New Study Incidentally Reveals Secrets to Real Estate Success: Long-Term Holds and Timing
However, its main conclusion (that apartments walloped other commercial real estate classes) is questionable, and marred with a significant oversight.
(Usual disclaimer: I'm just an investor and not a financial advisor or attorney. Consult your own financial professional before making any financial decisions).
A new study was just released by a pair of researchers through the NMHC (National Multi Family Housing Council). They took a very comprehensive look at real estate returns through the last 2 real estate cycles (back to 1987) and incidentally revealed 2 secrets to investing success. First, holding long-term was the secret to preventing losses and weak returns. Second, timing of purchases and sales is also crucial.
Unfortunately, the main conclusion (that apartments outperformed all other commercial real estate classes) was marred with a pretty significant error, that makes that particular conclusion suspect. I’ll talk about that at the end of this article.
The Long Game
As I’ve written earlier, I’m a conservative investor most concerned with capital appreciation. And at this stage of the cycle, I’ve not been comfortable investing in the medium-term, five-year hold deals that make up 95% of today’s crowdfunding equity investments. I feel these have too much risk if things go very badly in the next downturn. The deals I prefer are long-term (7 to 10 years or more) and can, I believe, ride out short-term fluctuations better.
So I was very interested when I discovered that this study looked at every medium-term and long-term hold over the last two real estate cycles. And what did they find? Going long crushed medium-term for safety and the prevention of weak returns.
There were numerous five-year holding periods where investors in every commercial asset class suffered anemic returns sub 5% (or negative) returns.
However, there were no negative returns for any 10-year holding period. And other than a few data points for office, every 10-year was more than 5%.
Now, if you’re an aggressive investor, you may look at this data in a different way. The 5-year holding periods had several data points where they returned 12-18%, which was above the 12% upper ceiling for the 10-year holds. So if things go well, 5-year holds do offer the possibility of higher returns. I’m not willing to roll the dice on this, but if your risk profile is different, you may be.
Timing is crucial
The study also found that timing is everything in real estate. There were two recessions in the data set: the moderate recession of 2001 and the Great Recession from the fourth quarter of 2007 to the second quarter of 2009. They found that purchasing properties during the recovery (two quarters after the economy came out of recession) boosted long-term returns on average by a hefty 1.4%. And they also found that selling after the recession wasn’t a great idea, and depressed long-term returns by 2.2%. (Interestingly enough, selling during a recession or right before, did not make much of a difference).
So my take away is that right after the next downturn, I want to jump into the market as well as hold off from selling if possible. This fits in well with my current strategy of holding considerable cash so I can hopefully be ready to purchase bargains when they appear.
Apartments lead, but is it real?
Incidentally, the main conclusion of the report, seems to be wrong. The researchers showed that apartments outperformed every other major commercial real estate class (industrial, office and retail) over every 3, 5, 7, 10 and 15 year holding period. It sounded really compelling on the surface, until I read their hypothesis as to the reason.
They hypothesized the outperforming was due to the lower cost of apartment maintenance (1.18% ) versus others (like office which is more than twice as expensive at 2.72%).
However, the researchers made a very important omission here. They assume that the investor always pays the capital expenditure expense, and thus these reduce the return. However, many investors who invest in industrial, office and retail do so with triple net leases (like I currently do with BroadStoneNet lease). A triple net lease pushes the cost of maintenance onto the tenant. And this report doesn’t take that into account and thus under-reports the return of these types of investments.
So personally, I still believe a well-diversified portfolio across all the commercial real estate types is an appropriate choice, and am continuing to do that. Additionally, I think it’s smart to analyze deals in nontraditional commercial real estate asset types, that have the potential to do better than average in the next downturn, like medical offices and mobile home parks.