What to Look for in Multifamily Apartment Investments in 2024
Multifamily properties have long been a favorite among real estate investors due to their relatively straightforward nature and stable income potential. However, as the economic landscape shifts, it’s more critical than ever to approach these investments with a detailed understanding of both the market conditions and the specific property attributes that drive value. Here are seven key considerations to keep in mind when evaluating multifamily apartment buildings as investments in today’s market.
Market Conditions
Understanding the current market conditions is essential before making any investment. This involves analyzing both macroeconomic and microeconomic factors.
- Macroeconomic Factors: As of Q2 2024, the U.S. economy is dealing with persistent (although moderating) inflation and elevated interest rates (though rate cuts are expected to begin in September). The Federal Reserve has increased rates several times to curb inflation, which has led to higher borrowing costs for investors. This has cooled the housing market, particularly in regions with overheated property values. However, it has also created opportunities in markets where property prices have adjusted to reflect the new economic reality.
- Microeconomic Factors: On a local level, assess the economic drivers that influence rental demand in the area. Is the property near major employers, universities, or hospitals? For instance, multifamily properties near employment hubs in cities like Dallas, Texas, have seen consistent demand due to the influx of young professionals seeking rental housing. Conversely, properties in areas heavily reliant on a single employer may face risks if that employer downsizes or relocates. Diversified local economies are more resilient and tend to provide more stable investment opportunities.
- The Great Migration: When evaluating a market today, it’s important to understand the impact of the Great Migration that began in 2020 following the onset of COVID. This migration was driven by several factors related to the pandemic, including remote work opportunities, concerns about health and safety, and changing lifestyle preferences. Cities like NYC, Chicago, San Francisco and Los Angeles saw meaningful population declines whereas places like Austin, Nashville, Phoenix, and Tampa saw a large influx of new residents. Similarly, markets like Dallas, Nashville, and Miami saw a significant uptick in new employers looking for a more favorable business environment and better cost of living for its employees. In other words, each market needs to be re-assessed to account for the impact of the Great Migration.
Comparable or Planned Developments
Evaluate the competition by researching existing and planned developments in the area. It’s also important to understand differences between classes of apartment buildings. In other words, new development will be a Class A property, which will service a different renter base than a Class B property in the same market.
- Existing Competitors: Look at nearby multifamily properties to understand their average rents, vacancy rates, and amenities. This will give you a benchmark to compare your potential investment against. For example, in markets like Phoenix, Arizona, where there has been a surge of new apartment construction, existing properties may face pressure to keep rents competitive, which could impact your investment returns.
- Planned Developments: Investigate any new developments in the pipeline. Significant new construction could increase supply and put downward pressure on rents, particularly if demand does not keep pace. Tools like city planning department databases or real estate market reports can provide insights into upcoming projects.
Condition of Property
The physical condition of the property is a critical factor in determining its investment potential.
- Building Systems: Assess the condition of major systems like HVAC, electrical, plumbing, and roofing. If these systems are nearing the end of their useful life, you may face substantial capital expenditures (capex) soon after acquisition, impacting your overall return on investment (ROI).
- Interior and Exterior Aesthetics: Evaluate the property’s aesthetic condition, both interior and exterior. Are there opportunities for cosmetic upgrades that could justify rent increases? For example, upgrading unit interiors with modern finishes or improving common areas can attract higher-paying tenants and reduce vacancy rates. It’s important to focus on your return on investment for dollars spent improving the asset – this involves understanding the cost to renovate as well as market pricing for renovated units or for properties with updated amenities.
Current Cash Flow
Cash flow is a primary driver of property valuation and return on investment.
- Income Analysis: Analyze the current rent roll and operating expenses to determine the property’s cash flow. In 2024, many markets are experiencing a shift in rental growth rates due to economic pressures. For example, markets that saw double-digit rent growth in recent years, like Miami, are now seeing more modest increases or even flat rents as affordability becomes a concern.
- Opportunities for Improvement: If the property’s cash flow seems low, identify areas where you could increase income. Could you raise rents to market levels? Are there opportunities to add amenities, such as on-site laundry or storage units, that could generate additional revenue?
Occupancy Level
Occupancy rates are a key indicator of a property’s performance.
- Stabilized Occupancy: Multifamily properties are generally considered stabilized when they reach 92-94% occupancy. If the property you’re considering has a higher vacancy rate, investigate why. It could be due to management issues, overpricing, or increased competition. However, if the local market fundamentals are strong, there may be an opportunity to improve occupancy and increase cash flow through better management practices or targeted marketing efforts.
- Economic Occupancy vs. Physical Occupancy: The physical occupancy rate is calculated by dividing the number of occupied units by the total number of units at the property. One short-coming of this metric is that it doesn’t account for residents under eviction (i.e., those units still count as occupied) or who currently owe rent. For this reason, it’s also important to look at economic occupancy, which shows the ratio of rent paid to gross potential rent. When underwriting a deal, it is important to assume there will always be some level of bad debt – tenants who are not paying rent – regardless of the physical occupancy rate.
Value-Add Opportunities
Value-add investments involve purchasing a property with the intent of making improvements that will increase its value and income potential.
- Renovations and Upgrades: Common value-add strategies include renovating units, upgrading common areas, and improving property management. For example, in older buildings, modernizing kitchens and bathrooms can significantly boost rental income and property value.
- Operational Efficiency: Implementing cost-saving measures, such as installing energy-efficient systems or renegotiating service contracts, can improve the property’s net operating income (NOI).
Appreciation Potential
The potential for property appreciation is another critical factor to consider. In many ways, appreciation will be tied to rent growth and cap rates at exit. In other words, at exit, a new buyer will pay a price based on the property’s net operating income (NOI), which is measured by the property’s revenue less it’s operating expenses. In lower cap rate environments, buyers are willing to pay more for in-place NOI.
- Market Timing: Property appreciation is often linked to broader market cycles. Properties purchased at the height of the market, which is difficult to predict, may experience less appreciation than those acquired during downturns. With the economic volatility of 2024, it’s essential to carefully consider where the market is currently in your target area.
- Local Economic Drivers: Evaluate the long-term viability of the local market. Areas with strong population growth, job creation, and infrastructure development—like Raleigh, North Carolina—are more likely to experience property appreciation over time.
Conclusion
Multifamily investing remains a popular strategy among real estate investors, but success requires careful consideration of multiple factors. By analyzing market conditions, evaluating the property’s physical and financial health, and identifying potential value-add opportunities, investors can differentiate between a good investment and a great one. As 2024 unfolds with economic challenges and opportunities, staying informed and flexible will be key to making profitable multifamily investments.