Investing in the multifamily real estate market is an exciting and potentially lucrative business. However, challenges inevitably arise that can potentially have a negative effect on an investor’s financial health and future goals. When they do, it is important to proceed with care.
Rapid Changes Present Challenges for Multifamily Real Estate Investors
Looking at the multifamily real estate investment market today, we see four areas that may be problematic for inexperienced investors.
1. Keeping Up with the Market
The multifamily real estate market is currently in a state of transition, creating a more challenging operating environment for investors. Centers of activity are shifting from primary to secondary markets, the relatively high supply in certain markets is limiting rent growth, and new investors are coming in as the demographic trends buoying the market attract wider attention. No one knows exactly where the market is headed or what future economic conditions will be, but the multifamily market is not cooling down to the extent that had been expected a few months ago.
One challenge on the horizon is the dwindling supply of value-add properties on the market. With a decreasing number of investment options, one property management executive suggests effective management, cost control, and the identification of new revenue streams will be key points of focus for investors trying to identify their next moves.
2. Replacement Cost and Exit Strategy
Replacement cost—the cost of constructing a certain building in a specific location— is an important consideration in today’s transitional markets.
An environment with a large supply of new apartments without corresponding demand can lead to forcing rents down toward the level of existing Class A (or perhaps even B ) properties. When the rents of new Class A properties and existing high-end properties coincide, it is difficult for existing property operators to grow rents. Renters typically choose the new property if the rents are equal, unless an existing property offers an irreplaceable location.
Macroeconomic factors can also limit the lifespan of a property. If rents in a Class C property reach the maximum its residents can afford, the building will begin to generate diminishing returns. In such a case, it’s more difficult for a property to recover. Unless you want to replace the property, you need to sell it before that point comes.
3. Exit Strategies and Real Estate’s Low Liquidity
Liquidity is the ease with which an asset can be sold without losing value. Real estate, which is a game for long-term players, is considered to have low liquidity. This fact is intimately connected with exit strategy, since an exit is an asset’s liquidation.
Low liquidity has to be balanced against the financial necessities of when and how to exit an investment. Thus, many 1031 exchanges are carried out to avoid depreciation recapture and to defer triggering capital gains taxes, and have to be completed within a strict time limit. Flexibility is desirable as well, in case an investor wants to respond quickly to a financial situation. For example, you might want to take advantage of opportunities, including a rising market for properties with value-add potential.
4. Making the Best, Most Logical Decisions
Real estate investing requires knowledge and skills that range from understanding macroeconomic trends to knowing how to use property-level data to conduct deep analysis of a property’s performance. Some investors consider these tasks burdensome; others approach them as thrills of the hunt. But beware; you can love your work too much. Often, investment decisions are colored by sentiment, enthusiasm, or the influence of a sharp sales pitch. If you rush into even one deal with incomplete information or faulty analysis, you run the risk of purchasing an asset that will not perform to your satisfaction. Similarly, delaying the sale of an asset unjustifiably can mean missed opportunities and be just as bad for your financial well-being. Self-discipline is a critical element of investment strategy.
How to Prepare for Investment Challenges Effectively
The most effective way to overcome the challenges listed above is to invest with great skill and care. Investors should not love their work so much that they are unwilling to seek qualified advice from specialists at trusted real estate investment management firms.
At CWS Capital Partners, we are a fully integrated multifamily real estate investment management firm that offers everything from due diligence and risk management to transaction support and property management. We specialize in assisting our clients with 1031 exchanges, acquisitions, repositioning, and development. We also own and manage luxury multifamily investment communities in major markets around the country, and employ a team of experts who can help you hone your investment strategy.
For more articles like this one, check out our investment strategy blog posts.
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The information provided here is for your general informational purposes only. It should not be considered a recommendation or personalized advisory advice. CWS has made this third party information available from authors it believes are knowledgeable and reliable resources. However, its accuracy or completeness cannot be guaranteed and sentiment may change due to legal or economic conditions.
All investments involve risk including the possible loss of principal. You should familiarize yourself with all risks associated with any investment product before investing.
Advisory services are provided by CWS Capital Partners LLC, a registered investment advisor.
Securities offered by CWS Capital Partners LLC are through an affiliated entity, CWS Investments. CWS Investments is a registered Broker Dealer, member FINRA, SIPC.