4 Ways To Make Money In Real Estate

by | Jan 24, 2024 | Investing Advice

Maximizing Your Returns: Understanding the Four Pillars of Profit in Multifamily Real Estate Investing

While many individuals traditionally turn to the stock market for investment opportunities, an increasing number are pivoting towards real estate, particularly in multifamily syndications, for its unique blend of benefits. 

Unlike stocks, real estate offers substantial tax advantages and a lower complexity in market dynamics. In this blog, we will explore four key ways through which real estate, especially multifamily syndications, can generate wealth: 

  • Appreciation
  • Depreciation
  • Cash Flow
  • Leverage 

To illustrate these concepts, we’ll look at the case study of Oakwood Apartments, a 100-unit multifamily complex in a growing suburban area.

 

1. The Power of Appreciation in Real Estate

 

Appreciation in real estate is the increase in the property’s value over time, which can be a result of both external market factors and internal improvements made to the property. In the case of multifamily properties like Oakwood Apartments, appreciation is often a byproduct of a strategic combination of market trends, location dynamics, and targeted enhancements to the property.

 

Forced Appreciation through Value-Add Strategies

At Oakwood Apartments, a key strategy for driving appreciation was through value-add improvements. This approach, known as forced appreciation, involves making targeted upgrades and enhancements to the property that directly increase its value. 

 

For Oakwood, this meant renovating interiors, updating amenities, and improving landscaping. These improvements not only attracted higher-paying tenants but also significantly increased the property’s overall market value, independent of broader market trends.

 

Value Determination: Based on NOI

Unlike single-family homes, where value is often determined by comparing similar properties in the area, the value of a commercial property like Oakwood Apartments is primarily based on its net operating income (NOI). 

 

This income-centric valuation method means that by increasing rental income and reducing operational costs, the Oakwood syndication could directly influence the property’s worth. The focus on boosting NOI through efficient property management and strategic upgrades was a critical aspect of their investment strategy, ensuring a solid return on investment for all involved.

 

Oakwood Apartments – A Case Study in Appreciation

When Oakwood Apartments was initially acquired for $10 million, it was identified as a property with significant upside potential. Located in an area experiencing population growth and economic development, Oakwood Apartments stood poised to benefit from these external growth drivers. Additionally, through a series of well-planned renovations and upgrades to both individual units and common areas, the property’s appeal and value were further amplified.

 

Over a five-year period, these combined factors contributed to raising Oakwood’s market value to an estimated $13 million, showcasing the power of appreciation in real estate investment and the impact of value-add strategies.

 

2. Depreciation: Tax Efficiency

 

Depreciation is a critical concept in real estate, particularly advantageous for tax purposes. It allows investors to take a tax deduction that reflects the property’s wear and tear over time, thus reducing the taxable income generated by the property. This benefit is particularly significant in the context of multifamily properties like Oakwood Apartments.

 

The IRS permits residential properties to be depreciated over a period of 27.5 years. However, with techniques like bonus or accelerated depreciation and cost segregation, a portion of the property’s value can be depreciated more rapidly in the earlier years of ownership. 

 

Maximizing Tax Benefits at Oakwood Apartments

For Oakwood Apartments, these accelerated depreciation strategies mean that investors can experience a reduction in their taxable income sooner, enhancing the overall return on their investment.

 

This tax efficiency is a compelling reason why many investors favor real estate over other investment types, as it can effectively provide income that is partially or entirely tax-free.

 

3. Cash Flow: Consistent Income

 

One of the most tangible benefits of real estate investing, particularly in a multifamily syndication, is the generation of cash flow. This is likely the way you immediately think about making money from real estate – by collecting rent checks!  (Also lucky that you don’t actually have to be collecting those checks – that is why this is a passive form of investing.) 

 

Cash flow refers to the income that the property produces after expenses have been paid (net income), primarily derived from tenant rent payments. Cash flow is the financial lifeblood of real estate investment, offering investors a steady stream of income.

 

Generating Stable Cash Flow from Real Estate at Oakwood

 

For Oakwood Apartments, the scenario is quite favorable. With 100 units occupied by a mix of families and professionals, the property generates substantial rental income monthly. There is even a small amount of income coming in from the laundry facilities on site.

 

After accounting for operating expenses, maintenance costs, and mortgage payments, the net income – or cash flow – is distributed among investors.

 

This continuous income stream is particularly appealing for investors seeking a regular, reliable return on their investment. Unlike stock dividends, which can fluctuate or even disappear, the cash flow from a well-managed multifamily property like Oakwood Apartments tends to be more stable and predictable, providing investors with a sense of financial security and regular income.

 

4. Leverage: Amplifying Your Investment Power

 

In real estate, leverage is the strategic use of borrowed capital to increase the potential return on investment. This concept plays a vital role in multifamily syndications like Oakwood Apartments. Here, leverage is applied by taking a mortgage on the property, allowing the investor group to control a larger asset with a relatively smaller amount of capital.

Leveraging Capital in Oakwood Apartments

 

For Oakwood Apartments, the investors brought in a portion of the capital needed for the purchase. The remainder was financed through a senior loan. This use of leverage meant that the investors were able to acquire a more valuable property than they could have with just their capital alone. The beauty of this approach lies in the tenants’ rent payments, which contribute significantly to covering the debt payments. Essentially, the tenants are indirectly aiding the investors in building equity in the property.

 

The Risks of Over-Leveraging

While leverage can significantly enhance investment returns, it is not without risks. One of the key dangers is over-leveraging – where the level of debt is so high that it amplifies the risk, especially in times when cash flow is reduced, such as during lower occupancy rates. Over-leveraging can place immense strain on cash flow, leaving little room for unforeseen expenses or market downturns.

 

Additionally, properties with floating interest rates introduce another layer of risk. As interest rates rise, so do the mortgage payments, which can eat into cash flow and reduce profitability. This scenario can be particularly risky if the market softens or rental income decreases, making it challenging to cover the higher debt service.

 

In the case of Oakwood Apartments, careful consideration was given to the level of leverage used and the type of debt incurred to mitigate these risks. The investment strategy involved ensuring that the level of debt was manageable and sustainable, even in potential downturns, thereby maintaining a healthy balance between leveraging for growth and safeguarding the investment.

 

The Multifaceted Benefits of Multifamily Real Estate Syndication

We’ve illustrated the multifaceted ways in which investing in a multifamily real estate syndication like Oakwood Apartments can be beneficial. From appreciation driven by market forces and strategic improvements to tax efficiencies through depreciation and stable cash flow generation, multifamily properties offer a unique blend of financial advantages.

 

Exploring Multifamily Real Estate Investment Opportunities

If you’re considering diversifying your investment portfolio, multifamily real estate syndications offer a promising avenue. With the right strategy and understanding of the market dynamics, properties like Oakwood Apartments can provide significant returns and serve as a cornerstone in your investment journey

 

 

 

 

As we enter 2024, the landscape of real estate investment, especially in the multifamily sector, presents a mosaic of challenges and opportunities. The pulse of the market this year is unique, shaped by economic forces that are reshaping investment strategies.

So, how are passive investors to know what type of multifamily to invest in 2024?

As we navigate the insights presented in Fannie Mae’s report and its implications for multifamily investments in 2024, this article will delve into three distinct investment strategies catering to varying investor profiles and goals. Firstly, we will explore the potential of distressed multifamily assets, which may emerge due to financial pressures from the economic slowdown. Secondly, we’ll examine the merits of investing in multifamily properties through preferred equity – a strategy offering fixed-income benefits amidst fluctuating mortgage rates. Lastly, we’ll revisit the traditional multifamily investment approach, which continues to hold appeal despite the forecasted recession. Each of these strategies brings with it unique opportunities and considerations, shaped by the current economic climate.

Key Takeaways:

  • Opportunities in Distressed Assets: How economic stress creates potential for value-add investments in multifamily properties.
  • Preferred Equity Investments: Understanding the benefits and stability of this investment approach in a fluctuating market.
  • Resilience of Traditional Investments: Why conventional multifamily investments remain a robust choice in the face of economic downturns.

 

A Forecast For 2024 From Fannie Mae

Starting with economics analysis is a good place. Here is what we’re seeing. A key piece of intelligence guiding our approach comes from Fannie Mae’s insightful November 2023 report, “Economy Expected to Slow in 2024, Rebound in 2025.” This forecast not only shapes our understanding of the broader economic climate but also sharpens our focus on specific investment avenues within the multifamily realm.

Fannie Mae’s report paints a picture of an economy gearing down for a mild recession in 2024, followed by an anticipated rebound in 2025. This expected slowdown brings with it a nuanced set of implications for the housing market. 

Doug Duncan, Fannie Mae’s Senior Vice President and Chief Economist, notes, “The economy is now slowing…and stress is growing on consumers’ ability to sustain their high levels of spending…housing has been and continues to be under serious affordability pressure, resulting in recessionary-level home sales activity.” Such insights are invaluable for investors, particularly those eyeing the multifamily sector, as they signal shifts in housing demands and affordability that could reshape the investment landscape.

The backdrop of an economic deceleration, as outlined by Fannie Mae, sets the stage for investors to explore multifamily properties through a new lens. 

While traditional investment wisdom might caution against activity during a slowdown, seasoned investors recognize that such periods can uncover unique opportunities. The report hints at a “lock-in effect” and a persistently low supply of homes, factors that could lead to a surge in demand for multifamily units. As investors, understanding these dynamics and adapting our strategies accordingly could be key to unlocking potential in a market brimming with both challenges and opportunities.

 

Opportunities in Distressed Multifamily Assets

As 2024 unfolds, the economic slowdown predicted by Fannie Mae opens the door to unique investment prospects in distressed multifamily assets. These properties often come into the market due to the previous owners facing financial hardships, notably their inability to refinance expiring debts. For investors, this scenario presents a valuable opportunity to acquire assets at below-market prices. However, these properties typically require significant capital expenditure for renovations and improvements.

The key to success in this domain lies in a strategic value-add approach. Investors need to be prepared for an initial influx of capital to revitalize these properties, but the potential for substantial increases in rental yields post-renovation is significant. The attractiveness of these distressed assets stems from their potential to be transformed into high-demand rental properties, especially in areas where affordable housing remains a pressing need.

 

Investing in Multifamily through Preferred Equity

Another compelling strategy in 2024’s multifamily investment landscape is preferred equity. This approach places investors at a different, often higher, priority in the capital stack, offering more security compared to common equity. 

Investors in preferred equity typically receive regular, fixed income derived from an agreed-upon interest rate, providing a stable cash flow regardless of the economic oscillations. This payment is made to preferred equity investors before any other investors get paid, due to the higher position in the capital stack. The payment is often backed by contractual language that states if not paid, the asset can be taken under ownership.

This investment method becomes particularly attractive in light of Fannie Mae’s forecast of mortgage rates averaging 6.8 percent by the fourth quarter of 2024. As mortgage rates retreat from their highs, the cost of financing for these projects becomes more manageable, potentially increasing the viability and attractiveness of preferred equity investments. Investors looking for a more predictable return, without the operational complexities of direct property management, may find this avenue particularly appealing.

 

The Resilience of Traditional Multifamily Investments

Despite the predicted economic downturn, traditional multifamily investments continue to be a resilient choice. According to Fannie Mae’s forecast, while there may be a short-term decline in home sales, the market is expected to begin a gradual recovery throughout 2024. This resilience is a key factor that keeps traditional multifamily investments attractive. They offer a relatively stable and predictable source of income, especially in areas where demand for rental housing remains high.

By the end of 2024, we may also see the results of the decrease in construction starts in 2023. With higher construction loan costs, fewer new units have begun to be constructed that would match the increase in population growth and demand forecasted. This means that by 2025, we may begin to see another increase in demand, and increase in rental rates that follows.

Moreover, traditional multifamily investments allow investors to benefit from long-term capital appreciation while also providing the flexibility to adjust rents in response to market conditions. This classic approach to real estate investment is well-suited for those who seek to balance risk with consistent returns, especially in a market that is expected to bounce back in the following years. Traditional multifamily properties, particularly in well-chosen locations with strong rental demand, are likely to remain a cornerstone in many investment portfolios.

 

Conclusion: The Enduring Value of Real Estate Investing

For decades, real estate has stood as a pillar in the world of wealth-building, offering tangible assets that appreciate over time. The forecast for 2024, as outlined by Fannie Mae, points to a market that, despite facing its share of economic challenges, continues to hold vast potential for those with a strategic approach to investment. Whether it’s capitalizing on the untapped potential of distressed multifamily assets, the steady returns of preferred equity, or the enduring appeal of traditional multifamily investments, each strategy offers a pathway to success within the real estate domain.

The key takeaway for investors is that there is inherently nothing amiss with real estate as an investment avenue, especially when approached with a long-term mindset. Economic cycles come and go, bringing their unique challenges and opportunities. However, the intrinsic value of real estate as a stable, appreciable asset remains constant.

For investors in 2024, the landscape may be marked by shifts and changes, but the foundational principles of real estate investment remain as relevant as ever. By staying informed, agile, and strategic, investors can continue to build and sustain wealth through real estate, navigating through the ebbs and flows of the market with confidence and foresight. In essence, real estate remains not just a sound investment choice but a cornerstone of long-term wealth accumulation and financial stability.

 

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