Have you ever wondered why the wealthy invest in multifamily real estate? Writing for biggerpockets.com, author Jered Sturm has written a superb post that explains everything, including all the numbers for a hypothetical multifamily purchase.
Why the Wealthy Put Their Money Into Multifamily & Commercial Real Estate
Have you heard stats such as “80% of millionaires attribute their wealth to real estate”? Or heard stories of living the good life off passive cash flow from rental property? Combine this with the recent years of unpredictable, disappointing stock markets, and you get masses of people realizing they have no control over many of their investments and therefore their life savings.
Jered Sturm isn’t your average writer interviewing an investment real estate expert. From starting as a handyman in 2006, Sturm has amassed a personal portfolio of nearly $4M. He believes there are some pretty simple reasons why the wealthy invest in multifamily real estate.
He points out that lot of folks are looking at investing in multifamily and commercial real estate, saying:
…masses of people realizing they have no control over many of their investments and therefore their life savings. Tired of blindly following the crowd of 401K stuffers, many have started looking at why so many wealthy people own real estate.
But there’s a caution in there about how real estate makes investors money:
We all love it so much, we forget to explain how it does this. This void in education leads people jumping in not realizing that even some investment strategies within real estate do not carry the benefits of others.
The Most Powerful Basic Factors
Starting at the basics, Sturm points out the three most important: “… control, debt (leverage), and taxes”. In fact, control is why Sturm likes multifamily investments, saying:
I focus in multifamily apartment complexes because of the control it provides in determining the investments results.
Although many investors don’t associate leverage with their investments, Sturm says it’s common in commercial real estate.
And, as to taxes, he makes the surprising admission that:
…the IRS and owners of investment rental property might as well be best friends because the IRS has made so many rules to benefit us.
Moving Right Into A Practical Example
Get your calculator ready, because next Sturm dives right into a practical example of buying an apartment complex—complete with math. In this case, John Q. Investor is putting $200K down on a $1M complex with a 8% capitalization rate.
After the basics of the note, he explains the depreciation benefit of the tax code. You’ll probably want to follow closely if you aren’t already a seasoned real estate investor; maybe even if you are: Sturm doesn’t skip many details.
In fact the author acknowledges as much, saying:
This is where most people shut off the brain and say, “My financial advisor says I can earn 8% in a mutual fund, and those have no tenants, no managing the property manager, no headaches. That peace of mind in itself is worth not owning real estate, right?” NO, not true at all! There are more major pieces to this puzzle that the wealthy use that so many that give up at this step never see.
A Surprise: Using Taxes To Your Benefit
For sure that’s a hard one to wrap your head around—benefitting from taxes. Add to that another term that doesn’t get much love: segregation.
Sturm says they’ll both be your best friends. He goes on to explain:
Another tool our buddies at the IRS gave real estate investors was a cost segregation study. They found out we like depreciation, and so they gave us more…
…this means the IRS lets you accelerate deprecation on things like cabinets, appliances, carpet, light fixtures, and other parts of the building. This forces more tax savings to the investor sooner.
Using Debt Too!
Another math-filled series of paragraphs starts simply enough. Sturm says a “huge difference between other investment classes and owning investment real estate is the power of debt”. This is where he ties back in amortization:
Back to our example, the $800k in debt you put on the building will have an army of tenants paying down your mortgage month after month. This is amortization.
Now let’s wrap the amortization into our example. Using the loan terms I mentioned, the first year of the loan will result in a $14k reduction in the amount you owe. If the property value stays the same, that can also be seen as a $14k increase in equity. If we add that $14k to the after-tax cash flow, we are left with an all-inclusive after-tax return of 22.4%.
Over 22% is nothing to sniff at; plus it blows away those sub-10% fund investments.
Increasing Value
At this point Sturm accurately points out that in this example “we assume the value of the property will not go up in value one cent”. That’s smart he says, because:
…assuming is another word for speculating, and speculating is risky investing. However, in multifamily (5+ units) or other commercial investment real estate, the value of the property is based on the income the property produces. The wealthy love to control things — this is exactly why the wealthy focus on commercial property such as multifamily apartment complexes. Being that you control the income and expenses in a property, you also control the value.
Sturm continues his excellent article to wrap up everything related to his sample investment: potential for increased rents, negotiating more favorable rates for garbage, landscaping, and property management, and the effect on the overall return of the investment.
Multifamily Investing Takes Knowledge
There are lots of reasons the wealthy invest in multifamily and commercial real estate, but if reading this article taught you one thing, it should be that you can’t do it by yourself. René Nelson and her team at Pacwest Commercial Real Estate are the local experts in multifamily real estate investment. Give them a call today at (541) 912-6583.
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