
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https://en.wikibooks.org/wiki/Real_Estate_Financing_and_Investing/Sources_of_Funds - J.P. Morgan Asset Management. Real Estate: Alternative No More. July 2012.
https://am.jpmorgan.com/blobcontent/131/169/1383169203231_11_559.pdf - The Street. Real Estate: Best-Performing Asset Class During the Past 20 Years. October 2016.
https://www.thestreet.com/story/13861401/1/real-estate-best-performing-asset-class-during-the-past-20-years.html - MetLife Investment Management. US Core Real Estate: A Past, Present, and Future View. 2017.
https://www.metlife.com/assets/cao/investments/US-Core-Real-Estate-Par-Present-Future-View.pdf - Mortgage Bankers Association. Commercial/Multifamily Mortgage Delinquency Rates for Major Investor Groups. Q2 2016.
https://www.mba.org/Documents/Research/2Q16CMFDelinquency.pdf - Forbes. Five Reasons 8 Out Of 10 Businesses Fail. September 2013.
http://www.forbes.com/sites/ericwagner/2013/09/12/five-reasons-8-out-of-10-businesses-fail/#605955d55e3c - Inc. Why 96 Percent of Businesses Fail Within 10 Years. August 2015.
http://www.inc.com/bill-carmody/why-96-of-businesses-fail-within-10-years.html - Business Insider. Millennials Are Getting Stuck Renting For Way Longer Than Previous Generations. August 2015.
http://www.businessinsider.com/millennials-renting-for-very-long-time-2015-8 - CNBC. Millennials will be renting for a lot longer. September 2016.
http://www.cnbc.com/2016/09/09/millennials-will-be-renting-for-a-lot-longer.html - National Multifamily Housing Council. Apartment Supply Shortage Fact Sheet.
https://www.nmhc.org/Advocacy/Apartment-Supply-Shortage-Fact-Sheet/ - Bloomberg. Student Debt Is Stifling Home Sales. February 2012.
https://www.bloomberg.com/news/articles/2012-02-23/student-debt-is-stifling-home-sales - Freddie Mac. Multifamily Research Perspectives. 2015 Multifamily Outlook Executive Summary.
http://www.freddiemac.com/multifamily/pdf/2015_outlook.pdf