Recession Resistant Investing
Updated: Dec 1, 2022
Inflation has been recorded near 8% year over year, paired with recent rate increases, dramatically increasing all costs. It seems all investments feel pressure. However, It's known that multifamily apartments are recession-resistant and perform well during any economic cycle. There are several reasons that multifamily fares well during a downturn. Multifamily fulfills an essential utility, benefits from economies of scale, and when incorporating strategic business plans, income and equity can increase even during a downturn.
During an expansion, it is relatively simple to capitalize on economic growth. A rising tide raises all ships. However, only savvy investors can create wealth during a downturn. Intelligent investors look for assets that will not have major volatility given a recession. Specifically, assets that continue to have high demand even during hard times.
Multifamily is prized as being a superior asset class to many others due to its recession resistance. Now, that doesn't mean multifamily isn't affected, it means that it's not affected "significantly". Multifamily is stable because it provides utility: apartments give people a place to live and fulfill an essential need. In contrast, another asset class such as shopping centers fulfills a need, but is not necessarily as essential as having a place to live. A renter will reduce shopping to save, however, rent must be paid or the renter will not have somewhere to live.
During downturns, there is often an increased desire for flexibility. People want options and outs when things get tight. Renting provides greater flexibility compared to purchasing a home. A renter can expect to sign a lease for one year compared to a 30-year fixed mortgage on a home. A renter can pay the first month, last month, and security much easier than 20% down for a home. Not to mention qualifying for a home when lending requirements tighten up. Therefore, renting can be a better option for many which increase demand for apartments, and keeps rent prices and occupancy stable.
For investors, owning multifamily apartments have many advantages over other rental classes. Multifamily apartments benefit from economies of scale (cost savings as production increases). The higher number of units the property is made of, the more savings investors benefit from. For example, it is much more efficient to run a fifty-unit apartment building rather than a three-unit. The fifty-unit can sustain two vacancies (4% vacancy) compared to a three-unit with two vacancies (66% vacancy). As unit numbers increase, so does cash flow. A three-unit building may produce $150/unit per month creating $450/month in cash flow at full occupancy. A fifty-unit building producing $150/unit per month creates $7,500 per month in cash flow at full occupancy (An oversimplified example). There is much more protection in the cash flow of the fifty-unit should something go wrong, compared to the three-unit. Besides cash flow, there are ways to dramatically increase the value of a multifamily asset regardless of the economic cycle.
Multifamily is valued based on its Net Operating Income (NOI). The NOI is the amount of money left after all expenses are taken from the income. The value of a property is derived by taking the NOI and dividing it by the local cap rate. This means that if a property's income can be increased, its expenses decreased, or both, the value of the property increases. Therefore, if investors purchase a property and execute a strategic business plan with the intent to increase value, they will not only create profit but also create a substantial buffer in the worst-case scenario that the market compresses dramatically and values decline.
Although multifamily apartments are recession-resistant, not all classes of multifamily fare the same in a downturn. There are different classes of multifamily based on when it was built, amenities, and location. Classes range from D- to A+. Different classes of multifamily are impacted differently by a recession. Class A multifamily are luxury spaces with the best amenities and location, offered at the top price point of the market. When money gets tight, consumers will often choose to downgrade their homes to cut back on spending. Therefore, Class A multifamily is the first to be affected. Class B and C multifamily are not as luxurious, may not have all the amenities as a Class A, and may not be in the prime location, but these apartments are offered at a lower rental rate. Class B and C multifamily are workforce housing. These apartments have been in the highest demand and have exceptional resistance to economic events. There is a national crisis to increase the supply of affordable housing as the supply has been massively behind for many years. Class D multifamily is offered at the lowest rental rate due to location, construction, or lack of amenities. These buildings are often reconstructed for a higher class rather than operated as it is.
Multifamily apartments are indeed recession-resistant. Multifamily performs well during downturns because of the utility offered compared to other investments. Multifamily also provides renters greater flexibility and less cash required compared to buying a house. Multifamily also benefits from economies of scale which provide savings due to higher efficiencies and greater reserves, should problems arise. Investors may also purchase a multifamily asset with the intent of increasing its value by raising the NOI, providing increased profit and protection against a worst-case scenario. Multifamily is broken down into several classes which perform differently during a downturn, classes B and C being the most recession-resistant. Multifamily apartments are one of the best asset classes to invest in, especially during hard economic times.