The allure of trophy assets and high-profile office
complexes can be difficult for an institutional investor to
resist when allocating capital to
real estate. Often overlooked are less flashy multifamily
housing developments, which can be a more consistent source of
An institutions decision to favor office buildings is
largely because of the profile of its tenant base. Office
buildings can attract large, well-known companies that sign
expensive, multiyear leases, whereas apartment buildings rely
on numerous shorter-term tenants who may only commit to occupy
the space for months at a time.
On paper, this longer duration bestows a sense of stability
and creditworthiness to office buildings that multifamily
projects appear to lack. But a closer look at the numbers
reveals a different reality. Research from the National Council
of Real Estate Investment Fiduciaries shows that unleveraged
average returns from multifamily housing units have outpaced
those of office buildings in four of the past five years
at times by more than 600 basis points. Why is this?
The most important reason multifamily developments
frequently outperform their office counterparts is quite
simple: consistent demand. Regardless of macroeconomic
conditions, people always need a place to live.
In a thriving economy, people can afford to live on their
own and quickly fill housing that meets individual needs and
brings them closer to jobs. During a down economy, renting may
grow more attractive than buying for a variety of reasons:
People lack the ability to save for a downpayment on a house,
which may free them from ongoing home maintenance costs, and
the short-term nature of renting provides location flexibility.
These factors produce a reliable and stable revenue stream.
The same cannot be said of office developments. When times
are good, office rent is consistent. However, during times of
economic distress, businesses close, and those long-term
leases, which looked so attractive on paper, can be broken or
restructured. Empty offices are more difficult to lease as
fewer businesses are launched or looking to move. The result:
fewer tenants, less revenue.
Additionally, the fundamental nature of office space may be
subject to disruptions with the advent of telecommuting and
preferences for open floor plans or campuslike environments.
Offices built just 15 or 20 years ago can struggle to fit the
needs of todays companies, which want more creative and
flexible spaces, rather than just private offices, conference
rooms and cubicles. However, the functional, physical
characteristics of homes have not changed: walls, roofs, living
areas, bathrooms and kitchens.
A new office complex can have a dramatic impact on the local
market. Just as a big buyer or seller of a thinly traded stock
moves a companys share price up or down, the addition of
hundreds of thousands sometimes millions of
square feet of new office space can upset pricing as the market
struggles to absorb new capacity. Conversely, the introduction
of even the largest multifamily developments creates minimal
Ironically, it is precisely the makeup of the multifamily
tenant base lower-priced short-term leases, which
institutional investors perceive as a negative that may
be its greatest strength. Unlike office buildings, multifamily
developments are nimble enough to employ dynamic pricing
models, much as airlines do when selling tickets for seats.
Leasing prices in multifamily developments can be adjusted on a
daily basis, up or down, depending on current demand and the
available supply of units.
Office buildings are loath to adjust prices downward,
especially when they are part of a publicly traded vehicle like
real estate investment trust, which can affect a stock
price and produce inordinate consequences on commercial leases
throughout the local market. The long duration of office leases
can also hurt returns when buildings find themselves locked
into agreements that were consummated at the bottom of the
cycle, thereby depriving them of the ability to capture a
Last, the costs of putting a new, large tenant into an
office space far exceed those of a new apartment renter because
tenant improvements for offices are customized to the company
and its aesthetic. Apartment renters may only expect fresh
paint. As a result, multifamily developments can keep vacancy
rates to a minimum, again ensuring a steady revenue stream.
Multifamily developments have another advantage for
investors exiting a property. When office buildings are
completed during down markets, investors suffer for two
reasons: First, the value of for-sale assets will be
considerably lower than original projections, which may have
been calculated during more optimistic times. Second,
properties built to be leased and held struggle to attract
tenants, and lease terms will be set below originally
By contrast, constant demand for multifamily housing and its
use of dynamic pricing models mean that builders can ride out a
downturn by continuing to rent the units and generate revenue.
Assuming that the project is not overleveraged, developers can
hold the property, keeping it leased and generating cash flow,
and sell when market conditions improve. This generates a more
favorable sale price and increased returns.
Institutional investors by nature are long-term stewards of
capital interested in generating consistent returns that meet
the needs of their current and future obligations. To use a
baseball analogy, institutions want a steady stream of singles
and doubles and do not view themselves as home-run hitters, who
also tend to strike out a lot. This long-term mandate to
preserve and enhance capital philosophically matches up with
the core characteristics of the multifamily asset class, which
similarly seeks consistent performance with less volatility.
Multifamily delivers that because of constant demand and the
flexibility to quickly adjust pricing. This is a critical, yet
often overlooked, consideration for institutional
Ultimately, although multifamily developments may lack the
superficial appeal of office buildings, the asset class
warrants serious consideration for institutional investors
deciding where to allocate capital within real estate.
Sean Burton is the president of CityView, a Los
Angelesheadquartered developer and investment management
firm focused on urban residential real estate in the western