Rules of Thumb, Part 2.
In our previous article, we focused on unit mix and the importance of choosing an apartment complex with the most beneficial unit mix. In this article, we are going to focus on property classifications for investment realty.
Property classifications are important because the investor will know what type of earnings come with investment realty and he will be able to convey to brokers the type of properties he is investing in. An investor will become familiar with cash flows and cap rates associated with each class of investment realty.
A-properties are the most recently constructed units, those that contain top amenities, require low maintenance, and are inhabited by young white-collar workers. These assets tend to be more stable, have less risk, and charge higher rents, all of which are the reasons they trade at lower cap rates. This type of investment realty will appreciate more, but cash flow will be harder to come by.
B-properties have typically been built within the last 20 years, and it usually has a mix of white-collar and blue-collar workers. The property will show its age by a bit of deferred maintenance or functional obsolescence. You may also see older heating and cooling systems, roofs that have a bit of wear and tear and parking lots that need repair. B-properties have a good mix of appreciation as well as cash flow.
Additional read: How to Get Started Investing in Real Estate
C-properties tend to be at least 30-years-old and contain mostly blue-collar workers and section 8 tenants. They contain a fair amount of deferred maintenance, and these properties are poised for cash flow. There’s less appreciation potential unless the investor repositions the property and improves operations. This is our favorite type of property class to invest in because these tenants are less likely to purchase homes and will become long-term tenants if treated properly. Our broker in Knoxville refers to C properties as “crap” properties, but loves to invest in this type of asset because of ability to cash flow and reposition to a higher class. Investors are always on the lookout to buy a C property and reposition it to a B property.
D-properties, the lowest class of property, are usually located in inner cities where it’s difficult to collect the rent and vacancy rates are high. This type of investment realty is highly management intensive and the tenant base is often difficult to deal with. Investors get lured into investing in these properties due to the low prices, but soon realize they got more than they bargained for. Unless you can purchase a D-property and reposition it to become a C-property, you’re better off staying away from them.
Additional read: Your Multifamily Investing Questions Answered
To recap, here are a few rules of thumb for these property types:
- A properties will have the greatest appreciation, but the worst cash flow. Investors will buy these A assets because they tend to be less risky and therefore the return will be lower. The less risk the asset has, the lower the cap rate.
- B properties will have a good mix of cash flow, as well as appreciation.
- C properties have great cash flow, but appreciation is limited, unless forced.
- A properties have the lowest cap rates, ranging from 4 to 6.
- B properties are in the range of 7 to 9.
- C properties hover in the 10 plus range.
- D properties start at 13, and can escalate from there. Just remember, a 15 cap rate looks great on paper, but it means ZERO if you can’t collect the rent.
If you would like any more information on multifamily investing, please visit feel free to share your questions here. Please leave us a comment below and let us know what type of property types you invest in.