We get asked periodically why we like this asset class.
The short answer is easy: it generates the best risk-adjusted returns. Not just among real estate, but among any asset class.
Of course, I can’t really prove that, just like nobody can prove that any other asset gives better risk-adjusted returns than multifamily real estate. But let me try to explain why we view the risk as very tolerable, and even low, for the returns we generate:
1. Straightforward to underwrite* (both for buyer and lender): it’s pretty tough to get acquisition costs, operating expenses, and rental incomes so wrong that a deal isn’t profitable.
2. Simple business model: prostitution may be the oldest profession, but landlording has to be in the top 5…if only because it’s easy to grasp.
3. Multi-source revenue: tenants can come and go and a unit can go out of service. But that doesn’t mean income stops, when there are other units generating cash flow.
4. Inherent value: there is always land, and almost always a building of some value (even after a fire or flood or other disaster).
5. Ample leverage: there are many banks, credit unions, and private lenders that are willing to provide the financing that makes these deals profitable for everyone involved.
6. Abundant pricing/comparable data: sure the free market will determine transaction price, but fair market value is rarely any mystery.
7. Good insurance products: whether it’s for a fire, flood, or lawsuit, you can be well-protected. That doesn’t mean the insurance will be cheap or easy to find, but it also means that a big disaster doesn’t have to translate into a big loss.
* As explained here, the term “underwriting” refers to one of two rather different processes in real estate:
1. The first use (which I am using in this blog post) is the process by which an investor evaluates a potential acquisition, including risks, benefits, and projected cashflow, in order to help determine how much s/he is willing to pay for that acquisition;
2. The second is the process by which a lender evaluates the creditworthiness of a potential borrower, in order to determine lending terms (or even whether to lend).