Passive investing in commercial real estate (CRE) through top-notch sponsors provides investors with current income opportunities, diversification, and potential equity upside that is not correlated to the stock and bond markets.   It may provide asset depreciation and tax-deferred exchange as well.

It comes in multiple forms and offers unique benefits.  One such is multifamily apartments that we explore below.

This class takes several forms – from small duplexes and triplexes, to 180+ units institutional-grade apartment complexes like the ones Carofin will offer.   

But there are other types into which you might look, such as student housing, low-income housing, and four classes of 55+ senior living communities.

Furthermore, an investor has various ways to invest through a limited partnership – in an individual building or complex, a syndication in each type of residential real estate, through funds, as well as public and private real estate investment trusts (REITs). 

The characteristics of multifamily apartment investments with which Carofin is most familiar, and which you can expect to see, are listed below:

• Size: Institutional-grade offerings of 180+ units
• Type: Both value-add acquisitions and ground-up developments
• Length of Lease: Standard one-year leases
• Restrictions: Good credit required
• Class: A and B-type properties
• Location: Typically, in major metropolitan areas
• Leverage: Bank financing between 60% and 80% LTC (loan to cost)  
• Investment Term: 3-5 years

There are two types of investments within multifamily apartment categories: value-add acquisitions and ground-up developments.

Value-Add Acquisitions:

These are projects that involve renovation, repositioning, and rebranding of existing properties.  These may have been mismanaged, may have high vacancy rates (over 10%), may rent below market potential, or may have reached the end of life in a REIT and owners need or want to sell.  Sponsors acquire, manage more efficiently, renovate, increase rents and seek to raise the property’s Net Operating Income (NOI) and, subsequently, obtain a higher sales price than the purchase price.

The investment objectives for value-add acquisitions include quarterly income distributions averaging an annualized 4-9% cash-on-cash dividends.

The other investment objective is to capture capital gains upon the sale of the property.  The typical target range is 15%-19% IRR if 1) the net operating income (NOI) has increased and 2) the market Cap Rates have been the same or have fallen.  Even if the Cap Rate has risen, a capital gain could be generated, depending on how the NOI has increased. 

Ground-Up Developments:

These are greenfield (new development) construction projects that bring additional levels of complexity and investment characteristics to investors. 

Investment characteristics for ground-up developments are different.  Investors can expect quarterly current income distributions only after refinancing the property’s construction loan (usually around year 3) and when the property has been leased-up to 90%+ occupancy.

In this case, capital gains should be higher than with value-add acquisitions. They may reach between 20%-25% IRR upon the sale of the asset, depending on economic cycles, location, and sponsor, although it can reach 40% IRR in some instances. And, where value-add acquisitions typically run 3-5 years, ground-up developments might be as short a term as 2.5-4 years.

Why invest in multifamily apartments?

1. Shifting demographics favor this asset class. For many younger adults, single family homes are not affordable. Demand is high, supply is low, and rents are rising. Consequently, this class affords attractive investment characteristics both for new and to-be-renovated properties. 
2. Individual investors may take comfort from the significant equity investments some of the largest and most conservative institutions in the world make in this class — insurance companies, pension funds, and university endowment funds.
3.  Commercial lenders finance 65%-75% of the capital at attractive terms with low interest rates, enabling the sponsor to afford to pay investors a good return.
4. For ground-up developments specifically, Carofin seeks to mitigate risk by offering investments in shovel-ready projects.  The sponsor has acquired the land, designed the buildings’ concept, obtained favorable environmental reports and financing, and is wrapping up architectural and engineering plans for obtaining permits to build.  This way, ground breaking can be reached a couple of months after the investment has closed. 

 Multifamily apartments, when the right sponsor, location and project characteristics combine for a successful offering, should provide investors with:  

• Lower risk compared to a single-tenant triple net leased (NNN) property which depends on finding a new tenant when the long-term lease (usually 10-20 years) expires; a high occupancy rate (90-95%) on short-term leases (usually 1 year) should maintain an adequate debt coverage ratio from recurring revenues; 
• Less risk when compared to other forms of real estate during a downturn; 
• Projected internal rates of return (IRRs) that may outperform stock and bond indexed returns in inflationary periods. 
• Liquid institutional markets in major metropolitan areas. 

Investment Risks 

 As with any investment, investors should do their due diligence before committing their hard-earned dollars.  Investments in real estate partnerships are illiquid, meaning investors’ capital will be tied-up for three to six years, only realizing their returns when the partnerships sell their properties.  

 After improving the apartments, will the rental rates per unit compare favorably to the competition?  Is an experienced operator managing those improvements? 

 Are the property management personnel diligent and experienced? 

 Is the sponsor experienced and does it have prior successes in operating this class of property?  What about geographic and demographic trends?  In other words, do they know the specific markets? 

 How leveraged is the investment?  And is the debt fixed at a favorable rate? 

 How will inflation affect the cap rate at the time of sale? 

Multifamily real estate investments, one asset class among several, may provide significant returns that are not correlated to the stock market.  But always consider the track record of the sponsor bringing the investment, and review the materials carefully.

 For  more information about real estate investing, see:

Investing in Real Estate

Real estate tear sheet