Multifamily vs 401(k) vs IRA
Young adults are yearning to find ways to make extra cash and put more money into savings. But with so many different investment options at consumers’ fingertips, how does one choose which investment fits their long-term financial goals? Stock options, 401(K)s, and IRAs are all well-known, popular investments, but what about assets that may require more start-up cash and ultimately provide higher yields, like real estate? Multifamily real estate is one of the most profitable and recession-resistant investments in the market and can help young adults significantly build their wealth over time.
How to Make Money as a Multifamily Investor
As an owner of multifamily real estate, there’s a few ways to earn income. First of which is tenant’s rent payments, and the ability to build equity in assets that other people are contributing. Each occupied apartment will pay a monthly rent fee that will go directly to the landlord (aka the owner). The rent rates can be adjusted to fit monthly costs and give the owner control of their income. If the rental rates are accurate and the building features high occupancy, the rent payments will cover the owner’s mortgage payment, property taxes, and building expenses. The most important thing when it comes to rental rates is finding the right balance. Tenant payments need to be enough to cover expenses, but not priced too high that units become hard to rent and the building’s vacancy increases. Vacant units are a costly expense that should be avoided as much as possible. However, the biggest attraction for real estate is not just the cash flow gained from rent payments. There are several tax benefits through depreciation which saves money the second the deal closes.
The other way to make money off real estate is through appreciation, otherwise known as when a property grows in value. A property’s value can increase even further through renovations and improvements, a major advantage to real estate. Experts encourage real estate investments because the real estate market tends to be more stable than the stock market over a long enough horizon. Instead, real estate tends to appreciate from the original date of purchase. The increased value can be caused by its location, if the neighborhood or area is popular and grows in demand, or if the area sees an influx of development or redevelopment. In addition, owners can gain appreciation by investing back into the asset and making improvements so at the time of sale the quality of the building is greater.
Some owners will pay a third-party property management company to manage the apartment office, grounds, maintenance, rent collections, etc. Although the company does help the owner split responsibilities, it will require a sum of income to go toward paying the third-party business, taking away from the landlord’s return on investment. This fee varies from three to eight percent depending on the size and location of the asset.
Multifamily real estate experienced two years of historical performance, with year-over-year rent growth skyrocketing and vacancy rates decreasing. This growth has slightly fallen off, but overall rates are still at record levels. Apartment demand is matching 2020 levels as interest rates are rising and mortgage payments become too expensive for many potential homeowners. The need for more affordable housing is stretching the 1- and 2-Star units thin, keeping the subsector’s vacancy low, while luxury 4- and 5-Star units are seeing vacancy rates rise in many markets. Overall, the multifamily sector is experiencing change, but steady rent growth and rising interest rates are in the market’s favor.
How Does Multifamily Compare to Common Retirement Funds – Pros & Cons
Liquidity
By investing in a 401(K) or IRA, a person is essentially locking up their money until 59.5 years old. If the goal of investing is to retire at the common age of 59 or older with a set amount in savings, a retirement fund may be the best option. On the other hand, if a person is looking to increase their overall wealth to retire early, real estate is the better choice. Real estate provides financial freedom, unlike any other investment, as the profit made goes directly to the investor, not into an account. Real estate often requires loan payments, maintenance costs, etc., so not all profit will go to the investor right away but investing in real estate still provides much more liquidity than a retirement account.
Management Responsibilities
A pro for typical retirement funds is that they require little to no management. The money is usually taken out of a paycheck or bank account a set number of times during a month, and the amount gradually grows over time. On the other end of the spectrum, multifamily requires extensive management throughout its hold period. Therefore multifamily investment is a great choice for young adults who may have more time and energy to put into their investment portfolio. The payoff outweighs the work in the end, as real estate appreciates faster and at a higher percentage. Regarding investments, an advantage is that setting up an investment account is quicker and has no minimums to build the portfolio.
Restrictions
Often, a 401(K) or IRA is limited to what a financial allows its employees to invest in, moving the balance of power from the individual to the business. 401(K)s have fixed investment options provided by the company and do not have the ability to invest in other individual stocks or indexes outside of the fixed investment line-up the company provides. Also, 401(K)s typically don’t allow the ability to use leverage in most company 401(K)s. This limits the investor because real estate allow for loans to be able to use and purchase the property as “leverage.” Real estate gives all the purchasing power to the individual, who can decide the property size, location, investment goals and quality.
Tax Benefits
Real estate offers a lower capital gains tax rate at the time of sale compared to the tax rate investors will pay at the time of withdrawal from a 401(K). Real estate comes with several tax benefits of depreciation, including the ability to lower tax liability and the ability to 1031 exchange for “like-to-like” property, providing tremendous wealth accumulation if done correctly for a high-value property. Tax payments are deferred when putting money into a 401(K) until an investor accesses the account. Although taxes were deferred, a person will owe income tax on the amount put in plus the capital gains tax on whatever the full withdrawal amount is. If a person retires making more than they have made most of their career, they will still pay the higher-tax bracket percentage on all income put into the account, meaning they will pay more in taxes than previously owed if the taxes weren’t deferred. IRAs are similar in that earnings in an IRA will be tax free, and taxes will be owed at the time of withdrawal. The key differences between a 401(K) and an IRA are the annual contribution limits and the investment freedom. Although a 401(K) allows a higher yearly limit, $22,500 if under the age of 50, a contributor’s choice of assets is limited to what their employer has chosen. A traditional IRA’s yearly limit is $6,500, but the contributor has a much wider variety of investment assets.
Recession-Resistant
In a volatile economy, multifamily provides an investment shield, as other investments like stocks or retirement savings take a hit. People will always need somewhere to live, securing the multifamily sector’s demand and stability. In addition, in high-interest rate markets where potential home buyers’ purchasing power is down, multifamily will thrive as the potential renter pool expands and the current renter pool stays longer. In markets with high apartment demand and low supply, a landlord can increase cash flow significantly as consumer demand allows for increased rental rates.
Overall, every person has different financial and retirement goals, so each option will need to be evaluated carefully. Retirement funds offer a simple, management-free way to save money for your future but constrain financial freedom significantly and only sometimes help individuals retire early due to the withdrawal restrictions. Multifamily real estate requires a larger amount of capital to start and needs to be diligently managed, but it also features liquidity, more cash flow, security, and several tax benefits. Young adults should greatly consider investing in multifamily as a way to expedite their retirement and grow their investment portfolio.
