Multi-Family Building Class Definitions

Multi-family buildings or apartments are commonly discussed in terms of classes. By including the apartment class in a discussion, we can quickly get a sense of the condition, age, amenities, and rents in a given market. These class designations are not meant to be rigid definitions. There are many variations of these class definitions by experts throughout the real estate world. We researched organizations like the National Apartment Association and National Multifamily Housing Association for a standard definition and found none. However, there are many articles that discuss the different apartment classes.

What we do know is that there are always three (A, B and C) or four (A, B, C and D) classes of apartments with four being more common. It’s also common to have a plus (+) or minus (-) associated with the class designation when a property exhibits characteristics of more than one class. For example, a Class C+ property has most of the characteristics of a Class C property, but also exhibits a few characteristics of a Class B property.

When we evaluate multi-family opportunities for syndication, the class discussion always considers the market where the property is located. The rents or price per unit for a Class B apartment in a booming market in the southeast will likely be significantly different than a Class B apartment located in a mid-size city in the northeast. The building age for each class will also be market dependent. The Syracuse market, for example, has Class D multi-family units that were constructed around 1920. In the southeast, we see some Class D apartments that were constructed in the 70s.

While there may be some debate between classes in adjacent categories (e.g.,Class B versus Class C), there is no confusion between a Class A and a Class C asset. These apartment classifications are commonly used in discussions and are quite helpful in telling a story about the asset when engaging with potential investors. Given that classifying apartments has to be taken in context of the market and with the understanding that there are variations, we offer our definitions of the four apartment classes.

Class A

Class A assets have higher-end finishes and tend to be newer properties with many amenities. These amenities could include pools, playgrounds, dog parks, gyms, garbage valet service, in unit laundry, cleaning services, conference rooms, and much more. The high-end finishes are typically granite or quartz countertops, hardwood floors, tile showers and high ceilings. These newer communities have typically been built or substantially refurbished in the last 15 years. Utilities tend to be individually metered.

When evaluating this type of community from an investment perspective, we would not expect to see any deferred maintenance because the buildings are newer or have been renovated. Deferred maintenance includes items like older rooftops and aged or inefficient mechanical systems.

Tenants pay the highest market rents to live in these communities. They are usually white collar workers that prefer renting because they don’t want the additional burden that comes with the upkeep of a single family home. Also, the barrier to entering a community may be more affordable by renting compared to home ownership for a particular community. These new or renovated communities are usually located in affluent neighborhoods with good schools.

Class A buildings tend to be bought and sold at lower market capitalization (cap) rates because they tend to be lower risk. These assets usually have high occupancy, little to no deferred maintenance and good paying tenants.

Of course, there is always risk. In difficult economic times that affect white collar workers, tenants will move out of a Class A property to save on rent. However, no one can downsize into a Class A asset. Saturation could also be an issue if new construction outpaces tenants willing to pay for these high end living spaces. This could have a negative impact on a property’s net operating income.

Class A assets are often owned and operated by real estate investment trusts (REITs) or hedge funds due to their consistent returns. Class A assets require excellent management and rely on market appreciation because there is typically little room to force appreciation by updating or adding amenities.

Class B

The next step down from Class A are the Class B assets. These buildings are roughly 15-25 years old and tend to be in generally good condition. The finishes in a Class B asset are likely dated. When walking these properties, we may find carpet, older fixtures, and various wood-tone cabinets. Class B assets have some amenities, but they are likely limited. These properties are in need of mainly cosmetic upgrades. Residents of Class B properties are provided very nice living conditions similar to Class A without the expense.

From an investment perspective, Class B assets have significant potential to weather a recession. Tenants that move out of a Class B asset can be offset by tenants moving in from a Class A asset. If managed properly, a Class B asset should always be highly occupied. Also, in good economic times, Class C tenants will be looking to move up into this class.

The value of a Class B asset can be forced to increase. This is done by updating individual apartments with modern finishes. Amenities can also be added. Providing updated finishes in the living spaces and adding amenities allows for an increase in rents, which will offset the cost of the upgrades.

Because the building is not terribly old, it typically does not need a major renovation. Usually, the exterior of the facility is in good condition and requires very little work aside from possibly having to replace or repair the roof.

We love these buildings because we believe they are one of the safest real estate investments. Rents are generally affordable to a large class of tenants. The buildings are slightly aged, but in generally good condition. If a Class B asset can be acquired in the “path of Progress” in a growing metropolitan area, the owner may benefit from market appreciation at the time of sale or refinance. We include Class B assets in our portfolio if we can buy at the right price and have opportunities to force the appreciation.

Class C

Class C buildings are typically more than 25 years old. Tenants are likely blue collar workers and possibly a limited number of government assisted residents. Some of these tenants may be delinquent on their rent payments.

The buildings are outdated and have a decent amount of deferred maintenance. The building exterior, landscaping and parking lot may need work. These communities typically have few or no amenities. Typical finishes in the living spaces include worn out cabinets, laminate countertops, one-piece surround bathtubs, old carpeting, and poorly painted interior walls. In general, these properties tend to be tired and may be poorly managed.

However, we get excited about the potential of improving a Class C asset. Anytime we see those old brown wood cabinets with laminate countertops, we understand the value we can bring by upgrading the cabinets, installing new countertops and modernizing the finishes. These improvements command a higher rent and add value to the property by increasing its net operating income.

Class C properties are where the best value add opportunities are. They can be a challenge to operate because of all the work required to reposition the asset. However, we overcome this challenge with an excellent business plan and project execution. Through this process, we can maximize the potential of a Class C property or perhaps turn it into a Class B- asset. Ideally, we will find a Class C asset that is mismanaged in a Class B area. The property will benefit from the market appreciation in addition to the renovations. It makes it much easier to turn it around when the rest of the neighborhood has gone through or is going through the same thing.

The approach is much like buying the worst house on the best block. Same thing here, but 100 units instead of one. Note that no matter how much money you put into the rehab budget and how many amenities you add, it will be unlikely to turn a Class C property into a Class A property. Other times it can even be hard to repurpose a Class C- to a Class B as the market may reject it if it does not meet the Class B standards for that market.

Class C assets are our favorite to acquire due to their potential if acquired at the right price with the right business plan in place.

Class D

Class D properties are either over 35 years old or located in distressed or high crime neighborhoods. The facilities are worn down and dated. Extensive repairs are needed to the living spaces, exterior and mechanical systems. It is typical to see boarded up windows, damaged steps, wood rot, trash thrown about and junk piled up outside or on porches.

Rents for Class D properties are the lowest in the market area. Operating these properties requires a substantial amount of work to upgrade the facilities and manage the tenants. If acquired, renovation costs are extremely high, and it may be difficult to find reliable tenants that pay rent on time. Given the challenges of the local neighborhood and tenant base, it may also be difficult to justify rent increases that would offset the improvements. Because of the challenges, a Class D property comes with a significant risk to those acquiring such assets.

In my career as a licensed real estate agent, I have had potential seller clients ask me to list Class D properties for them. In one instance, I walked through a property and observed tenants living without hot water or a working stove. I refused to work with this seller until they improved the living conditions.

As a realtor, I have seen investors renovate in these areas, and they never seem to be able to force the appreciation to the value planned at the beginning of a project. If done properly, these properties can provide excellent returns if acquired for the right price. We have seen Class D properties buy and sell at cap rates over 20%. With high returns comes even higher risk. We do not target Class D properties for these reasons.

We will continue to search for a standard definition of the classes and will post any updates if we find something.