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What is the Optimal Investment Period for Real Estate?
By Adam Gower Ph.D.
Many of the most common questions that I receive from those learning the ropes of the commercial real estate business have to do with timing. Typically, it has to do with when to get in the market- and when to get out. I'd like to take this opportunity to explore an aspect of the latter category and answer the question: what is the optimal minimum investment period for real estate investing?
Better Off in the Long Run
Most data regarding the optimal investment period for real estate points to the fact that you're better off investing in real estate for at least ten years, with better returns the longer you hold. There are two primary ways of looking at the question. The first involves looking at the growth patterns of the American economy. Historically, the United States grows 8 1/2 years out of every decade. This means that commercial real estate demand generally grows about every 8 1/2 out of 10 years, mirroring the financial picture of the economy as a whole.
So you're looking at climbing demand for most of the time, followed by about a year and a half of declines- which can often be steep. A prime example of this is the 2008-09 housing crisis. Prices took a substantial dive for a few years, and ended up bouncing back for a prolonged period, in many areas of the country home prices have continued to grow unabated since the dark days of the crash.
You sort of suffer for a couple of years, and capital abandons you for a couple of years, which is very difficult if you're a capital-intensive industry like real estate is. If you weather those couple of fear-filled years where capital abandons you and short-term thinking dominates, you can expect to see growth most of the time during the next ten years.
You might find little pockets of the country that didn't grow, and yes, you can find segments that didn't fully recover, but you can also find those that more than fully recovered. You're betting, then, on this pattern of growth, which has continued to occur.
The other piece of the puzzle that you're betting on is that supply doesn't go crazy. If you grow 10 percent, the economy grows 10 percent then all is well, but if you add 100 percent to the real estate stock, that's not going to be ideal. Realistically the economy can only produce so much, and if supply far outpaces demand, you will not see returns at the level you would see when supply more or less grows around the same rate as real economic activity. This introduces a political/social factor like the wars raging between YIMBYs and NIMBYs in places from NYC to the Bay Area.
Poorly Managed Debt Can Lead to Disaster
As long as you stay in the game, your chances of a total loss investing in real estate are slim. However, from my experience, which is also backed up by the data, there is one main way most people get into trouble with their commercial real estate investments – by taking on too much debt. Even if the underlying investment is not all that risky, the addition of too much debt can leave investors vulnerable to downturns- and if they can't make it to the other end of the tunnel, they often face substantial losses.
If you look back, most of the people who got squeezed out of their properties during the various down periods, at least in my lifetime, were right in terms of timing- they just were wrong in their capital structure. People I've interacted with and even worked with have chosen the right buildings in the right areas, with plenty of tenant demand. Their only problem was their inability to stick around in the long run, as well as their failure to avoid foreclosure or a fire-sale of the property due to changing economic tides.
In many ways, commercial real estate investments should be thought of as a marathon, not a sprint, the more you pace yourself and think of the big picture, the more likely you are to see success in your portfolio.
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Multifamily Outperforms Other Commercial RE During 10-Year+ Holds
Compared to other categories of commercial real estate, like retail or industrial properties- multifamily apartment buildings see higher gains over a given ten-year period, somewhere around half a percent higher than other property types. With the power of compound interest taken over a decade, that adds up to a pretty substantial advantage for multifamily properties.
Multifamily not only outperformed in terms of average yearly gains, but the distribution of their 10-year returns has also historically been advantageous for investors. It's one thing for an investor to get an 8 or 9 percent return, but half of the time, they're negative- and quite another to see an 8 percent return and almost no negative returns during that decade window. Multifamily assets performed best in the sense of not being negative in that regard- it's just not as volatile in its occupancy.
If you think about it, you need to lose 5 percent of your tenants to even start worrying- which for many larger multifamily properties is a huge number, even during economic downturns. On the other hand, if you own a shopping center and lose a single large client, you could be in big trouble when it comes to paying your monthly loan or keeping your project generating the returns you need. Multifamily does better because it’s more stable and there just isn’t as much downside.
In the world of commercial real estate, there is money to be made within any timeframe- from days to decades. However, on average, by holding for ten years or more, investors can increase their returns while decreasing volatility and risk. Working with multifamily properties can also reduce risk and increase gains for investors, primarily due to their large tenant base and countercyclical recessionary qualities.
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