Multi-Family Asset Classes - Why I like B/C Apartments
Updated: Jan 6
Multi-Family Asset Classes
You’ve been reading about investing in apartments and are intrigued by the idea of passive income, but the more you read, the more you realize there is a lot to learn.
That is true, I won’t sugarcoat it for you.
One of the main points you need to define is your investment criteria. What type of properties do you want to invest in?
That’s what we’re going to discuss today. The different Multi-Family asset classes and how you can quickly tell what’s what.
Multi Family Assets are graded A through D. Just like in school, A’s are the best and you’ll want to avoid the D’s. When I was in school, I managed to avoid D’s for the most part…. except for Spanish class…. Hola!
Let’s jump right in.
Class A Properties:
As mentioned above, Class A properties are the cream of the crop. These are luxury apartments in highly desirable neighborhoods. We’re talking granite countertops, stainless steel appliances, tile showers, etc. The complex itself will typically have resort style pools, a full-service fitness center, dog parks, valet trash, etc.
These complexes are typically built within the last 10-15 years and the tenant profile is typically white-collar folks who rent by choice, not necessity.
These properties have the highest rents, highest price per door, and have low market caps. Cash flow tends to be on the lighter side and investors are typically looking for appreciation here.
Class B Properties:
Logically, after Class A comes Class B properties. Class B properties are still very nice, generally well maintained, and are often found in nice neighborhoods. Typically built in the last 15-30 years, these apartments offer some nice interior finishes as well. You’ll likely find vinyl plank flooring, solid surface countertops, black appliances, and above average cabinetry.
Amenities in class B apartments can vary widely. Some rival those of class A with nice pools, a clubhouse, fitness center, and gym. Others might not offer any of those.
These properties typically have a mixed tenant profile of both white and blue-collar workers. Some renters are there by choice, others by necessity. Think of a more working-class profile, which can be a benefit to you as an investor.
Investors look for more cash flow than Class A, but still might expect some appreciation as well.
Class C Properties:
Like you can expect, Class C properties are sort of average. They aren’t going to blow you away, but they aren’t bad places to live either.
Typically built over 30 years ago, you’ll often find them in more developing neighborhoods. You can expect some deferred maintenance (old roofs, peeling paint, etc.) with outdated interiors. You will likely find laminate flooring, carpet, and old white appliances in these types of properties.
The tenant base here is blue-collar and low-to-moderate incomes. Most of these renters are there by necessity and may be renters for life, but you’ll also have younger folks just starting out in their careers.
Class D Properties:
Like in school, D’s are bad news and you’ll more than likely want to avoid them. These are properties in sketchy parts of town and places you don’t want to be after dark.
This is typically government housing and what some would consider the “projects.”
Newbies can get caught here, as on paper these deals can look like they produce great cash flow. However, they require intense management and even security at times. There is likely a lot of deferred maintenance and high vacancies at these types of properties.
I would highly encourage you to avoid these types of properties all together or be sure you’re aligned with an experienced team when trying to tackle this type of property.
Just kidding, but to quickly review what we’ve learned so far:
Class A apartments are the best and highest quality apartments you’ll find. They are in the best neighborhoods, have the most amenities and attract the highest rents. But they are also the most expensive and have less cash flow.
Class B & C – not as nice as class A, but still solid apartment communities with some amenities. Safe and affordable
Class D – stay away, seriously. You’ve been warned
At Bonne Capital, we focus on Class B and C Properties
B and C properties give us an opportunity for value add, provide reduced risk, and still kick off healthy cash flow. Let’s dive into a bit more detail on these three components of B/C housing.
Opportunity for Value Add
Our focus is on value-add apartments, and these are often found in the B and C communities. I’m not interested in major turnarounds. I’m interested in making some small and predictable improvements to increase NOI and ultimately the assets value. The deals we buy have typically been well maintained by the previous owner and that owner was making good money, but we see an opportunity to increase rents through a renovation strategy, management play, etc.
For example, many of the assets we acquire have outdated interiors. The current owner didn’t keep up with the more modern look that today’s tenant demographic demands, and therefore rents have stalled accordingly.
We go in and update the cabinetry, flooring, and appliances and then can increase rents to market. Our tenants don’t mind, as they see the new owners have a vested interest in improving the property and ultimately the community. And notice I said, “market rents”, meaning we aren’t charging higher than all our competitors as tenants can pack up and move. If we can offer a superior product, but similar rents, we’re in really good shape from a competition standpoint.
These properties allow us to mitigate risk during a recession as we are investing into workforce housing. All the new development going on is being built for Class A as it’s simply too expensive to build anything less than Class A given the many fixed expenses during construction (labor, permits, etc.) With the increased class A supply, we’re facing a shortage of class B/C affordable housing.
So how does investing in B/C reduce my risk?
Think about it, class A has the highest rents and therefore when a market correction hits, those properties will be impacted the most as folks can move to more affordable Class B apartments. Or, class A owners will have to greatly subsidize rents to keep their tenants in place. Either way, not good for investors.
So Class A moves to Class B and Class B to C…we don’t see as much C to D. Class C is the most affordable before you get to the government subsidized housing we mentioned before in Class D, and folks want to avoid moving to D at all costs.
You can make the argument that the demand for Class B and C apartments increases during a recession, and therefore I like that I’m investing in recession-resistant assets that have an upside.
Cash flow tends to increase with risk, and it should. D properties have the highest cap rates, meaning investors demand better returns given the level of risk.
We already agreed we would stay away from D properties as they are a high risk, high reward play. I’m personally not interested in any high-risk opportunity. I can get above average returns with less risk, so no need to make those mistakes.
But what about the cash flow on B/C properties? Is it good enough to weather a storm?
Short answer is yes, at least in the deals we’ve done recently. Always ask to see a sensitivity analysis when looking at deals.
The sensitivity analysis we’ve put together on our recent deals shows that we can go to 70-75% occupancy and still cash flow. If you look at the 08-09 recession in the markets we invest in, vacancies rarely got below 85%. Therefore, that data tells me I can weather a storm worse than 08-09 and still come out OK. I may not get the projected returns I’m expecting, but I’m not losing all my money either.
Cash flow is king, don’t let anyone tell you otherwise.
Which Multi-Family asset class do you prefer to invest in?
It’s certainly up to you, but I’ve laid out the reasons why I like putting my money in B/C apartments. You can certainly make money in any of the asset classes, but is it worth the risk?