What does it mean?
For those of you just getting started in multifamily investment, you’ve probably heard terms like “class B” property thrown around casually.
It’s probably obvious to you that a class A property is better than a class B property based on the report cards we all grew up with in school, but what are the criteria that would cause you to classify one property as a “C” and another as an “A?”
In this article, we’ll explain the different classes, some of their characteristics, as well as provide some comments about the nature of each multifamily asset class when viewed as an investment.
Remember to Be Flexible
One thing to keep in mind as you’re purchasing properties is that you have to be flexible and willing to pivot based on market conditions.
You shouldn’t necessarily be married to one class over another and instead should maintain some working knowledge of all classes, even those you aren’t actively invested in.
Markets shift and change – your company should have the knowledge and capability to shift as well.
Having a well-rounded knowledge of all the classes of multifamily real estate will allow you to continue to provide your investors with the highest returns and lowest risk in a variety of market conditions.
Cap rate spreads between the classes of multifamily real estate. The more desirable a property and location, the lower the cap rate.
Class A:
- Less than 10 years old
- Lowest cap rates for the submarket they are located in
- Highest valuation on a per door basis
- Highest rents for the submarket they are located in
- The highest quality level in their submarket
- Are often mid-rise or high-rise apartments
- Typically located in urban cores
- Often accessible or located near public transportation
- Possess a high walk score and typically in trendier downtown areas
- Located in areas with high population growth
- White collar worker tenant base
- Tenant base includes high percentage of young professionals
- Typically include a more robust amenity package, ie. fitness rooms, saunas, common area working spaces
- Upon purchase, minimal work needed to be done. May still be areas of value-add, but the amount will be minimal to none
- Investors likely anticipate appreciation, however properly priced class A should cash flow just fine when the debt is structured properly
Class B:
- Range from 10 to 25 years old
- When compared to class A, there is more room for upside as an investor
- Provide a natural affordable workforce housing option (see our Workforce Housing Explained article for an overview of workforce housing and a discussion about subsidized workforce housing developments)
- Are often value-add opportunities
- Moderate price per door when compared to class A
- Some ability to push rents and drive up NOI, adding value
- Well maintained with minimal deferred maintenance
- Many garden style suburban apartments fall within class B
- Middle class tenant base that is typically a mixture of white and blue collar workers
- Tenant base may either live there by choice or by necessity
- Some tenants prefer lower cost, lower maintenance renter lifestyle
- Some tenants can’t afford or are working towards an eventual down payment on a home purchase
- Can benefit from and ride upward rental pressure from nearby class A properties as a more affordable alternative
- Typically do not require large amounts of renovation work
- Minor upgrades such as new countertops or exterior paint may be typical value add items for class B
- The cap rate spread between class A and B in your submarket can help determine which class to target. The difference can be as low as 10 basis points and can range up to 30 basis points. If the spread in cap rate between class A and B is minimal, investing in class A is advisable
Class C:
- 25-40 years old
- Provide a natural affordable workforce housing option (see our Workforce Housing Explained article for an overview of workforce housing and a discussion about subsidized workforce housing developments)
- Tenants will be blue collar with the occasional first time renter
- High “renter for life” population, responsible tenants that pay on time may stay in the same complex for many years
- May include some government subsidized / section 8 tenants
- Property management will end up rejecting most applicants as unqualified, must be pickier with tenant selection
- Property management must be more hands-on with the tenant base
- Rent collections may require more intervention from the property manager, collections may go overdue on a somewhat regular basis
- More work will need to be done than B class
- These properties are pretty much always value-add. Do not overpay based on the expectations of future performance, the value is based on the current state of the property
- Curb appeal renovations should be tackled before interior renovations. The exterior presentation of a property plays a huge psychological impact in people’s perceptions of its quality level. Improving the property’s curb appeal will help you improve the tenant base more quickly and easily
- These are the most attractive properties on a pure cash flow basis
- Higher cap rates
- Look for C class properties in B class submarkets. These deals have the most meat on the bone for value-add as you can reposition your property into class B under the right circumstances
- Properties gain reputations within a submarket. You and your team could do tons of work, improve the tenant base, fix or remove obsolescent building features, and the like, but bad perceptions of the property might still exist from its life under the previous owner(s). This negative inertia can sometimes take years to overcome and should be accounted for going into a class C investment
Class D:
- 40+ years old with no major renovations
- Highest cap rates
- Higher turnover with high vacancy rates
- May be in areas with declining population levels
- Good cash flow on paper, usually difficult to make a reality
- High amount of government subsidized or section 8 tenants (NOTE: This isn’t a bad thing in and of itself. See our Section 8 and Government Subsidized Tenants Explained article for some of the benefits of these kinds of tenants).
- Highest amount of criminal activity
- High amount of deferred maintenance and obsolescent design
- Best avoided by the majority of investors
- Some investors specialize in finding the most responsible tenants in these rougher areas and have a PM team with class D experience. When done correctly, class D can be lucrative, but the risks are far higher than the other multifamily classes.
What does it mean?
For those of you just getting started in multifamily investment, you’ve probably heard terms like “class B” property thrown around casually.
It’s probably obvious to you that a class A property is better than a class B property based on the report cards we all grew up with in school, but what are the criteria that would cause you to classify one property as a “C” and another as an “A?”
In this article, we’ll explain the different classes, some of their characteristics, as well as provide some comments about the nature of each multifamily asset class when viewed as an investment.
Remember to Be Flexible
One thing to keep in mind as you’re purchasing properties is that you have to be flexible and willing to pivot based on market conditions.
You shouldn’t necessarily be married to one class over another and instead should maintain some working knowledge of all classes, even those you aren’t actively invested in.
Markets shift and change – your company should have the knowledge and capability to shift as well.
Having a well-rounded knowledge of all the classes of multifamily real estate will allow you to continue to provide your investors with the highest returns and lowest risk in a variety of market conditions.
Cap rate spreads between the classes of multifamily real estate. The more desirable a property and location, the lower the cap rate.
Class A:
- Less than 10 years old
- Lowest cap rates for the submarket they are located in
- Highest valuation on a per door basis
- Highest rents for the submarket they are located in
- The highest quality level in their submarket
- Are often mid-rise or high-rise apartments
- Typically located in urban cores
- Often accessible or located near public transportation
- Possess a high walk score and typically in trendier downtown areas
- Located in areas with high population growth
- White collar worker tenant base
- Tenant base includes high percentage of young professionals
- Typically include a more robust amenity package, ie. fitness rooms, saunas, common area working spaces
- Upon purchase, minimal work needed to be done. May still be areas of value-add, but the amount will be minimal to none
- Investors likely anticipate appreciation, however properly priced class A should cash flow just fine when the debt is structured properly
Class B:
- Range from 10 to 25 years old
- When compared to class A, there is more room for upside as an investor
- Provide a natural affordable workforce housing option (see our Workforce Housing Explained article for an overview of workforce housing and a discussion about subsidized workforce housing developments)
- Are often value-add opportunities
- Moderate price per door when compared to class A
- Some ability to push rents and drive up NOI, adding value
- Well maintained with minimal deferred maintenance
- Many garden style suburban apartments fall within class B
- Middle class tenant base that is typically a mixture of white and blue collar workers
- Tenant base may either live there by choice or by necessity
- Some tenants prefer lower cost, lower maintenance renter lifestyle
- Some tenants can’t afford or are working towards an eventual down payment on a home purchase
- Can benefit from and ride upward rental pressure from nearby class A properties as a more affordable alternative
- Typically do not require large amounts of renovation work
- Minor upgrades such as new countertops or exterior paint may be typical value add items for class B
- The cap rate spread between class A and B in your submarket can help determine which class to target. The difference can be as low as 10 basis points and can range up to 30 basis points. If the spread in cap rate between class A and B is minimal, investing in class A is advisable
Class C:
- 25-40 years old
- Provide a natural affordable workforce housing option (see our Workforce Housing Explained article for an overview of workforce housing and a discussion about subsidized workforce housing developments)
- Tenants will be blue collar with the occasional first time renter
- High “renter for life” population, responsible tenants that pay on time may stay in the same complex for many years
- May include some government subsidized / section 8 tenants
- Property management will end up rejecting most applicants as unqualified, must be pickier with tenant selection
- Property management must be more hands-on with the tenant base
- Rent collections may require more intervention from the property manager, collections may go overdue on a somewhat regular basis
- More work will need to be done than B class
- These properties are pretty much always value-add. Do not overpay based on the expectations of future performance, the value is based on the current state of the property
- Curb appeal renovations should be tackled before interior renovations. The exterior presentation of a property plays a huge psychological impact in people’s perceptions of its quality level. Improving the property’s curb appeal will help you improve the tenant base more quickly and easily
- These are the most attractive properties on a pure cash flow basis
- Higher cap rates
- Look for C class properties in B class submarkets. These deals have the most meat on the bone for value-add as you can reposition your property into class B under the right circumstances
- Properties gain reputations within a submarket. You and your team could do tons of work, improve the tenant base, fix or remove obsolescent building features, and the like, but bad perceptions of the property might still exist from its life under the previous owner(s). This negative inertia can sometimes take years to overcome and should be accounted for going into a class C investment
Class D:
- 40+ years old with no major renovations
- Highest cap rates
- Higher turnover with high vacancy rates
- May be in areas with declining population levels
- Good cash flow on paper, usually difficult to make a reality
- High amount of government subsidized or section 8 tenants (NOTE: This isn’t a bad thing in and of itself. See our Section 8 and Government Subsidized Tenants Explained article for some of the benefits of these kinds of tenants).
- Highest amount of criminal activity
- High amount of deferred maintenance and obsolescent design
- Best avoided by the majority of investors
- Some investors specialize in finding the most responsible tenants in these rougher areas and have a PM team with class D experience. When done correctly, class D can be lucrative, but the risks are far higher than the other multifamily classes.
