What is meant by the multi-family property classifications A, B, C, and D?
In investment terms which of these property types are classified as core assets and which can be considered core-plus assets?
If you are looking to pursue a conservative investment strategy or if you prefer a more aggressive one that has the potential to deliver a higher yield in which class of multi-family property should you be looking to invest?
All these questions and more will be clearly answered in this article.
Classification – Class A
Class A multi-family properties are buildings that are less than 10 years old. If they are more than 10 years old, they will have been extensively renovated.
The fixtures and fittings will be of the very best quality.
The amenities will be comprehensive and of a luxury standard.
While Class A properties tend to generate a lower yield percentage, they can grow exponentially and they tend to hold their value even in major economic downturns.
In terms of their investment profile, they are considered to be core assets.
An article on multi-family investing at millionairedoc.com explains why Class A apartment buildings, with a ‘core asset’ risk profile, offer a lower yield percentage:-
“Owners purchase these properties using lower leverage, therefore with lower risk. REITs and institutional investors purchase these assets for income stream. The lower risk profile results in lower returns in the 8-10% IRR range.”
A property in the Class A category would not likely have a “core plus” risk profile unless it were slightly downgraded in some way perhaps by a less favorable location, housing type or a number of other factors.
Classification – Class B
Class B properties are older than class A properties. Usually, class B properties have been built within the last 20 years.
The quality of the construction will still be high but there could be some evidence of deferred maintenance. The fixtures and finishings will not be as high quality and the amenities will be limited.
Classification– Class C
Class C properties are built within the last 30 years. They will definitely show some signs of deferred maintenance.
The property will be in a less favorable location and it will likely not have been managed in an optimum way.
Fixtures and finishings will be old fashioned and of low quality. Amenities will be very limited.
Both Class B and Class C properties can be candidates for a ‘value add’ investment strategy.
By bringing deferred maintenance issues up to date or by upgrading the property by means of an interior and/or exterior renovation there is an opportunity to increase the tenant occupancy and receive a higher return on your investment.
In his article, ‘what are the 4 investment strategies?’ Ian Ippolito explains why pursuing a value add investment strategy is a higher risk:- “Much of the risk in value-added strategies comes from the fact that they require moderate to high leverage to execute (40 to 70%). Leverage does increase the return, but also increases the risk, and makes the investment more susceptible to loss during a real estate cycle downturn.”
Classification – Class D
Class D properties are generally more than 30 years old. The property will be showing signs of disrepair and will be run down.
The construction quality will be inferior and the location will be less desirable.
The property may be suffering due to prolonged and intense use and high-level occupancy.
Both Class C and Class D properties can be candidates for an ‘opportunistic’ investment strategy.
Because these properties require major renovations they are the highest risk investments but they can also yield the highest returns.
Summary
In overall terms, the US multi-family real estate market continues to give excellent returns for well-informed investors.
This article has clearly explained how different types of multi-family properties are classified. The article has also given an overview of how each class of property fits the different types of investment profiles. We trust that this information will assist you in assessing your multi-family real estate investment goals.
For further assistance please connect with our team.
The demand for rental accommodation continues
to significantly outpace supply. The current status quo is that rental housing
supply is falling short by hundreds of thousands of units each year across the
United States. This situation, according to The National Multifamily Housing
Council and The National Apartment Association, looks set to continue for many
years to come.
Current demographic preferences reveal a trend
at both ends of the age spectrum for renting as opposed to owning. The younger
demographic are finding it more challenging to get the financing for property
ownership and the baby boomer generation favor downsizing and the increased
freedom that allows. The result is that the demand for rental property is
increasing.
The combination of these two market factors
gives a strong positive indication for sustained revenue growth in the
multifamily sector. The conditions look
set to remain positive for multifamily investment in most locations for the
foreseeable future.
Let’s take a look now at four more reasons why
investing in multifamily makes good financial sense.
#1 Economy
of Scale
The basic meaning of the economic term, ‘economy
of scale’ is that there is a fundamental cost-saving benefit to being bigger.
To quote Investopedia, an ‘economy of scale’ is
an advantage “that arises with increased output of a product. Economies of
scale arise because of the inverse relationship between the quantity produced
and per-unit fixed costs.”
How does this concept apply to the argument
that multifamily investing is more advantageous than investing in single-family
property?
To give a simple example, if you have been
collecting 10 rents for 12 months from your multifamily property and then the
roof needs fixing, that’s a much better scenario than collecting 1 rent for 12
months on your single-family property and then the roof on it needs fixing.
The rationale applies even more if you add more
single family properties to the equation. The cost of managing 10 individual properties,
which could be spread across multiple states, and the cost of hiring different
contractors to care for each one would be punitive. The cost would be much
greater and the management less efficient and less cost-effective than caring
for one multifamily property of 10 units in one geographic location.
#2 Greater
Control of Property Value
With a single-family property, you are almost completely
at the mercy of market forces.
If you need to sell in a down market your hands
will be relatively tied. The value of your property will be determined by what other
properties have sold for in the local area at that time.
A multifamily property is perceived somewhat
differently because of its commercial nature. It is managed and run as a
business and therefore a significant part of its value is determined in the
same way as a business. This means that the value is much more in your own
hands.
Businesses are valued largely on their
profitability and, in a similar way; a multifamily property’s value is
determined by its net operating income.
Something as straightforward as adding a
laundry facility or some paid parking are two examples that can very positively
affect the profitability of your multifamily property and in turn, its value.
With a multifamily property, there are many more
ways that you can bring your management and entrepreneurial skills to bear to
increase the value of the property independently of the surrounding property
market.
In a nutshell, you have the ability to raise
the value of your multifamily property by decreasing expenses and increasing
income.
#3
Positive Cashflow
In addition to the ideas mentioned previously, namely,
adding laundry facilities and paid parking, there are lots of amenities that
could be added to your multifamily property to keep positive cash flow.
In addition, the old adage of not having all
your eggs in one basket applies here also. A tenant vacancy in a single family
rental property will bring your cash flow to a grinding halt. In contrast, if
one of your units in your multifamily property is vacant, the impact on your
cash flow will be minor because you will still be collecting rent from all the
other units.
#4 Tax
Benefits
One of the great things about supplying housing
for the populace is that in doing so you are helping the government fulfill one
of their important responsibilities. Not surprisingly, in return, the
government offers you certain tax advantages.
One of the most significant tax advantages for
multifamily property owners is something called ‘depreciation deduction,’ in
effect it can allow you to deduct a large amount of the income your property
generates. For details on how it works, take a look at the following Investopedia
article, How
Rental Property Depreciation Works.
Another way multifamily property tax laws
benefit you is that you are permitted to use some of the cash flow from the
property itself to pay down the mortgage.
It is permissible to collect revenue but show a
much smaller amount of income on your taxes. This allows you to take a portion
of that rental income and use it to pay down your debt on the property, which
will steadily increase the equity.
With the help of a good tax advisor, you may
find that there are many other legitimate ways to capitalize on the tax
deductions and incentives and even grants that the government makes available
to multifamily property owners.
Summary
In the present fluctuating economic climate
multifamily properties are tangible assets that represent a sound focal point
for your investment and wealth creation strategy.
Due to shorter lease terms that give room for
regular increases in rent, multifamily assets represent less of a risk than
other commercial real estate investments.
The prevailing demographics are also favorable.
The steady increase in the number of professionals in the workplace, families,
and empty nesters looking to downsize and simplify their lifestyle means that
focusing on the multi-family market makes sense.
Multifamily is and will continue to be a solid strategy
for investors looking to achieve financial freedom by means of strong investment
returns that are attractively low risk.
