Why You Should Invest in Multifamily Instead of Stocks

Many investors automatically think of stocks when they think of investing because of 401(k)s, IRAs, mutual funds, and sensational news about the stock market reaching all-time highs or falling off a cliff. However, many investors can also passively invest in multifamily real estate, even through an IRA. Both of these asset classes can be good, passive investments in a balanced portfolio, so what are the differences, and should you consider investing in multifamily real estate?

Multifamily real estate offers many benefits to a passive investor that are hard or impossible to find in other asset classes.

Hard vs paper assets

To start off, apartments are a physical asset and easy to understand, whereas stocks are a paper asset. If you wanted to, you could go visit an apartment property and see if it is in good condition and talk to the residents to make sure the management team is doing a good job. Most multifamily operators will gladly jump on a call with you to answer your questions about the property. It's very unlikely that you could talk directly with the executives of a corporation you own stock in, and it's hard for you to understand how the company is performing from the outside.

Cash flow

Both stocks and multifamily investments can offer cash flow while you hold the investment, but there are differences. Cash flow from stocks is called a dividend, and fewer and fewer companies offer them. Of those that do, the dividend is around 3% and is not guaranteed to continue. A company can choose to stop offering the dividend or to reduce it if the company has a bad quarter or year. On the other hand, many multifamily opportunities offer 6-10% annually on your investment as cash flow from profits. Many of these opportunities also offer this cash flow as a preferred return, meaning you as the investor get paid this return to the full amount before the operator gets a share of the profit. It is also common for this preferred return to accrue, so if there were not enough profit to pay the full return, the amount remaining must be paid in the next month or quarter until it is all paid. In general, the cash flow from multifamily is much better than from stocks.

Leverage

A huge benefit to multifamily real estate is leverage, or the ability to use a loan purchase an asset with much less cash than the purchase price. Anyone who has bought a house understands this concept. You can buy a $500,000 house with just $100,000 if you have a loan to cover the other $400,000. The same is true with apartments, and this leverage actually increases your returns.

Let's say you invest $200,000 in a $1,000,000 apartment, and in a few years you sell for $1,200,000. The capital gain is $200,000, so your return is 100%. If you had instead paid $1,000,000 in cash for the property, your return would only be 20%.

You can even refinance a property to pull out equity tax-free to use for other investments. Stocks generally do not provide leverage, and there isn't an option to refinance. To pull any money out of stocks, you have to sell them, which means you lose your stock and you have to pay taxes on your gains.

Taxes

Speaking of taxes, real estate also has incredible tax advantages. For passive investors, the main advantage is depreciation, which allows you to show paper losses on your tax return, even though you made money. I went into more detail on the tax benefits of multifamily in this article. Stocks do not have these tax advantages. Instead, you are stuck paying capital gains taxes on any gains you have when you sell.

Volatility

A significant issue with stocks is the volatility of the stock market. One day it may be up and the next it is down, sometimes by a lot. We saw this frequently in March 2020 as the news around COVID-19 changed every day. Multifamily real estate values do not fluctuate rapidly since their values are derived from their net operating incomes. National news and events affect net operating incomes much less than the stock market.

In addition, you can have some control over the value of multifamily real estate by increasing income and decreasing expenses, sometimes called forced appreciation. You do not have control over your stock portfolio, which is subject to the whims of the stock market and the companies providing the stocks.

Liquidity

The last comparison is liquidity, which is a significant benefit to stocks. You can buy and sell stocks anytime for a small flat fee or no fee at all, whether you buy one stock or hundreds at a time. That is not possible with real estate. Transactions usually take 60-90 days to complete after you find a buyer to sell to or a property to purchase. In a down market, it can be hard to find a buyer if you need to sell quickly. The transaction costs are also high, costing thousands of dollars to pay attorneys, surveyors, lenders, property inspectors, and, in a syndication, the operators.

Summary

Multifamily real estate is a strong asset class that should be part of everyone's investment portfolio. Compared to stocks, it has many advantages, including cash flow, leverage, and tax benefits. Stocks are much more liquid, which lowers the barrier to entry and helps if you need to buy or sell quickly, but they are volatile and not backed up by a physical asset.