Multifamily Risk - the 'Tales'-Side of the Investment Coin.
Heads and tales, risk and reward - the two sides of an investment that must weighed to make an informed decision. It is also precisely why asking investment advice can be tricky – risk and reward are not necessarily a 50 /50 proposition as no two investors evaluate them with the same weight. Temperament, experience, education – all factor together to determine your brand of investor. Some are risk averse, thus the risk side of coin “weighs” more. Others may invest with a “damn the torpedo’s” attitude, looking toward reward and minimizing talk of risk. My goal here is to take my personal bent out of the equation and give context to the question – How risky is Multifamily (MF) investing?
First, we look to the grand teacher – history. It makes sense when evaluating risk to begin with the worst-case scenario, but most people’s reference point for this is the Great Depression. This is hardly helpful since real estate (RE) investing has changed a bit since the 1930’s. More recently, we can look to data from the Great Recession from 2005 – 2015 and how it impacted RE.
Second, we need a comparator. Single Family homes are a good place to start since most RE investors are comfortable with the idea of making a Single Family (SF) investment, having experience from their own home purchase. Familiarity can lead to the belief that SF is a less risky path since it is better understood. The logic is sound – people lost a lot of equity in their homes during the Great Recession, it makes sense that MF apartments would lose much more, right? But the data demonstrate that there it is quite a bit of difference between the risk profiles of each of these real estate asset classes.
My goal here is not to talk anyone out of SF investing, but to offer perspective to those considering MF options. From a historic perspective, how do the durability of both investments compare during tough economic times?
The chart below from Freddie Mac demonstrates this clearly for the period from 2005 – 2015. There is a stark contrast between the default rate of single-family loans and multifamily loans. Single-family loans defaulted at a much higher rate (300-400%) than multifamily loans despite the Government pulling out every trick in the book in order to prop up the market.
At less than 1%, the delinquency line for MF is so flat you could rest your head comfortably on it during tough economic times and still get a good night’s sleep knowing your MF investment is not likely to default.
All real estate is local, as the adage goes, so there are certainly risks inherent with multifamily assets. Apartment communities located outside of large and growing urban areas, like Dallas, San Antonio, or Houston for example, or in communities that are dominated by a single industry like a military base will carry more risk in a market downturn.
In larger cities with diverse employment, occupancy rates can actually increase in multifamily assets that are well located and managed. When the real estate bubble bursts, those who lose their homes either move in with friends or family, or into apartments. In an economic downturn, those forced out of their homes may need to retreat into more affordable housing options that MF apartments provide. Occupancy rates may even increase as the supply of more affordable housing decreases.
As long as occupancy rates and rent revenue stays intact, multifamily apartments are able to continue payments on their debt obligations. This durability during challenging economic times is another reason we love investing in multifamily apartments.