If you’ve ever bought a home before, you know that one of the most exciting parts of the process is making your list of must-haves and nice-to-haves. Your wishlist, so to speak.
Four bedrooms, two-and-a-half bathrooms, fully finished basement, in-law suite, two-car garage, on a quiet street, in a good school district, with low-maintenance landscaping, and complete with a tiny house in the backyard. Hey, a girl can dream, right?
Those wishlists are easy and fun to make, because you’re picturing yourself living there.
When you’re investing in a rental home or apartment building, however, it can be harder to gauge what to look for. After all, you’re speculating on behalf of someone else (i.e., the tenants). Will they want to live on a quiet street, or in the middle of all the action? Will they have kids? What about pets?
Part of thinking through your investment property wishlist is thinking about the tenants you want to attract. Are you looking to rent to families, young professionals, or retirees? Each will be looking for different things, and each renter profile comes with different considerations for you as the investor and/or landlord.
The Multifamily Properties Asset Class Report Card
Did you know that there are different property classifications for apartment buildings? Property classes for multi-family real estate ranges from new builds (which are usually Class A) to class B and class C buildings (which are the mid-range, more common classes of multi-family real estate) to class D apartments. Breaking down this large asset class into smaller subsets using property classification such as this helps you choose the best investment options that fit your goals.
When evaluating multi-family properties, a grading system is used to categorize each asset into a property class based on when the property was built, potential deferred maintenance issues, and more. Just like a report card, multi-family assets get a letter grade, ranging from an A to a D. There are no F’s in the apartment building world because, well, as long as the apartment building is standing, it passes. ?
Let’s take a closer look at these multi-family asset classes, as well as which properties tend to be a great investment opportunity.
Class A Apartment Buildings
Let’s start at the top, with Class A. Just as in school, Class A properties represent the top tier. These are luxury apartments. Class A properties typically are very recently built, located in the most highly desirable neighborhoods, and nearby 10-rated schools aplenty.
Inside the apartment building, you’ll find hardwood floors, granite countertops, modern fixtures, and stainless steel appliances. Bathrooms will likely include beautiful tile work, and maybe even a rain shower.
Class A apartment communities often include top-quality amenities as well. Full-service gym, resort-style pools, clubhouse, rooftop patios, dog parks, picnic areas, and anything else you can imagine.
Feeling right at home, aren’t you?
Just don’t forget that these well-located Class A properties also come with the highest rents.
Class B Multi-family Real Estate
Next, we’ve got Class B apartment buildings. Don’t worry, Class B apartments are still pretty nice. These multifamily assets tend to be in nice neighborhoods as well, often around the corner from a Starbucks or Target.
Class B apartments tend to have nice finishes too! Often, you’ll find hardwood look-alike flooring (high-quality vinyl or laminate), black appliances, solid surface countertops, and nice cabinetry.
Class B assets tend to be a bit older, built within the last twenty to thirty years or so, and the buildings tend to have little to no deferred maintenance.
Amenities in a Class B property can vary. Some may offer amenities that rival Class A properties, while others may have fewer amenities.
As you can imagine, rents for Class B apartments are lower than Class A apartments, so these multifamily assets tend to appeal to more of a working-class tenant profile, which can be a huge benefit to investing in Class B properties. More on this in a bit.
Class C Properties
Moving along, we’re now down to Class C properties.
If you’ve ever gotten a C in school, you know that it’s not exactly what puts a smile on a parent’s face. Not terrible either, just kinda in the middle.
That’s exactly what Class C properties are like. They often tend to be in more developing neighborhoods. They don’t particularly stand out when you drive by them – they’re not falling apart, but they’re not sparkling either.
Often, when you look closely at a Class C property, there’s some deferred maintenance (e.g., older roofs, peeling paint, etc.). Inside Class C properties’ units, you’ll often find more dated kitchens and bathrooms, as well as laminate flooring or carpets. I’ve certainly seen my fair share of “vintage” appliances in Class C apartments.
Class D Multi-family Assets
At the bottom are Class D apartments. As you can imagine, these are the apartment buildings you would normally avoid. There’s typically quite a bit of deferred maintenance and neglect, which is apparent even from a distance.
Class D apartments tend to be in the sketchier areas of town, where you probably wouldn’t want to be caught alone after dark.
The interiors of these multi-family units, as you can imagine, are consistent with the exteriors. Dated, worn, and poorly constructed. Don’t expect to find any stainless steel appliances here!
Comparing Real Estate Apartment Classes
Let’s start with a quick recap.
Class A properties are the highest quality apartments you can find. They’re in the best neighborhoods, with the best finishes, but also cost the most.
On the opposite end of the spectrum, Class D apartments are those you wouldn’t want to touch with a ten-foot pole. The buildings are often falling apart and are located in rougher areas of town. Just ask the cops; they tend to know these buildings well.
In the middle are Class B assets and Class C apartments, which, for us, are the sweet spot.
Why We Love Class B and C Multi-Family Real Estate
Seriously, y’all, Class B and C apartments are where it’s at.
At Goodegg Investments, we specialize in investing in Class B and C multi-family real estate because they provide the most potential value for investors, as well as the greatest potential impact for communities.
Opportunity for Value-Add in Apartment Classes
Perhaps the biggest reason we invest in Class B and C multifamily assets is because of the opportunity to add value. We typically look for properties that don’t have huge maintenance issues, like the need for roof replacements and foundation fixes.
Instead, we look for properties that have strong bones, but that need some cosmetic upgrades. Perhaps the kitchens haven’t been updated in 20 years, and bringing in some new flooring, cabinetry, and appliances would allow us to increase the rents to market rates, while also providing the tenants a home they can be proud of, and creating a greater sense of community.
In the commercial real estate space, value-add is a terrific strategy, as it gives us more control over the value of the property. Rather than relying solely on the market to appreciate, we can be proactive in improving the property, raising rents to market values, and thereby increasing the equity in the property.
Think of it as a fix-and-flip, just on a massive level.
Shortage of Workforce Housing
These days, any time you see a construction site for a new apartment building, you can almost guarantee that a Class A apartment building will be going up there.
Why? Because it’s just too expensive to build Class B properties, and especially Class C apartments, these days. Labor costs have gone up, and with all the work that goes into the permitting process, developers tend to focus their efforts on constructing the top-tier asset class (Class A commercial real estate), as they make the most financial sense for them.
What this means, though, is that, as the population continues to rise, and more and more Class A buildings hit the market, we’re seeing a shortage of workforce housing (Class B apartments and Class C buildings), as compared to demand.
As such, occupancy in Class B apartment buildings and Class C properties tends to be very high (90-100%), while occupancy in Class A apartments tends to see more variance.
Risk Mitigation During a Recession
The third reason we’re proponents of investing in Class B and C properties is that they allow us to mitigate risk during a recession.
During a downturn, as markets contract, people are getting laid off and losing their jobs. As a result, people who have been living in Class A apartments start to move to Class B properties, and from a Class B property to a Class C property, and so on.
During a recession, demand for Class C apartments and most Class B properties actually goes up.
It’s the luxury and new-build property asset classes (Class A) that are the most vulnerable during a recession since there’s a smaller pool of people who can afford those rents during a recession.
Because we tend to hold our investments for five or more years, we can’t predict when the next recession will hit. So, investing in more recession-proof asset classes allows us to hedge our bets and mitigate those risk factors.
So, Which Apartment Class Should You Invest In?
Come on, you know I can’t tell you the answer to that. The SEC would have my head on a spike.
All I can say is that there are investors who invest in each of the asset classes, from Class A to Class D, and there are ways to make money and have an impact in each asset class.
You’ll have to decide for yourself what your risk tolerance is, how involved you want to be, and what kind of impact you want to have. Then, you can start to identify which type of commercial real estate aligns best with your passive income goals and how to best diversify your investment portfolio.
Finally, when you decide that an investment opportunity in multifamily real estate will support those goals, you can begin to evaluate which asset class represents the return profile you need to support the lifestyle you want. A great place to start is by filling out this Real Estate Investing Roadmap.