Not All Properties Are Created Equal – Multifamily Classification System
By assigning multifamily assets a letter signifier, those in the industry can get a quick grasp of a property’s features, as well as its potential risk and reward.
A quick glance through apartment listing online makes it clear that multifamily buildings come in a wide variety of conditions with a range of amenities. These characteristics, along with the building’s age, location, and renovation status, comprise a classification system used to identify apartment types.
Class A Properties
While investors pursue other property types with an eye toward renovation, class A properties have little room for economically efficient improvement. That is because class A assets are less than ten years old. Alternatively, they are sometimes a bit older but have recently been remodeled or are in a highly desirable area like a city center.
Class A properties feature the amenities that most people associate with perks of rentals: pools, fitness centers, parking options, and more. Those extras accompany a well-maintained structure with high-end finishes.
Given that class A properties are often in the parts of town with the highest demand, meaning high price tags and monthly rental income, investors like these buildings for property appreciation and revenue potential.
In addition, they offer the lowest amount of risk because they usually come with a reliable tenant pool and high operating income. On the other hand, class A buildings have the lowest cap rates, and consequently, the highest purchase prices. The high price tag leaves tighter profit margins.
Class B Properties
Whereas class A properties start with a high value, investors like class B properties for their potential for added value. They are a little older, often have some deferred maintenance, and command lower rents. As a result, class B buildings have the potential to become class A properties.
As such, investors pursue these properties with the intention to improve them, increase rents, possibly refinance early to return capital, and sell at a higher market rate.
Class C Properties
Class C properties also appeal to investors who wish to add value, but they will need much more attention than a class B property. Class C buildings are more than 20 years old, in less desirable parts of town, and require significant interior renovation and repair.
The worst class C buildings have large amounts of deferred maintenance and require major infrastructure repairs. As such, the exterior is usually visibly degraded.
Class C properties carry the most risk because the rents are low and may be irregular. Often, the tenants have lower incomes and only live in these units out of necessity, so there may be frequent turnover and disruptions to cash flow.
Lower end assets do carry huge potential for added value, but only consider syndications bed by an experienced sponsor who understands and can manage the risks of dilapidated building.
Takeaways for Investors
Use the classification system to filter for syndications that meet your appetite for risk and other investment goals at a given time. To further mitigate risk, only consider projects with with a proven track record of success. Alternatively, learn to be a real estate sponsor yourself and take the lead on real estate projects through my multifamily coaching program.