When it comes to the study of millionaires in this country, Dr. Thomas Stanley collected the definitive body of research. His life’s study is summarized in the book the “Millionaire Next Door.”
In it, he found several commonalities among self-made millionaires.
Over and over again, Dr. Stanley discovered that those who made their first million did so by living below their means and investing in their future. The two most successful investments for achieving millionaire status were starting a business and buying real estate.
With that said, what are the risks associated with these two asset classes?
Starting a business risks and rewards
When it comes to business, we live in transformative times. According to Yale professor Richard Foster, companies in the S&P 500 index in 1958 stayed in the index, on average, 61 years. Today that number is only 18 years. In fact, at the current churn rate, 75% of the S&P 500 index will be replaced by 2027. Just consider some of the once heavy hitters who have fallen out of the index since 2002.
- Sears
- Radio Shack
- Wendy’s
- Maytag
- Eastman Kodak
- Compaq
- Bear Stearns
- The New York Times
- Quaker
- Circuit City
Business cycles are unstoppable forces that are becoming harder to keep pace with as they accelerate and come in faster waves. Modern technology is advancing at breakneck speed making it nearly impossible to keep up with the latest trends and advancements. What is in today will be out sooner than ever before in our history.
And business is a zero sum game. The latest greatest shiny object on the market gains market share by taking it from someone else.
So yes, business ownership can be lucrative, but it’s also very risky. In fact, those who take the business route have to confront some pretty scary facts:
8 out of every 10 businesses fail within the first 18 months of operations.
96% of businesses fail within the first 10 years.
Knowing that only 4 out of every 100 businesses are still operating ten years after inception makes business a risky endeavor indeed.
An investment in real estate risks and rewards
In contrast commercial multifamily real estate is far less risky. After all, it is an investment in the basic need of shelter. Stability comes with investing in our basic needs as opposed to our ever-changing wants.
Despite the incredible advances made throughout history, mankind has always needed and will always need shelter. That makes commercial multifamily real estate 100% evergreen. Nobody has ever come up with a substitute for food, shelter or clothing and I predict that nobody ever will.
Therefore, there is no next great thing that can displace apartments. They can’t go the way of the steam engine, the horse-and-buggy, Blockbuster video, Blackberry, and so many others.
How much easier is it to sleep at night knowing your money is invested in something that can’t be replaced?
To look at the failure rates in commercial multifamily real estate, all you have to do is turn to the Mortgage Bankers Association. They keep track of distressed notes in our industry by following the 60-day delinquency rates. While 60-day delinquency rates will slightly overestimate the foreclosure rate, it provides a reasonably good estimation.
As the graphs below show, since 1998, those properties that conform to strict underwriting standards (commercial Fannie Mae, Freddie Mac, and life insurance company) have enjoyed 60-day delinquency rates well below 1%.
Sources: Wells Fargo Securities, LLC and Intex Solutions, Inc., American Council of Life Insurers, Fannie
Mae, Freddie Mac, OFHEO and Federal Deposit Insurance Corporation
Whether you are investing for retirement, stable passive income, or to create legacy wealth for your heirs going in with your eyes wide open and knowing your odds is an important piece of due diligence. While business can be quite lucrative, a 20% success rate after 18 months and 4% after 10 years is abysmal. The deck is absolutely stacked against those starting new business ventures.
On the other hand, for those conservative investors who believe in Warren Buffett’s #1 rule of investing – Never Lose Money – commercial multifamily real estate seems far more suitable. The choice between business and commercial multifamily real estate is clear.
