A Fresh Perspective on Multifamily Risks and Returns

As an investor you have many different investment vehicles and asset classes to choose from.  In a world where you have easy access to unlimited options, how do you decide which investments are right for your portfolio?

 While every asset has different characteristics and features, the two factors they all possess are a degree of risk and an expected range of returns. If you were to make an investment decision based solely on these two factors, assuming you could easily identify them, the obvious decision would be to pick the investment with the lowest degree of risk and the highest expected return, however in practice this is difficult to do.

The best investment professionals work extremely hard to pinpoint the relative risks and range of returns for an investment, and very often they still get them wrong. This is because there are so many variables that influence these factors, and while you can perform sensitivity analyses, unforeseeable scenarios do happen, and they can quickly turn a great investment into an awful one.

As an investment allocator into multifamily real estate, I understand that I can’t eliminate all the risks associated with an investment, but by performing extensive due diligence before acquiring a property, and by developing experience from acquiring, managing, and selling these properties, I can effectively identify and mitigate these risks to the best of my ability, providing greater confidence that they will achieve or exceed the expected returns.

There are several reasons why measuring risk is difficult, here are few important ones:

1. There are different types of risk: Financial, inflation, interest-rate, etc.
2. They’re affected by many qualitative factors which are not easily converted to quantitative data.
3. Historical returns are not indicative of future returns
4. And even if you were to consider historical volatility of returns, this information is not well-documented.

In one of my previous articles, I discussed the benefits of investing in real estate and why multifamily, specifically, is my top investment choice. Here is a link to the article if you didn’t get a chance to read it: (INSERT LINK). If you look at the listed benefits I had provided for multifamily real estate, you may notice that each of these benefits hedges against some form of risk:

1. Organic Demand – Having a place to live is something that will never go “out of style” or be significantly disrupted by new technology any time soon. While consumers will lose interest in most products over time, they will always need a place to live.
2. Tenant Diversification – The more tenants you have in a property, the less affected you will be financially when one of them leaves. Multifamily real estate typically has more tenants than other commercial real estate assets, reducing the financial risk from loss of tenants.
3. Long-Term Stability – Typically tenants are locked into twelve-month leases, providing greater predictability in future cash flows, also lowering financial risk.
4. Hedge Against Inflation – Rental income is highly correlated with inflation, providing a hedge against inflation risk.

While it may be difficult to measure risk, as an investor you should strive to have a strong understanding of the different risk factors associated with the investment you’re considering. Once you’ve developed this confidence, the next step is to measure the relative range of returns compared to other investment options available to you.

With multifamily investments, there is a wide range of returns, and this range is mostly dependent on the investment strategy. I discuss four of the primary strategies (Core, Core Plus, Value-Add, Distressed/Opportunistic) in this article (INSERT LINK).

While most sponsors will generally agree that returns increase as you progress from core to distressed/opportunistic deals, there may be differing opinions on the expected range of returns for each strategy. Also, because the market is heavily influenced by external factors such as movement in interest rates, these ranges are less static in nature than most would like to believe.

Investment returns are measured in several different ways (ie. total profit, net profit, average cash-on-cash return, net present value, internal rate of return (IRR), and equity multiple), but the metric discussed most often in the multifamily investment world is IRR. The IRR is a return metric that sets the present value of all future cash flows to zero, and it’s a popular one because it considers the time value of money over the investment period.  Although I had stated that there may be differing opinions on the range of returns for each investment strategy, this article would be incomplete without sharing my own. The table below summarizes the investment profile of each of the four primary strategies, with an expected range of returns for each.

Investment Strategy	Core	Core Plus	Value-Add	Distressed/ Opportunistic
Relative Risk Profile	Low	Moderate	Medium	High
Expected Returns (IRR)	5% – 9%	10% – 14%	15% – 19%	20%+
Return Composition	Current Income	Current Income and Capital Appreciation	Current Income and Capital Appreciation	Capital Appreciation
Hold Period	10+ Years	5+ Years	3 – 7 Years	3 – 5 Years
Investment Profile	High-quality stabilized assets	Stabilized assets with some upside potential through modest improvements	Assets with upside potential through strategic improvements and heavy repositioning	Neglected properties in need of major repairs, and/or Repositioning.

IronOak primarily invests in properties that are well-positioned for a value-add investment strategy. These assets are typically B and C class properties in primary and secondary US markets, that exhibit strong indicators for future population, employment, and income growth. By performing extensive due diligence, we attempt to mitigate the risks associated with this strategy and maximize the potential return to our investors.