GUIDE TO UNDERSTANDING PROPERTY CLASSIFICATIONS IN APARTMENT BUILDINGS

Apartments or Multifamily real estate investing breaks down into four distinct asset classes: Class A apartments, Class B apartments, Class C apartments, and Class D apartments. Multi-family assets are evaluated primarily based on their location, age, amenities, and level of rental income.

As investors, it is important that you have the ability to understand and distinguish between the four, which will enable you to determine which asset class best fits your apartment deals and goals as well as which ones you should avoid.

 

APARTMENT ASSET CLASSIFICATIONS

1. Class A Apartments:

These are newer apartments built in the last 10–15 years in higher-growth areas. Amenities found in Class A properties would include workout facilities, a resort-type pool area, a dog park, some concierge features, and more. Tenants would typically pay the highest rents at an A-class property to enjoy these amenities. 

From an investment perspective, the CAP rate for a Class A property would be lower than for the other classes in the same geographical area, and it would have a potential upside in appreciation if the management can continue raising rents. However, these properties are often more expensive than the other classes, and the additional cost to invest is not statistically correlated with the potential income. 

 

 

Class A Apartment Properties

• Newest and most luxurious apartment complexes built within the last ten years
• Located in popular and desirable areas
• Class A apartments have the highest price per door
• Market cap rates are generally lower than any other multifamily real estate asset class
• In most cases, investors purchase for appreciation

 

2. Class B Apartments:

These are apartments built in the last 15–20 years and would include some amenities to attract those who might not want to rent from a Class A property, though the amenities are not as extensive as those in the A class category. The tenant mix would be primarily composed of working-class long-term renters. There is usually some deferred maintenance to account for when considering an investment. 

The Class B apartment allows the investor to realize higher rents when the upgrades are complete. Class B will usually sell at a higher CAP rate than would a Class A in the same general location, and like Class A, Class B would also be owned by institutional money and large private investment groups.  

 

 

Class B Apartment Properties

• Class B assets have generally been built within the last 15-20 years
• The asset class is well maintained but less luxurious than class A apartments
• The Cap rate is between class A and class C apartments
• In most cases, investors purchase for property appreciation over cash flow

 

3. Class C Apartments:

These apartments sell at a greater CAP rate than Class B apartments and would have been built over 30 years ago. Tenants in a Class C apartment would be blue-collar workers and service-related professionals. There could also be a presence of government-assisted tenants. The initial income might be greater for the owner of a Class C property, but the potential for appreciation might be quite lower. Smaller investment groups and individual investors would be likely to own these assets.

 

 

Class C Apartment Properties

• Typically over 30 years old
• Class C apartments typically incur below-market rents
• Class C assets will typically have outdated interiors and exteriors.
• Most tenants in class c buildings rent out of necessity
• Class C assets generally provide the best cash flow for investors
• Most real estate syndicators use a value add strategy and will force the appreciation of the asset through operational efficiencies, renovations, and rebranding.

 

4. Class D Apartments:

These are the most management-intensive assets due to the location, age of the property, and tenant mix. Class D properties are located in lower-economic and higher-crime areas with no growth or negative growth in population. The deferred maintenance would be such a large part of management that the ability to repair aging and obsolete equipment and systems would require large capital investments. 

Often, the repairs are not made, and the property suffers even more decline. Rents for Class D apartments tend to be the lowest in the market due to the deferred maintenance issues and lack of amenities. Many Class D tenants may require government assistance to afford the rent.

 

 

Class D Apartments Properties

• Class D properties are generally over 40 years old
• A class D asset could be considered a run-down apartment
• Typically located within high-crime areas
• Tenant profile includes many government-subsidized tenants
• High vacancies may occur
• More challenging asset from the property management front

 

CONCLUSION

Ultimately, in commercial real estate, the multifamily asset class you choose to invest in depends on your risk tolerance and desired return. You should also consider other factors such as how much time you have for property investment, and what type of tenant demographic would work best with your needs.

The bottom line is that investors are able to make a return on their investment in various asset classes, and each class comes with its own characteristics and challenges to that end goal. The C and D assets require a larger amount of management involvement in deferred maintenance and rent collection. Class A and B apartments may command a higher rent and encounter less rollover and deferred maintenance, but that does not necessarily mean that they will bring a greater return on investment. 

The addition of better amenities, location, and management may improve your ability to increase rents and occupancy and will determine the ability to make a greater return on your investment, a benefit that tends to have the highest impact in Class B and C apartments.

 

As informed investors we should understand the risks associated with real estate investing and that there is no guarantee. Please do your due diligence.