Interest rates are low, inflation is rearing its head and equity markets are at all-time highs. This puts many investors at a crossroads and in need of a strategy that can generate income, hedge against inflation, and is largely secular to the equity markets, and our recommendation would be to look at investing in commercial real estate.
There was a time when commercial real estate investing for a retail investor was speculative and the barriers to entry in acquiring high quality institutional assets proved to be high. Recent policy developments have led to accredited investors being able to access these prized assets and benefit from the income, appreciation and tax benefits once only available to large institutions. Not all commercial real estate has performed well however, with retail and hospitality properties bearing the brunt of negative effects of the pandemic over the past year. On the other hand, one of the shining stars in commercial real estate has been multifamily properties owing to the basic fact that people will always need a place to live.
Within multifamily properties, B-Class middle income housing has proven to be a strong performer simply by being in the middle. It is the largest pool of renters who may have student debt or are unable to afford a down payment and are likely to remain renters for an extended period of time. In times of economic boom, renters in C-Class apartments will upgrade to B-Class and in times of economic uncertainty, A-Class apartment residents will trade down to a B-Class community to save money. Being in the middle is comfortable, relatively safe and lucrative.
With regards to income and returns, B-Class properties can punch above their weight when combined with a “value add” strategy. This involves exterior and interior updates that bring the property up to modern standards, commanding higher rents and driving the overall value of the property upwards. Investors can enjoy a passive stream of tax advantaged income from the property starting on the very first day of investment and will see these cash-on-cash returns grow as the capital improvement plan progresses and the rents grow. At the end of a typical holding period of 5-7 years, the property can be sold, refinanced or rolled tax-free into a different property. This is where the value of the property improvement process is realized, delivering strong returns on the backend at a capital event.
Between the income, tax benefits, appreciation, and principal protection of owning a real, stabilized asset, a pivot towards a multifamily investment strategy may be exactly what a sound investment portfolio needs in these times.
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