Before adding any new investment to your portfolio, it’s important to consider a broad range of factors: Is it a proper fit for your investment strategy? What’s the broader financial climate like? What time or knowledge constraints do you have that could impact your investment? Will the investment benefit your tax strategy?
If asking these questions is a routine habit of yours as an investor, you’ve no doubt seen it pay high dividends over the years. If you’re new to the game, here are a few of the most critical “pre-assessment” questions you should be asking yourself before investing in multi-family real estate.
Frankly, many of these questions also hold true for any new asset class you’re evaluating, so you should tuck them away as general “investment rules of thumb”.
#1) Have You Studied the City Where You’re Planning to Invest?
Clichés are clichés for a reason--they usually hold more than their fair share of wisdom. So, we’ll say it again: location, location, location.
This is often told to individuals or couples who want to purchase a new home for their own personal use. But it holds doubly true when you’re considering purchasing a multi-family property for investment purposes. There are several important reasons for this, so let’s spend a minute exploring what they are in more detail.
When you are considering investing in multi-family real estate, it’s imperative that you do your due diligence. Every city will have residential properties of one kind or another. You can pretty much make that a given: anywhere there are people, there must be living spaces for them to inhabit.
However, what may not be in abundance are multi-family properties such as apartment buildings and high-rises. Multi-family properties may not fit the zoning laws or desired lifestyles of the community you are thinking about for investment, so they may not exist. And, when making a substantial real estate investment as an accredited investor, you want to be sure there are a number of attractive options that are available for investment.
Investing in a “scarcity situation” forces a semi-defensive mindset of “I’ll take the best deal that comes up, whatever it might be,” as opposed to taking the offensive by defining your criteria for the “perfect property” in a city with many different options you can select from at your will and leisure.
Doesn’t that sound like a better location? But you can only get there if you do your due diligence location by location.
#2) What Tax Impact Will Multi-Family Real Estate Have on Your Portfolio?
If you’re into tax breaks (and who isn’t), real estate is one of the best asset classes you can get involved in. As with most of the benefits of real estate as an asset class, this is especially true for multi-family properties. (If you’re noticing a general theme here that multi-family properties amplify and multiply all the benefits and advantages of general real estate, you’re onto something…)
The first major tax impact when investing in multi-family properties is a depreciation tax break. Even though there are many good reasons that the value of a multi-family commercial property will only increase with time, the IRS categorically assumes that it will depreciate with the passing of time due to the need for repairs and replacement.
However, it’s key to note that the IRS also states that commercial properties are generally only viable and profitable for a maximum of 39 years based on the property type and use. So, property owners may only claim depreciation deductions for that amount of time from the building’s completion and initial occupancy.
The second tax advantage from multi-family real estate investing comes from a number of specific tax deductions: from management costs to insurance premiums, repair and maintenance, utilities and even marketing costs. Suffice it to say, there are several types of deductions that are available to an investor in multi-family commercial properties.
This is one of the primary reasons why investing in apartments and high-rises is one of the best-kept secrets of the mega-rich: they know how to make money, but also how to shield as much of their earnings from taxation as possible.
Being tax savvy is one of the building-blocks of long-term wealth creation, and multi-family commercial properties are one of the best avenues available for accredited investors to expand their wealth. Always consult with your tax professional to understand how an investment may impact your taxes.
#3) What Do Historical Rates of Return Look Like for Multi-Family Real Estate in the United States?
Recognizing returns can vary by state and market, but everyone wants to know what they can reasonably expect when they invest in multi-family properties.
Long story short, the historical performance of multi-family real estate is both a testament to the profitability and the resilience of the asset class. Average 20-year annual returns on apartment investments have historically been as high as 8.98% in the Eastern U.S., 8.70% in the Midwest, 9.16% in the South, and 10.38% in the West.
That is the reward. What about risk? It is important to consider how an asset class can shield you from the economic downturns expected in your lifetime. These charts from Wells Fargo clearly indicate that even during the Great Recession of 2008, when many investors lost up to half their assets, investors in apartment buildings still enjoyed a 92% occupancy rate and only suffered a negative downturn in rental rates of approximately 6%.
During a time when many were facing grave economic uncertainty and many people’s stock portfolios were utterly decimated, taking a temporary 6% hit on an asset that’s still generating passive income seems pretty desirable.
The takeaway from all of this? Multi-family commercial real estate, such as apartments and high-rises, scores extremely well on all the key questions anyone should be asking themselves before investing in any asset class.
As long as you study your investment location and do your due diligence, you should have no shortage of profitable deals available to you as an accredited investor. Furthermore, adding multi-family real estate to your portfolio will give you access to a wide variety of substantial tax breaks. Lastly, the historical performance of this asset class has been strong and consistent. People need places to live even when the stock market is producing big losses for its type of investors.