What are the differences between Multi-Family building classes?

Question

I hear a lot about "A" - "B" - "C+" - "C" ect class multifamily buildings.

In layman's terms, what are the differences between these classes?

Thanks! :)

David Faulkner · Answer

I'll tell you a funny little story ... I moved from a C neighborhood, to a B neighborhood, to an A neighborhood. I like to do a lot of my own work on properties, so I have a bunch of power tools and such in the garage. Anyway, after I moved into the A neighborhood (and this is what made me realize it was an A neighborhood) one weekend we went away on a trip. Apparently when we tried to close the garage door, the sensor tripped and it didn't close, but we left without realizing it ... so the garage door was wide open, with all the tools exposed for anyone to take them. I got a call from my neighbor on Sunday ... he had noticed that the garage door was open all night ... he went over and closed it for us. When we returned, not a thing was missing after having a wide open garage door for 2 days. Thinking back on the places I used to live, I came up with this:

• A- You can leave the garage door wide open and nothing gets stolen, in fact your neighbor calls to let you know and shuts it for you.
• B- You have a 50/50 chance of something getting stolen if you leave your garage door open, but will be ok if it is closed.
• C- You have a 99% chance of something getting stolen if you leave the garage door open, and a 25% chance if it is closed.
• D & F- 50/50 shot with a closed garage. People case the place to see if/when you leave ... if you have something of value in the garage, sooner or later the odds will catch up to you and it is getting ripped off.

Michael Le · Answer

While it is subjective if you've seen a few, like Russell says, it's relatively clear if something is an A, B, or C property and if it is in an A, B, or C neighborhood. Whether it is a B- or a C+ is when the lines get much more blurred. For me at least I think of an 'A' property as somewhere I'd like to live. A 'B' as somewhere I would live if I had to. A 'C' is not somewhere I'd want to live. And a 'D' I wouldn't  want to be there at night and maybe not even during the day.

Account Closed · Answer

If you want stability in any market environment, stick to B & C. Amateurs often look for Class A, shiny new buildings that look pretty. But during economic downturns, Class B & C experience very little volatility in market values and market rents. Let me explain.

For ex. the decline in oil prices and resultant job losses in the Houston market caused many Class A tenants to downgrade to Class B, maybe even C. The rents for my partners Class B & C assets remained steady. And they own many 300+ unit buildings, lot's of them. They reported no change or drop in rents, but an actually uptick in occupancy levels and a large waiting list for tenants looking to move in. The Texas market also saw lot of new construction, many of them have lost some value and have had to lower rents and offer more concessions.

As an investor, you will always find value-add opportunities in Class, B, C and even D. I know it sounds bad when one thinks about class C & D, but it works. A article recently published in Biz Journal about a friend of a friend who purchased a 160 unit Class D- with $65k/month in rents brought it up to $90k/month. Fact is, most investors get discouraged when they tour Class C & D properties. They see the type of asset it is, the type of people that live in them and the overall condition and get discouraged. Most wannabe investors want to see granite counter tops, wooden flooring and nice appliances, all with a discount so they can get a good deal! That's impossible. Not going to happen. I brought many crappy buildings in MA to compete and I'm not going to sell that to you at a discount. You will find value in buildings that are kind of falling apart cosmetically or maybe even boarded up. Sure, location is critical, but the condition of the property is even more important. I know what I'm saying is counter intuitive. My partners own 1,400 units and they executed the same strategy. I use the same strategy as well. I just posted in the success story yesterday about one of my properties. Look at the before pictures. It looks bleak, but I see value.

So my take, focus on Class B & C for stability without having to worry about the impact the next recession will have on your properties and rent collections.

David Jenkins · Answer

@David Faulkner I'm keeping that one. From this point forward I'm calling it the "garage door analysis"

David Jenkins · Answer

Account Closed This all makes sense, thanks! Question -- What about the potential pitfalls of bringing a building back up to market value? Meaning... cost (especially hidden costs) - time - and if you're raising rents, that the current tenants will leave for cheaper options?

Tamar Mar · Answer

Ha!  @davidfaulker, your description rings a bell with me.  Especially because the last two properties we have renovated have been broken into.  Good way to think about it!

Andrey Y. · Answer

Maybe so, but when you look at strictly ROI/IRR (which is all you should be looking at), over time Class A assets (both single family and apartments!) outperform the rest. This is no secret why the so called "negatively cash flowing" markets are the ones with the highest total return.

David Thompson · Answer

I'll throw one other angle in there.  You have buildings classes and area classes (A,B,C,D).  You want to move up the scale from a building to an area standpoint.  What does that mean.  If you purchase a value add B/C class property, ideally you want it in a A/B area respectively to see the best opportunities to move the value up on that property with renovations.

Bruce Petersen · Answer

It is supposed to be a combination of asset age, amenities and rent per square foot.  All of these criteria would be compared to the sub market you are in and will vary.

For age of construction, I would call anything 10 years or newer "A" with respect to age of asset. B would be 10-20 y.o. and C would be 30-40 y.o.

Like previously mentioned this is an art and definitely not a science.  For example, I own a 256 unit apartment complex in Central Texas that was built in 1984 so by my above comment you would assume it is a C but because of the amenity package and neighborhood it's every bit a B.

I know not totally clear definition but hopefully this help.

Russell Brazil · Answer

@David Jenkins it is very very subjective.  Sometimes people will really be referring to the overall market like say DC verse Detroit...or to the age of the construction, or the tenant base, or the price of the rents.  Yet while it is very subjective, you all sort of arrive at pretty similar conclusions of what an A, B, C, D is even within that subjectivity, and it is hard to pin down exactly how we do that. It is just kind of like Malcolm Gladwell's book Blink, we just sort of know what class the building or area is intuitively through experience.

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