Multifamily Rent roll Curation: Next steps in Portfolio Management

Estimated read time 6 min read

Investors in real estate typically reduce the risk of their portfolio by diversifying their geographical footprint. What if investors went deeper and actively diversified their rent rolls at the property level to minimize risk for a particular asset? Multifamily owners can reduce the impact of market declines on their portfolios and take a more aggressive approach to other risk levers, such as geographic concentration or leverage, if they see high conviction opportunities.

Portfolio Theory

A good portfolio is much more than just a list of stocks and bonds. It’s a well-balanced portfolio that provides the investor with protections as well as opportunities in a variety of situations. Harry Markowitz

The Portfolio Theory is an investment framework. The theory states that by combining assets with low correlations or negative correlations you can reduce your overall portfolio risk. Oil company stocks and airline shares are two examples of stocks that move in opposite directions when the oil price changes. (Oil is an important expense for airlines).

Multifamily applications

The risks associated with multifamily properties are higher than most investors think. This asset class benefits from government-subsidized financing, which encourages higher leverage due to the lower interest rates. The high leverage of this investment increases the risk of the investment. This is due to the lower interest rates.

Rent roll curation at the property level can reduce risk. In an economic downturn for example, you may have selected tenants who reduce your property’s Beta. This is because, as the owner, you have taken proactive steps to select tenants. Rents could still drop, but not as much as the submarket.

The proactive tenant curation can also provide valuable insight into the risk profile for your tenant base. This allows you to make more accurate risk assessments and forecasts.

How it Works

Consider a multifamily building in Las Vegas.

Las Vegas was among the worst-affected markets during the Great Recession in the late 2000s. Investors suffered due to lower rents and declining values.

Not all sectors of employment have fared equally.

Source Bureau of Labor Statistics

The Education and Health Sector (defined by BLS) has performed better than the overall employment trend. Education and Health never experienced negative job growth year over year because the industry was protected from the economic trends at the time. As of June 2022, this sector accounted for 10.7% of Las Vegas’ employee market.

Property in Las Vegas, a market that is highly cyclical, with a large proportion of tenants who are from stable sectors of employment should perform better than comparable properties with tenants coming from volatile sectors.

Great. I will buy a house next to a hospital.

The Great Recession (before Covid-19), was one of most severe recessions of recent times and could serve as a useful benchmark in the absence a pandemic.

You can certainly invest in an asset that is adjacent to a hospital where you will benefit from the strong employment trends. Market participants are aware of this, so the price is likely to be higher. Many investors believe that anchor employers, such as universities and hospitals, offer job stability and growth opportunities.

You can buy it but you will pay more for tenants who have stable employment.

Remote Work is Another Option

Employers (and employees), the Covid-19 pandemic offers an opportunity to experiment with remote work. Many people no longer have a geographical connection to their employer. In terms of real estate, they are now free agents.

As employees evaluate their options, the distribution of remote workers continues to shift. According to McKinsey an estimated 35% can work at home five days per week. This offers employees the opportunity to migrate to a more comfortable lifestyle or better financial opportunities.

Remote workers can access the much larger national remote labor market because they are not bound by geography. Since this is a relatively new phenomenon, data are scarce. However, it appears that remote workers with higher levels of skill could be able to benefit from a lower unemployment rate because their pool of employment is larger and more liquid.

As the population evaluates its options, we are probably at the start of a new sorting wave. Multifamily investors should target remote workers directly to take advantage of the process. They can use the remote worker as a portfolio management tool in order to curate and position their rent roll for success, according to their goals.

How to Do it?

Organise your property so that it appeals to the target market. Since remote workers don’t meet with their colleagues, they will value basic amenities such as reliable high-speed internet, and community-focused amenities such as large WeWork-style communal areas.

An investment that is excessive in amenities that are appealing to the market will send a strong signal that the target market is sought after.

Moreover, financial incentives are tailored to the audience. Multifamily owners, for example, have used tools like preferred employer discounts for years to encourage residents to rent their apartments. These discounts can be expensive (3% gross rent), and they are not precise (they only target the biggest employers in a given area). As an alternative to ongoing discounts, cash incentives upfront can be a more cost-effective option.

There is much more that can be done to retain and attract these residents. These ideas should be developed into a unique marketing strategy.

Potential Impact

This example based upon Indeed.com data for job listings (for PreCovid and may-2022) shows the diversification benefits that remote worker hubs can provide to multifamily properties. Nationalizing the tenant risk profile to reduce overall risk without affecting the Net Operating Income of the property is possible.

Investors would not have to target the same proportion of units immediately to see benefits. A step-by-step strategy could be used, with only a few units tested to prove the strategy.

Addition of tenants with high incomes who do not rely on local labor markets can help to boost valuations. To capture a larger share of wallets from the target tenant base, additional monetization options could be investigated.

Summary

Portfolio management can be moved from macro to micro by using proactive job category targeting on individual property rent roll. Diversification is also improved due to a lower dependence on local labor markets. This curation unlocks significant additional value over and above the expected return on a multifamily in that location.

The remote worker sorting is still in its early stages. Investors and workers will have the opportunity to create a win-win dynamic as new market needs are identified and met.

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