When I first set out to compare investments in the stock market to passive multifamily real estate investments, my analytical, engineering brain first assumed it would be a walk in the park. I figured I could make a direct comparison and there would be a clear winner and a clear loser, right? As I began to think on the topic, my initial naivety gave way to the reality of how difficult and daunting this comparison was. (If you’re wondering “what is a passive multifamily investment?” perhaps read THIS short article first)
What characteristics make one investment vehicle superior to another? This, of course, is an impossible question to answer with one broad, sweeping response. The elusive “Perfect Investment” means different things to different people depending on their age, economic status, or risk tolerance. In fact, I would argue one’s own “Perfect Investment” could mean different things during different points in his or her investing career. So how do we make an unbiased comparison of one investment to another?
To simplify this process, we outlined the key metrics which determine the success of an investment and its desirability which are Returns, Associated Risk, Taxation, Liquidity, and Control. By breaking an investment vehicle down and grading it based on these categories, we can more easily determine the superiority of one investment versus another.
RETURNS:
The bottom line everyone wants to know first: “how much money do I stand to make on this investment?” For the last 18 years, housing has generated higher returns than the stock market, and has outperformed the S&P 500 2:1 since the turn of the century. Even when the stock market is at its best, real estate remains competitive; since 2011, both the S&P 500 and real estate have brought in roughly 12% in average annual returns. Historically, one can expect average returns between 7% and 9% in the stock market prior to fees and taxes. Brokerage fees can lower this return another 1% to 2% depending on the individual fund or brokerage. Compare this to the returns of savvy investors who entered multifamily deals 3-5 years ago who enjoyed returns in the mid to high 20% range on a regular basis. I will admit, these massive returns have been somewhat tempered as the economic cycle has matured. The multifamily real estate deals I’ve participated in recently hover in the 15% to 19% range for average returns and often offer 7% to 10% guaranteed return to investors. Think about that, a guaranteed return matching or beating the average return of the stock market without the associated fees and taxes (we’ll cover this soon) of stock investments. Clearly the advantage in this category can be handed to multifamily real estate which consistently outperforms the stock market when it comes to investment returns.
Advantage: Multifamily
ASSOCIATED RISK (VOLATILITY):
One tremendous advantage to multifamily real estate is the long-term stability of the asset class. For decades, the multifamily market has proven much less volatile than single family homes, the stock market, and precious metals. When the housing bubble burst in 2008, the delinquency rates on Freddie Mac single-family loans hit 4% in 2010. By contrast, delinquency on multifamily loans peaked at 0.4%. At its worst, the multifamily delinquency rate was 90% lower than that of residential real estate. As added proof to multifamily real estate’s resilience, it should be noted the Dow Jones lost 54% of its value between October 2007 and December 2009. Many of our investors remember this tumultuous period vividly and have since vowed to not let history repeat itself with their investments. The winner of this category is multifamily real estate which has proven time and again the ability to weather economic storms.
Advantage: Multifamily
TAXATION:
The U.S. government is dedicated to providing affordable housing for its citizens, and therefor encourages investments in real estate. This encouragement is achieved through various tax incentives and write offs unique only to real estate. Our investors typically pay zero taxes on cash returns from their investments and single digit tax percentage on the capital gains when the asset is sold. I won’t go into detail on how we achieve these low tax rates, but for those who are curious I encourage you to read my article on Bonus Depreciation HERE. As for stock market investments, depending on one’s taxable income for that year, one can expect to pay taxes in the range of 20% to 35% on the gains from his or her investment. The ability to pay little to no taxes gives multifamily real estate the upper hand in this category.
Advantage: Multifamily
LIQUIDITY:
This category can be defined as the ability or ease with which assets can be converted to cash. In today’s world, one can convert a stock investment to cash with the click of a button during trading hours. Compare this ease of liquidation to the longer-term investment for a multifamily real estate deal which is typically in the range of 5 to 7 years. I should note, most multifamily syndication teams aim to return all or a portion of investor’s capital prior to the end of the holding term via a strategic refinance, but for the purpose of this comparison we will use the full 5 to 7 year term. Also, there are numerous ways to remove one’s investment from a multifamily real estate deal depending on how the syndication was initially formed. Clearly, stock investments take the win for this category, although I would argue this could be a double edge sword. The ability to liquidate into cash instantaneously at almost any given time can and has lead investors down a dark path of trying to ‘time the market’ which inevitably ends in failure. I have been guilty of this in my personal stock investments, and I would venture to say you might have been guilty of this in the past as well!
Advantage: Stock Market
CONTROL:
How much say do you have in the direction of the investment? Investing in multifamily real estate syndication allows an individual to decide which city, asset class, and business plan suits his or her goals and investing philosophy. It also puts the investor a short phone call or email away from those managing the asset to address any questions or concerns directly. Obviously, this is a stark difference to buying a large cap stock online where it is unlikely one would ever have a chance to correspond with management or have a choice in the company’s business plan. On top of this, real estate is a tangible asset and as a passive investor you hold a second lien position on the asset. This means that on the very remote chance everything fails in the investment venture, you would still have a tangible property to possibly recoup your investment. Typically, when a stock fails, the common shareholders recoup little to no value for their investment. Multifamily real estate has the advantage over the stock market when it comes to control.
Advantage: Multifamily
CONCLUSION:
Multifamily real estate has distinct advantages over investing in the stock market in 4 of the 5 categories outlined above. This begs the question, if multifamily investing is clearly a superior investment, why aren’t more people doing it? I have several answers to this question ranging from putting on a tin foil hat and declaring it’s a Wall Street cover-up conspiracy, to the simpler (and probably more accurate) explanation that there is just a general lack of knowledge and clarity in investor’s minds as to how the multifamily business works and how they can get involved. Also, most typical investors do not possess the necessary qualifications to passively invest in multifamily real estate which means it is a more exclusive investment option not available to the masses. Instead of asking why more people are NOT investing in real estate, a far more telling question is who IS investing in multifamily real estate? The answer to that question is a veritable who’s who of famous billionaire and multimillionaire families who understand and appreciate the returns and tax advantages of real estate investments. To learn more about how you can take advantage of these same benefits to create a legacy of wealth we encourage you to schedule a call with us. We look forward to hearing from you!
