Saying that direct ownership in high-quality commercial multifamily real estate has less risk than the stock market is like saying that broccoli is better for you than Twinkies or water is better for you than soda. It just is…the evidence is clear.
Of course, there is no such thing as a risk-free investment. All investments have risks. However, they don’t have the same risk. Therefore, minimizing risk is an important part of maximizing reward.
When it comes to investing your money, I would think that your number one priority should be principal protection. It is for me and for Warren Buffett too. In fact, his number one rule of investing is, “Don’t lose money.” His second rule is, “Don’t forget rule number one.”
I’m certain you’d also like to grow that principal, create stable streams of passive income, reduce your tax burden, stay ahead of inflation and so many more priorities come into play when deciding to invest in commercial multifamily real estate. Nevertheless, reducing your risk, A.K.A. principal protection, is of utmost importance.
With that said, let’s look at the facts.
The Street Magazine declared in 2016 that direct ownership of real estate was the “best performing asset class during the past 20 years.”
They based their conclusion on the above graph that shows superior returns compared to the stock market with 3x to 4x less risk. It’s clear to see why they would make such a claim. After all, facts are facts.
The funny thing is that the Street Magazine is Jim Cramer’s publication. You know the guy on CNBC’s Mad Money. He’s a stock market guy…right? I guess even stock market guys can’t deny the facts.
So what is it about commercial multifamily real estate that allows it to have significantly less risk than the stock market?
First, it is an investment in the basic need of shelter. Unlike business products that have a useful shelf life but eventually get replaced, apartment buildings aren’t going anywhere. Mankind has always and will always need a roof over its head.
Additionally, think about who already invests in commercial multifamily real estate and how much due diligence and risk mitigation they have done to determine that investing in apartments is right for them.
For example, AAA rated life insurance companies hold a significant portion of their portfolio in commercial multifamily real estate both on the debt and equity sides. These are some of the most conservative investors in the world. They want to grow their money, but they absolutely have to do so cautiously as they have guaranteed benefits that they have to pay out.
Furthermore, commercial lenders are by far the biggest investors in apartments. They do so on the debt side and it is pretty typical to find them fronting 70%-75% of the money to purchase these properties. They research the quality of the market, submarket, and operator long before they ever put their money into the deal.
Private real estate acquisitions and asset managers with a track record for success (like 37th Parallel Properties) can earn preferred status with these banks. Our experience and expertise affords us the unique position of being able to secure lending rather expeditiously.
So if we wanted the bank to invest $14 million in a $20 million dollar apartment building, they’d be happy to invest with us on that deal all day every day as long as the property met their underwriting standards and was in an approved market.
In fact, not only would they do it, but they would give us non-recourse debt. What that means, is they forfeit the right to come after the owners and managers to recover their losses should the property not perform. Why would they do that? They do it because of the safety profile of this asset class.
I could never walk into a bank and ask them to front me $14 million toward the purchase of $20 million worth of stock. They would laugh me out of the building. The stock market is just too risky.
Lastly, when discussing the subject of risk, the Sharpe ratio (risk-adjusted return) inevitably comes up. The Sharpe ratio is an economic measure that looks at the risk adjusted return of an investment. The higher the Sharpe ratio the better the return is and the lower the risk.
Over any long-term period, commercial multifamily has the best Sharpe ratio of any other real estate asset class. As seen in the above graph, it also beats the stock and bond markets over the last twenty years.
As such, commercial multifamily real estate has a stabilizing effect on paper heavy portfolios. Consider the effect of adding commercial real estate over a 20-year period to a 50% stock, 40% bond, and 10% T-Bill portfolio (Portfolio A):
As you can see, when that portfolio diversifies into commercial real estate (10% in Portfolio B) it achieves better returns and stabilizes the portfolio (by decreasing the standard deviation of returns and increasing the Share ratio). Increasing the proportion of commercial real estate further (20% in Portfolio C) increases returns and stability even more.
So yes, commercial multifamily real estate is less risky than the stock market. To quote J.P. Morgan Asset Management:
“…the reality is that investment portfolios focused on the “Big Two Traditionals,” bonds and equities, are forcing investors to compromise – either by sacrificing return for lower volatility or enhancing return at the expense of higher risk. Real estate may offer a way out. This is why we believe real estate is increasingly being viewed, not as an alternative, but as an essential portfolio component.”
I couldn’t agree more. Have you diversified into this essential portfolio component? If you’re looking for an investment with a lower risk profile, historically high returns that are uncorrelated to the stock market then commercial multifamily real estate might be right for you.