Do C class property only attract C class tenants and what to do about it?

22 Replies

Hello BP!

I keep reading on BP and elsewhere that renting to high quality tenants is the most important risk control a landlord can have. There were a few BP blog posts on this topic with the main idea that if you want to have a steady income and few headaches from your properties rent them to those with 650+ credit score, income of 3.5 rent payments, etc. I totally agree with this idea but the reality is quite different.

I am looking for properties either SF or small MF with cap rates of 8% or better. Sometimes I even find them but they all are C class in C neighborhoods populated by C tenants.

There is another interesting fact I learned. I always thought that security deposit is supposed to be one month rent and sometimes even higher (pets, waterbeds, etc.) but looking at rent rolls of two completely different properties (C and B!) I found that the actual deposits ranged from 0 to $300 on $700-800/mo units. An owner of yet another C class apartment confirmed the same. 

Is the small deposit a function of class C properties and C tenants? I thought it would be the opposite as higher risk people should have higher deposits.

If I don't want to deal with C tenants, what kind of property should I look for? A or B seems the obvious but the cap rates are a lot lower and the properties are generally more expensive.

If I buy such a C class property, are C class tenants is my only option? I can renovate a building and make it more attractive but I cannot change the neighborhood. So, why A or B tenants would want to live there?

Thanks
Nick

Right now, I have what I consider a Class A tenant in a Class C/D neighborhood. Actually, I've had several over the years, until a major life event threw them off the rails. The main difference I see with tenants in this kind of area is that they are rarely able to cope with a major setback - job loss, relationship breakup, unexpected family addition. Without a financial cushion, or a family in a financial position to help them, they can become Class F tenants almost immediately. One missed paycheck is a disaster.

These tenants live in Class C/D areas almost by necessity I would imagine. You live where you can afford, or close to where you work. Rents are lower than in better areas. Or they can get a larger property for less money. Or they have friends/family there. If they've lived in the area for any length of time, they likely have a higher tolerance level for what the area offers.

I don't bother with credit checks for these tenants, or 3.5 times the monthly rent in income. I check for evictions and criminal background. The security deposit is non-negotiable. In NJ, 1.5 times the monthly rent is the highest allowed. And when a tenant has gone bad, it's never been enough to cover the damage and/or lost rent. Some landlords will charge less, knowing that a large deposit may be hard to come by. Probably true, but I need to protect my property as best I can. Tenants have often gotten their security deposits from church groups or social services. 

We stopped investing in these areas a long time ago, but investing in much better areas doesn't guarantee a trashed property won't occur, or evictions.

Hi @Aly L ,

Thank you for your feedback. Are your properties SF or MF? The ones with lower deposits in my examples are MF - 16 units (C) and 341 units (B), different locations and sizes but similar deposits.

I understand why people may choose to live in "C" environment but my post was not about it. I am trying to decide if C is worth the trouble at all.

I have heard several stories of distressed C or D properties being "repositioned" to B and even A (so called "value play") but these stories seem to be more of an exception than a rule. Am I right in this assumption?

Thanks
Nick

Maybe the sort of rules you are talking about make sense in cities, or other areas with transient populations where there is a steady rental pool.

For me in my rural area, I would almost never get any tenants.

650 FICO + income 3.5 times rent + several thousand dollars in the bank(for deposits) = Buying their own house.  

So I would have to count on people who were moving in and might be moving out again, or were auditioning the area.  There just aren't enough of those.

So I figure I am getting 2 or out of 3, at best.  Personally, I want the deposit more than the income, and I rate references over FICO.

I have 3 rentals.  One has a fantastic couple with great credit and income, who paid the full deposit.  They will buy very shortly if her job as an ESL teacher at our local high school doesn't go away.  I may never see others like them.

The other 2 are young families with thin credit files and income that is on the line.  But local ties (so in the event of issues I can glare darts at their moms in the grocery store, who will promptly investigate what is up, and I'm actually not kidding) and they came up with the deposit.

@Nick B.

Here is my experience. I own Class A, B and C properties.

1. Deposits are generally lower on Class C properties because most Class C tenants can not afford Rent and Security deposits up front. Typically you get a little from them so they can afford to move in.

2. Class A have the lowest Cap rates and Class C can have the highest. However, Class C requires a lot more work and dedication. If you are not in for the work, go for the lower cap rates, if you can afford time and energy, go for the Class C .

3. All my Class A or B were Class C. I found a growing neighborhood, bought a Class C Apartment complex and held on to it for awhile. When the area was ready, I renovated and rented out to a different tenant. 

My advise, drive by emerging areas and look for apartment complexes that seem run down. Contact owner and see if you can buy. You will know when the time is right to flip your Class C into a Class B.

Brett

Hi Nick, sorry, I thought you were asking about an A or B tenant living in a C area, and sometimes you'll get those. 

My properties are SFRs in that area. I would think that in a C area, you'd need to be really careful about the tenant mix in a multi, because it only takes one or two bad tenants to drive out the good ones. To reposition a distressed C or D property itself might be easier, with enough money to throw at it. But the value play of filling a building with good tenants to attract more good tenants might be a lot harder to accomplish. At the unit sizes you're looking at, a property management company would likely be handling them, no?

I lived in a multi-family in a marginal area many years ago. At one point, there were 2 old ladies in one of the apartments, and they were so disruptive to the rest of us that had the landlord not offered them a version of "cash for keys", he would have lost 3 other good tenants. They were definitely Ds.

@Nick B.  From California I was surprised how difficult it is to get fair SD in both my B and C properties in Texas. I am not sure about other states or regions.  

A B property in a c/d area is going to have a tough time getting b tenants. That is why the neighborhood is so important. You can bring up the property, but the hood is tougher.

Medium sig  3 Jeff Greenberg MBA, Synergetic Investment Group, LLC | [email protected] | 805.372.1799 | http://www.synergeticig.com | Podcast Guest on Show #115

@Brett B. , could you please share basic stats about your apartments? Age, # of units, occupancy & cap rate when you bought and now?

How do you define "emerging area"? I can see a bad area from a good one but not sure about emerging. 

It is interesting that you advise "driving for dollars". I always thought it is good for SF and it has never appeared to me that this method is good for apartments as well. I rely on marketing materials provided by brokers, mainly Marcus & Millichap. The financial details are there as well but to fit them in my model the price has to be cut severally.

@Aly L, 16 units are currently managed by the owner and I am debating to do the same or go for a management company. I looked at 341 units for information and edication - I am not in the position to buy one.

@Jeff Greenberg , I agree about neighborhood. Buying C property in A neighborhood is ideal but the opposite is now.

@Ben Leybovich , thank you for stopping by. I know what the right thing is (e.g. A class apartment with 10% cap) but I doubt it exists. So what's the solution?

@Ben Leybovich , I continue to learn and this post is a part of a learning process as well as reviewing financials for properties I find attractive.  

But why do you say I could not make money with A class and 10% cap? Buying A class at 10% cap in my area means buying it at half price. Anyone can make money if they have 50% instant equity and cashflow on top of it.

You'll never buy A Class at 10 CAP - that's pipe dream. A Class will set you back 4-6 CAP, and you can't make money in that neighborhood. A Class isn't meant for making money - protecting money.

On the other hand, 10 CAP could make money, but only if it's the right kind of 10 CAP :) Not if it's advertised as 10 CAP...

@Nick B.

I have a lot of projects so I will just focus on 1. It was a 12 plex that is in an artsy type area of town.The complex was built in the 1960's and were all 1/1. All 12 tenants were on SSI and hung around the property all day long. I would say that it was about a 8 cap at 90% leased.

A few months after purchasing it I kicked everyone out, sunk a ton of money into it, turned the laundry room into an efficiency and made it a 13 unit complex. The property is 3 years old and I have little to no turnover. I went from a Class C all bills paid to a Class B and no bills paid. I have increased the property to a comfortable 15 cap and increased its value by 37% over acquisition and construction.

As for emerging areas look at the trends. Are there house flippers coming to a certain area? Are there people fixing up their homes in particular neighborhoods? You only need a few people to start to improve an area before it starts to pick up. Look for those artsy areas. Those seem to pick up at a rapid rate.

@Ben Leybovich   is right. Class A properties at a 4-6 cap is a great way to protect money but not really make any. Anyone selling a Class A at a 10 cap for a good price sounds a bit fishy.

Brett

I know all that, of course. I used A @ 10 cap as an example of something that even I can recognize as a bargain :-) Recognizing the other 10 cap property is a real challenge though.

Originally posted by @Nick B.:

I know all that, of course. I used A @ 10 cap as an example of something that even I can recognize as a bargain :-) Recognizing the other 10 cap property is a real challenge though.

 The above for meant for Ben

@Nick B.

I will say that @Ben Leybovich is also right about advertised deals. Marcus and Millichap is a very reputable firm. However, if you are going to one of these brokers to make money, I would tell you that you would make a lot less from those deals as if you were to find a person failing at a property and scooping it up. These deals usually comes from small brokers and people you may know in the industry.

@Brett B. , how did you find that particular property? Was it listed with any broker or was a drive by?

Thanks
Nick

@Nick B.   That property came from the guy that I had purchased a similar 10 plex from 2 years earlier up the street and did the same thing to.

The first complex I bought from him I found on MLS. What I used to do is find several properties in an area that I was interested in. What I would do is make a dozen low ball offers. Out of 40 offers you may get one call back. That is all you need.

You never know someone's motivation for selling. Some are trying to make money, some are trying to get out. I have had a deal where this guy had a property listed for $200,000 more then what he took for it. Come to find out, he still made a few bucks getting out so he was ok with that. His hope was to make a big splash on the way out but nobody was biting. Him calling me back on my low ball offer opened the door for me to convince him why he would never get what he was asking and my deal was the best he was going to see.

If the deposits are low it can be a sign that there is an oversupply of that particular type of unit. If a place sits vacant for too long the landlords/managers will start offering deals like "no deposit!" "$99 moves you in!"

Of course, that could have just been the situation when those particular tenants moved in and the vacancy rates may have dropped since then. Check craigslist and see if those sorts of deals are currently being offered.

My apartments are C class, but we can still charge a full month deposit and a full month rent at move in. But they are the nicest units in the area at that price point. This means that we are at least dealing with folks who have the wherewithal to pull together that sum. It doesn't, of course, guarantee their ongoing financial security. Like Aly NA  said, there's no cushion, so things can, and do, fly off the rails easily. 

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I bought a quad in a C area, not a high crime area, just working class.  We renovated the building upon purchase; new siding, new roof, new windows, new hand-rails on each unit, the works, plus a new AC on one unit.  After the work was done, I was hit hard with move-outs, evictions and vacancies.  Some of the tenants though that I would raise the rents to pay for all the work.  Truth be told, the property was a good deal when I bought it, and I got the seller to pay for most of the work, apparently he really wanted to sell.

When we were trying to place new tenants, we were having trouble getting any interest.  We advertised on multiple web-sites, had a big sign up by the high way, nothing.  We even offered 1/2 month off discounts.  Nothing.  We then raised the rents about $40 a month, and with in a week all my vacancies were gone. 

My take away was that even though it might not be the nicest part of town, people still have their pride, and if the price sounds too good to be true, they will not even look.  Had I know that raising the rent was the answer, I would have tried that first.  Since then, we haven't had any issues, and I have encouraged the other owners on the block (all quads on the street) to do the same thing.

Thank you @Jesse Waters for your story. Lowering rent would be my natural reaction as well but your example demonstrates that the opposite was the right approach. I will keep this technique in my tool-box :-)

I see reference to Class A, B, C in this thread.  I can extrapolate the references to understand the designations; however, I was wondering if there is a more formalized outline somewhere which highlights specifically the qualities/characteristics which categorize class A - C?

Here is one definition: 

http://www.boma.org/research/pages/building-class-definitions.aspx