Why CONTI is Certain About Multifamily in an Uncertain World

The reality of today’s economy is that there is very little certainty. Now more than ever, investors are looking for long-term economic safe harbors that offer resilience and preservation. Known for its stability, multifamily real estate in particular has been the historical safe harbor investors consider when they want to add resiliency to their portfolio.

Why Multifamily?

When it comes to investments, the commercial real estate market plays a crucial role in portfolio diversification, representing an estimated $16 trillion in investments in 2018 (NAREIT). Compared to the U.S. stock market at $30 trillion and the bond market at $40 trillion, commercial real estate investments represent over 18% of market assets. The four main classes amongst commercial real estate include multifamily, retail, office, and industrial. Historically, commercial real estate has provided better risk-adjusted returns than other investment products such as stocks or bonds. Over the past two decades, the average annual return of commercial real estate of 7.31%, has far exceeded both the average return of stocks at 5.61% and bonds at 4.55%.

Average annual returns

Commercial real estate provides an opportunity for investors to hedge risk against other asset classes and diversify their portfolio. Commercial real estate returns display low correlation in comparison to investment alternatives; over the past 20 years, stocks posted negative returns 25% of the time; commercial real estate only posted one year of negative returns within the same period[1]. Additionally, commercial real estate can provide a hedge against inflation through relatively short-term rental contracts (1-5 years, on average, dependent upon asset class) that provide an opportunity for owners to mark-to-market, realize increases in rents, and income, and force appreciation.

Amongst commercial real estate classes, not all are created equal. While office, retail, and industrial rely heavily on job growth to support demand and their corresponding returns, multifamily relies on population growth and provides one of the three essential needs in life: shelter (alongside food and water). Shelter can take many forms, including (but not limited to) single-family houses, apartment complexes (multifamily), condominiums, townhouses, duplexes, or manufactured housing. In the United States, renters account for approximately 36% of all households, which represents over 100 million Americans (NMHC) and has grown by an estimated 19 million renters since the Great Recession. The multifamily housing market is estimated to represent over $4 trillion in value (NMHC), approximately 25% of the commercial real estate investment market.

Additionally, multifamily stands above the rest when analyzing prospective risk and return profiles. When making an allocation decision, investors must consider both the expected return of an investment and the respective risk of that investment. In a 2018 study conducted by the National Multifamily Housing Council, multifamily investments proved to be the most attractive investment vehicle relative to other commercial real estate classes. This comprehensive study analyzed 30 years of commercial real estate returns available through the National Council of Real Estate Fiduciaries (NCREIF) and revealed that the average 10-year apartment holding not only had a higher average return than any other commercial real estate class, but also had significantly less risk than industrial, office, or retail. If the past is any indication of the future, investors can expect the best risk-adjusted returns from multifamily assets.

10-yr holding

As shown above, multifamily boasts both the highest average return (mean) and the lowest return volatility (S.D., standard deviation). As such, investors can take advantage of an investment vehicle that both maximizes their average return and minimizes their risk[2].

Value of apartment stock

Why Now?

In the context of an ever-changing and volatile investment world, multifamily investments are positioned to outperform investment alternatives, given the fundamental needs for housing. Demand for apartment housing was extremely strong before the COVID-19 crisis and will only intensify as households face growing debt burdens and dwindling savings. The latest figures display a record amount of U.S. household debt amounting to over $14.15 trillion in Q4 2019 before the impact of the coronavirus.

In the fourth quarter alone, household non-housing debt, which includes student loans, auto loans, and credit card balances, increased by a whopping $79 billion. All three non-housing debt sectors reached record levels by year-end 2019 (Federal Reserve Bank of New York){3]. The average American household budget constraint is tightening, which in turn will force more people to rent instead of purchasing a home.

At its most fundamental economic level, the demand for apartments is a function of the price of a substitute good, or purchasing a home. The price of homes is closely tied to borrowing standards issued by mortgage lenders, and as borrowing standards increase (higher down payments, more stringent credit thresholds), the effective home price will increase for potential buyers. In recent news, JPMorgan Chase has increased its mortgage borrower standards to include a minimum credit score of 700 and a 20% down payment, which is expected to have a material effect on home purchase ability. The Mortgage Credit Availability Index plummeted 16.1% in March to its lowest level since June 2015 (MBA)[4]

Demand cannot be measured without supply, and as the main alternative to apartment renting, single-family home prices follow these same axioms. As social distancing measures delay potential home sellers’ decision to enter the market, the inventory of U.S. homes is evaporating. In March, the national inventory declined by nearly 15.7 percent year-over-year and hit a record low. Consequently, the median listing price in March increased by nearly 4 percent[5]. This dual-edged sword of supply shortage and immediate increase in borrowing standards will effectively increase prices for homes, making it harder for current and future potential homeowners to purchase houses. Couple this price increase with a tightening budget constraint and the choice is clear for many American households: rent.

Businesses across all asset types and sectors have been experiencing unparalleled drops in revenue and income, and commercial real estate is no exception. In spite of worldwide disruption, multifamily has performed relatively strong against its peers; according to Nareit’s rent collections survey of 54 listed REITs representing over $400 billion in market capitalization, the apartment sector collected 93.5% of typical rents in April while the office sector collected 89.3% and shopping centers collected a measly 46.2% of typical rents[6].

Equity market cap