Investing in multifamily housing and office buildings helps private investors build a portfolio that weathers risk better and builds wealth — and individual investors are wise to consider this two-pronged approach. Real estate is a hedge against volatile stocks and bonds, a way to build wealth as property values rise that is also very tax efficient.
But diversification is just as important in a real estate portfolio. Each property type performs differently based on market conditions, and investors can’t assume that one will always be a great investment because it has performed well in the past. Instead, a better real estate investment strategy is to build a portfolio that combines different types of income-producing properties.
For instance, at the moment multifamily investing is hot, the demand for rental housing has given individual investors an unprecedented opportunity to build wealth. The office market is also compelling thanks to strong employment growth in business and professional services, as indicated by the Bureau of Labor Statistics and the trend to call remote workers back to headquarters. Multifamily and office real estate are two asset classes that also marry well together, and a portfolio that combines them will benefit from their differences and be better able to weather economic storms. Here’s why.
Multifamily Investing Benefits From A Rental Revival That Draws Young And Old
More Americans are renting their homes today than ever in the last 50 years, according to the Pew Research Center. Apartments are in higher demand across all age groups, including middle-aged adults who traditionally have been less likely to rent. The 2008 recession soured them on homeownership as a sure way to wealth.
As renters, they pay no taxes or homeowner association fees and need not worry even about yard work. Condominiums promise maintenance-free living but apartments deliver it. Renters also have the flexibility of not being tied down -- at the end of the lease, they can lock up and leave. No wonder vacancy rates hover at historic lows in Census estimates over the past year. This suggests that this trend has staying power.
The Office Market Expands With The Growing Economy
Meanwhile, the office real estate market is still growing. Leasing hit a two-year high in JLL’s most recent office report. Commercial real estate investors have been focused on a spurt in new construction, but construction starts have begun to level off.
Nearly half the leasing activity comes from expansion. Demand is outpacing supply in many markets, including Atlanta, Austin, Chicago, Denver and Raleigh-Durham. Much of the growth is in outlying submarkets that combine city and suburban attractions. As renters move to cities with a better quality of life, nearby office markets benefit as well. Shorter commutes in cities like Charlotte, which have built up their transportation infrastructure, have contributed to the strength of their office markets.
Together, Multifamily And Office Reduces Real Estate Risk
While office and multifamily trends reinforce each other, the two asset classes have offsetting structural differences that help balance a portfolio. Rents are the best example of how apartments and offices complement each other.
Shorter duration leases in a multifamily property tend to track inflation and growth more closely than long-term office building leases. With an array of nine- to twelve-month leases, rents can be reset as wages and consumer prices rise. In a typical office deal, leases are much longer, ranging from five to 10 years in duration with pre-set increases that may be lower than wages, inflation and rising consumer prices. This gives commercial real estate the seemingly slower growth and greater stability of bonds.
As a commercial landlord, you’ll ink a number of leases at a time, and those tenants are contractually obligated to pay that amount. If there’s a downturn and you’re locked into that rate, good for you! Otherwise, even with a 2% or 3% rent escalation baked into a lease, you’ll have to live with a ceiling on revenue until those leases expire.
Conversely, as an apartment landlord with shorter leases, you’ll profit from a rising market. But tenants are more able to leave a downturn, which could be brutal for occupancy rates and the revenue stream.
However, a portfolio that combines office and apartment properties strikes a good balance. There is less of a correlation between multifamily and office than other asset classes. Together, they offer a better ability to weather an economic storm than each one on its own. If one revenue stream goes down another can rise. In a good market, both might stay up. The combination offers better protection against economic shocks than either individual investment. Also, both multifamily and commercial real estate retain tax advantages under the new Tax Cuts and Jobs Act.
Another good real estate investment strategy is for investors to combine both short and long-term leases in a mixed-use property, with apartments over a medical office, law practice or restaurant. Or they can look for a private equity real estate fund with multifamily, office and mixed-use investments. Either approach can produce a reliable revenue stream.
Real Estate Managers Can Enhance the Landlord’s Edge
Investments in both multifamily and office buildings offer the opportunity to unlock “trapped” value through a business plan. Real estate managers can raise property values significantly by addressing shortcomings in a building and its grounds and by improving its operations or by bringing in new partners. To build diverse portfolios, investors should look for real estate managers who have a successful track record across a range of multifamily and commercial real estate investments. That will give them confidence in a portfolio optimized for steady income and long-term appreciation.
