The wealthy have long been attracted to certain alternative assets like cash flowing businesses, real estate, agriculture, and commodities for the following benefits:
- Passive Income
- Better Risk-Adjusted Returns Insulated from Wall Street Volatility
It should come as no surprise that one of the most preferred alternative assets for creating wealth is in real estate.
I’ve read that the number of millionaires in this country that attribute their wealth to real estate is around 80%. For the millionaires who didn’t make their fortunes in real estate, most inevitably add real estate to their investment mix to grow and preserve their wealth.
Many wealthy investors are drawn to real estate because of their distrust of Wall Street.
With Wall Street, the wealthy feel a lack of control over their investments and aren’t willing to leave their life savings and retirement to chance. That’s why the wealthy turn to real estate, and the segment they’re drawn to most is multifamily.
Besides passive income, appreciation, above-market returns and diversification, multifamily properties provide the following additional advantages:
- Control over investments results
- Tax Benefits
- Value-add opportunities
- Historically steady and high demand with strong metrics for the foreseeable future
Multifamily funds are particularly appealing to wealthy investors because it allows them to passively invest in the multifamily segment without the time commitment, large capital outlays, or expertise required for direct investment.
Real estate is mainly uncorrelated Wall Street volatility. Multifamily investments, unlike retail and office space, are particularly shielded from market downturns. The non-correlated nature of multifamily investments makes income, cash flow, and profit projections and investment analysis more predictable.
By investing in multifamily assets, the wealthy enjoy more control over the results and returns of their investments than investing in the unpredictable Stock Market.
Unlike stocks where borrowing is hard to come by because of its speculative nature, an investor can leverage bank lending to acquire real estate to supersize returns. This can be accomplished whether investing directly or indirectly.
A passive investment fund that leverages bank lending passes the advantages on to its partners.
Because lenders typically finance investment properties with down payments of just 20–25% of the sale price, investors can take advantage of leverage to multiply their earnings.
If we assume a down payment requirement of the max. 25%, let’s consider two scenarios with starting capital of $100,000 each.
In Scenario 1, an investor can buy one property entirely for cash for $100,000. In scenario 2, an investor can leverage their $100,000 by taking out four loans with a down payment of $25,000 each to acquire four $100,000 properties.
Assuming the average annual return of 9.5% for commercial real estate for the past 20 years, let’s compare the returns on investment in both cases after five years.
Initial Investment: $100,000
Total Return: $100,000 x .095 x 5 = $47,500
Cash-on-Cash Return Rate: 47.5%
Average Annual Return: 9.5%
Initial Investment: $100,000
Total Return: $400,000 x .095 x 5 = $1,900,000
Cash-on-Cash Return Rate: 190%
Average Annual Return: 38%
The power of leverage in Scenario 2 allowed the investor to quadruple their average annual return.
Tax Benefits –
The wealthy have been taking advantage of the tax benefits multifamily investing – and commercial real estate, in general – for years.
Some of the major benefits include the following:
- Long-Term Capital Gains. Multifamily investments held for more than a year and sold for a profit qualify for long-term capital gains treatment. Compare the top long-term capital gains rate of 20% vs. the top ordinary-income rate of 37%.
- Avoidance of FICA and Medicare Taxes. Passive income from multifamily investments is not subject to FICA (Social Security) and Medicare taxes. That’s a savings of 7.65% to 15.3% on that income.
- Regular Depreciation. Regular depreciation deductions allow investors a business deduction for the cost of items that have a “shelf life” like a building. The typical depreciable period is 27.5 years. For example, if the cost basis of a multifamily property (the structure only and not including the land or improvements) is valued at $1,000,000, the annual depreciation deduction allowed over 27.5 years would be approximately $36,400. In a passive investment, this depreciation would be distributed pro-rata to all the partners.
- Bonus Depreciation. Besides regular depreciation, the bonus depreciation allows for the deduction of 100% (increased from 50% to 100% with the Tax Reform) of items with a shelf life of 20 years or less. This bonus depreciation is geared towards commercial building improvements.
Value-Add Opportunities –
Multifamily, more than any other real estate segment, affords significant value-add opportunities to the experienced manager to acquire a property, make improvements, improve operational efficiencies and reduce expenses to significantly boost cash flow and grow long-term appreciation.
Significant Demand –
The U.S. becoming a renter nation will ensure demand for multifamily properties for years. The growth of the renter population is now outpacing the owner population, with owner population growth in negative territory.
With a shortage of affordable housing and with Baby Boomers, Echo Boomers (children of Baby Boomers or Gen-Xers), and Millenials all choosing to downsize and live more simply, demand for multifamily is projected to outpace supply for years.
The wealthy have long gravitated to cash flowing alternative assets for its passive income-generating, appreciation, non-correlation to Wall Street, and diversification advantages. Besides those advantages, multifamily offers additional benefits that make this segment extra attractive to wealthy investors.
Benefits such as control, leverage, tax benefits, value-add opportunities, and strong demand all make multifamily superior to other alternative asset classes. Moreover, the twin benefits of cash flow and leverage make for a recipe for supersized returns.
When fixed income is leveraged to acquire even more income-producing properties, returns become exponential. That’s why the wealthy have had a longtime healthy obsession with multifamily investments.
Investor, writer, speaker, and founder. Kyle Jones, key principal of TruePoint Capital, is accountable for investment decisions, asset management, and overseeing financial activities, operations, and investor relations. Kyle additionally is a Global Sales Leader for a large Fortune 100 technology company. Kyle received a Bachelor of Science degree from Texas State University – San Marcos.