Classification of Multifamily Property
Many different descriptions and categorizations are used to classify commercial real estate. While the most high-level classification is the type of asset (i.e. multifamily, industrial, retail, etc.), perhaps the second most common descriptor is the asset class. The multifamily classes range from A-D with “A” being the newest and most expensive. The purpose of categorizing properties in this way is to give a quick all-encompassing description of the asset’s age, geographic location, overall maintenance and the type of renter it attracts.
Class A properties are the newest and most expensive class of multifamily property. They are usually less than a decade old and are located in prime areas. Most renters in class A properties are renters by choice (i.e. they could purchase a home if they wanted) and they typically work white-collar jobs. Because of their age and desirability, class A properties are typically valuated the highest and will sell at the lowest cap rate in a given market. Investors purchasing class A properties are typically less interested in immediate cash flow and more in long term appreciation potential.
Class B properties are slightly older but still typically built within the last 20 years. Although the buildings could not be described as new, they are typically well maintained. Many tenants are renters by choice with a few renting out of necessity. The work force is a mix of white-collar and blue-collar employees. Although the cash flow is more than an A class property, they are still bought more for appreciation than cash flow.
Class C properties are noticeably different from A and B class properties for several reasons the first of which is that their age can be as much as 40 years old. Renters in C class properties rent from necessity and are statistically likely to rent their entire lives. Although C class properties come with more inherent risk (due to their age and tenant base), they offer the opportunity of purchasing a property at a lower price (higher cap rate) and often appreciate more quickly in a market that is improving. Investors typically have an interest in C class properties when they are either looking for a high cash flow return or hoping to reposition (change) the class of the property to a B if the geographic location will support a B property.
Class D properties are the most challenging to own and manage due to their old age and tenant base. Some can be more than 40 years old and are typically not well maintained. The locations where D class properties reside are often marked by high crime and require intense management. Many of the tenants are unable to qualify for better housing which leads to many issues with nonpaying tenants or tenants who are on government subsidization programs. Class D properties are reserved for investors who are willing to take a higher level of risk for the best cash on cash returns available.
So which class of multifamily should you be looking to invest in? If you are an experienced investor looking for high cash flow, then maybe class D would be suitable. Most investors however prefer to avoid these properties and their associated risk. On the other hand, unless you are a high net worth individual looking to park money for a long period of time or a REIT (real estate investment trust) then you probably will not be interested in class A either. For the most investor, a B or C class asset is typically suitable just depending on your appetite for risk and your preference for returns coming from cash flow versus long term appreciation.
If you would like to learn more about investing in multifamily real estate or have any other questions, please schedule a call with us here.