The ABCs of Determining Multifamily Investment Property Class
Investors, lenders, and brokers have developed multifamily investment property classifications to make it easier to communicate amongst themselves about investment properties and areas. The general property classifications used are A, B, C, and D.
These letter grades are assigned to properties and areas by characteristics such as age, tenant income levels, growth areas, appreciation, amenities, and rental rates, to name a few. It’s important to understand property and area classifications before investing so that you understand how they can affect your investments, and so you can meet and exceed your investment goals. You will also be able to effectively communicate with industry insiders what you are looking for.
While these letter grades can sometimes be more of an art than a science, the property classifications will typically be characterized by the following:
“A” Class properties are newer properties built within the last 15 years with the most amenities, highest income earning tenants, lowest vacancies, and will typically demand the highest rents with no deferred maintenance. These buildings are usually owned by Institutional investors and demand the lowest Capitalization Rates (CAP Rates), highest per unit prices, and generally have the most appreciation potential, but lowest cash flow starting out.
“B” Class properties consist of properties built in the last 15–30 years with some amenities; rents will be a bit lower than the A Class buildings with low deferred maintenance. These buildings demand rents slightly lower than Class A properties, with a mix of white-collar workers and more skilled blue-collar workers. Class B properties are typically owned by Institutional investors and private investment groups, or very high net worth individuals. They are valued at slightly higher cap rates than Class A properties and usually have appreciation potential with decent cash flow on acquisition.
“C” Class properties are typically older properties, built 30+ years ago with much fewer amenities, if any; rents are lower than B Class buildings and usually have more deferred maintenance and a lower occupancy rate. Your tenant base will be mostly blue-collar service employees, and could have a mix of government-subsidized tenants. These buildings are usually owned by private investors and private investment groups, and provide for higher cash flow and CAP rates, but will normally have much lower appreciation.
“D” Class properties are older buildings in challenging neighborhoods and potentially dangerous areas. They are older, with no amenities, have high deferred maintenance, functional obsolescence, and the tenant base can be very challenging and very management intensive. These properties will usually have double-digit CAP rates and will not have appreciation potential. D Class properties are the most challenging, and definitely are not recommended for most investors, especially new investors. While they might look like cash flow kings, the cash flow is often diminished greatly due to repairs and lack of payment by tenants.
When you look at areas, the classifications are very similar, with the same A, B, C, and D classifications as follows:
A — newer growth areas
B — older, stable areas
C — older, declining, or stable areas
D — older, declining, potentially rapidly declining areas
Have you determined what type of investment you are looking for?
The key is to pick properties and areas that are aligned with your investment goals. You should pick a property with a classification of equal to or better than the area (i.e. B Class property in a B or A area) and you want to avoid areas that are lower than your property class (i.e. A Class property in a C area). The area you invest in is going to have a great deal of influence on the stability of your investment over time, as well as its growth or appreciation potential. Areas with the highest appreciation potential are A and B areas, while a C area might be more sensitive to economic trends. Also, an A Class property is going to have a much harder time performing like an A property in a C Class area, and a C Class property might perform better over time in an A Class area.
For example, if you are looking for investments with the most appreciation potential, but aren’t worried as much about the initial cash flow, you’ll want to look for A and B Class properties in A and B areas or in the path of progress, and avoid C Class properties in C areas. If you are looking for investments with strong cash flow, but appreciation is less important, Class C and B properties in C and B areas would be the best fit.
Now that you’re more familiar with the ABCs of multifamily property and location classifications and how they can affect your investment, you will be able to more effectively communicate with real estate professionals what you are looking for, and you can apply this knowledge to your investments so that you can meet and exceed your investment goals.
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