Although we are inching towards the later stages of the cycle, the multifamily investment market has remained healthy. Providing evidence of this is the fact that national vacancy rates have only slowly inched up in the face of high levels of new supply.1 But doing well in this sector involves more than buying an apartment building and sitting back as a passive investor. Before you start your property hunt, however, you need to ask whether that Class A “luxury” investment, or Class B “workforce” property fits your risk profile and your investment goals.
In previous articles, we’ve discussed the differences between Class A, Class B and Class C assets. The same definitions can be – and must be – applied to apartment complexes. Class A multifamily are the brand-new, amenity-laden, strategically located properties, which appeal to higher-income residents.
Almost all of the new supply that has delivered in the past several years – almost 320,000 units in 2017 which was up 5.3% from 2016 – is Class A, partly because building anything else is not cost-effective.2 Because these newer apartment developments tend to have a larger number of units, economies of scale can cut down per-unit maintenance costs. But vacancy rates can be higher than those of other classes.
Class B properties had Class A status when they came online in the 1990s and 2000s, but they’re older these days. They also might not have the same amenities as their newer counterparts. Interestingly enough, Class B properties (and Class C, to an extent), are called “workforce housing,” as they offer more affordable rents to the average working family.
Then there are the Class C properties. An investor can acquire a mature, possibly run-down Class C property for a relatively inexpensive price and then renovate it. Those upgrades can include adding or enhancing amenities such as a fitness center, swimming pool or package storage room; updating the units themselves with new appliances, countertops or flooring; installing state-of-the-art security measures; and refreshing the property’s exterior.
The Real Estate Adage
If you’ve invested in real estate, you’re likely already familiar with that infamous adage of “location, location, location.” The adage holds true with apartment investments. A multifamily property in a central business district might have higher rents – but could have more vacant apartments. Meanwhile, your suburban asset might be further out from employment centers and command lower rents – but could also be fully leased. Furthermore, if you invest in a Class B asset, and boost the value through property improvements, you could end up increasing rents by attracting a higher-income tenant mix.
Geography also matters – a downtown apartment investment in, say, Chicago, might offer a vastly different cash flow when compared to its purchase price than, say, one in downtown Seattle or one near Pittsburgh’s central business district. Consider Class A multifamily cap rates (NOI divided by purchase price) across two major metropolitan areas: New York and Dallas. Whereas in New York, Class A multifamily apartments trade on average at a 2.52% cap rate, in Dallas, Class A multifamily trades at a 4.56% cap.3
What’s Right for your Portfolio
We started this article by indicating that multifamily remains a strong investment sector, as it has in recent years. But, there is more to multifamily investments than buying an apartment building and hoping for the best. Understanding different property classes is important, especially as it pertains to your investment goals. As is the case with other real estate investments, the right property depends on the portfolio returns you envision, due diligence and other factors.
Finding the right apartment property to meet your investment goals can be tricky. The experts at Realized Holdings can help you determine the multifamily asset that fits your risk profile and investment objectives. For more information, call us at 877.797.1031 or log on to https://www.realized1031.com/.
- Steve Guggenmos. Multifamily 2018 Mid-Year Outlook. Freddie Mac. August 9, 2018.
- The Multifamily Sector: A Tale of Two Classes. Commercial Real Estate Direct. June 5, 2017.
- Retrieved from https://www.reitnotes.com/cap-rate-by-real-estate-properties-in-US-cities/