By Patrick Grimes
“There’s a lot of conflicting advice when it comes to creating and preserving wealth, especially in the age of COVID-19. But history demonstrates that the wealthy do things differently, investing for the long term and choosing to own more assets than securities.”- Patrick Grimes
Smart, successful investors use hard assets to reduce portfolio volatility, minimize losses in times of systemic market risk, and protect their purchasing power.
But, what kind of hard asset works best to achieve those goals?
Colleagues and prospective clients often ask me what I think is the best hard asset one can own as a passive investor. I tell them I think that nothing beats multifamily investing when it comes to creating and preserving wealth.
1. Multifamily can “beat the Street.” Wall Street is notorious for promising the universe, then delivering less than stellar results over the long haul. The average annual returns touted by Wall Street marketing companies are far less spectacular when you consider inflation, fees, and tax liabilities. The chart below shows how these can be a drag on your returns from a theoretical annual return of 8.29% to a mere 4.21%.
2. Stabilized cash flow
Within the first year, multifamily investments typically produce significant income to allow for cash flow distributions to passive investors. This is primarily because lenders require the property’s income to be in excess of the expenses and debt service by a significant margin (typically ~25%). A competent syndicator (deal sponsor) will choose opportunities based on their ability to provide solid tax-shielded cash-on-cash distributions. I want my investors to experience predictable cash flow in addition to future upside potential through value-add renovations.
3. Early return of capital Done properly, passive investment in multifamily has a high probability of returning at least part of your money. This will free up cash you can use to invest in other assets. In a typical deal, after executing the value-add strategy in 1-3 years, the general partners will refinance the property and return a significant portion of the invested capital back to the investors. Since this is a return of capital that occurs at a refinance event, this money is not taxable… You can take it and put it into another property for additional cash flow with the same bucket of money. This strategy of compounding returns is one of the most advantageous attributes of multifamily investments.
4. Numerous tax advantages You probably know that the US government incentivizes investors to provide housing through multifamily investment. It’s one of the biggest reasons the wealthy choose real estate. Passive real estate investors save thousands on taxes through a variety of mechanisms. For example depreciation, based on a standard 27.5 year schedule, allows for 3.6% of the building’s value to be passed through to the investors each year. Cost segregation and bonus depreciation are other methods used by passive investors to avoid paying more in taxes than absolutely necessary.
5. Provides a hedge against inflation Inflation happens all around us, all the time. The Federal Reserve actually targets a 2% annual inflation rate. Many wealthy people invest in multifamily because they know that rents tend to trend with inflation. Also, real estate is value- based on net operating income (NOI), which increases with higher rents. With the more recent Federal Reserve cash infusion into the economy, multifamily will provide investors an effective insulator against inflation.
6. Immunity from fluctuating market cycles While many other types of investments live and die by the market’s sword, multifamily is not as vulnerable to those ups and downs. A well-underwritten property produces cash flow in both up and down markets. This is because seasoned operators sock away months of operating reserves and also structure leases to stagger throughout the year. During a market shift, staggered lease durations shield the property from Wall Street’s mood swings. A single unit within a larger complex has low impact on the total property’s income or long-term value. Also, while cash distributions to investors might fluctuate somewhat during a market downturn, the original investment is unaffected, in contrast to what happens with the stock markets.
7. You can buy bigger properties A lot of people tell me they don’t have the money to invest in larger, more upscale apartment complexes. They believe that those kinds of multifamily investments are off-limits to all but the wealthiest individuals and corporations. But, that is often not the case. By pooling your resources with those of other like-minded investors, you gain access to bigger, more lucrative opportunities. This is the genius of syndication. Syndication is the legal name for an alliance of investors who come together to purchase larger properties they would not be able to purchase on their own. Syndications allow for more efficient use of capital and are heavily regulated by the Securities and Exchange Commission. Handling of the partnerships, stipulation of distributions, and other details of the syndication is directed by an SEC attorney and outlined in the LLC formation documents. These documents are reviewed and approved by each individual investor in the syndication.
8. You don’t need to go back to school. The most awesome thing about being a passive investor in a syndication is that your syndicator does all the heavy lifting for you. You don’t have to commit big chunks of your scarce leisure time to attending meetings, conferences, and training sessions. You don’t have to learn every jot and tittle of every law surrounding your investment. You don’t even need to know all the syndication jargon in order to participate. Your deal sponsor does all that for you…and a lot more. As a passive investor, you will get to enjoy all the benefits without having to add one more time-draining project to your full plate. Anyone who has tried to flip houses or make a living trading stocks can tell you how stressful and time consuming those methods of making money are. Passive investing in multifamily can help you grow your wealth more efficiently and without you having to give up your weekends to work on your “side gig.”
These are just a handful of the reasons I love investing in multifamily real estate and why I think you should consider it as well.
In future blog posts, I will go more in-depth on these benefits and prove to you why ordinary hard-working people just like you are choosing to passively invest in multifamily projects.
In the meantime, when you are thinking about these benefits, write down your questions and go here to make a telephone appointment with me.
Schedule a free strategy call with us if you’d like to learn more about Invest on Main Street or our future investment opportunity.
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Patrick Grimes is a design engineer and CEO and Founder of Invest on Main Street, LLC. His real estate holdings include general partner ownership of a multifamily and single-family real estate portfolio valued over $146M, including 1,950+ units across the southeastern United States and Texas.
He has been active in real estate investment since 2007, including purchasing land and distressed assets, renovating them, and stabilizing them for long-term cash flow. To scale his real estate portfolio, Patrick moved from single-family to multifamily investing and founded Invest on Main Street, a private equity firm specializing in multifamily value-add projects in emerging markets.