Posts by Chad Warner
Multifamily investment properties have four main classifications – A, B, C and D. These classifications are used by investors, lenders, and brokers to help communicate the quality of an investment property or area. While not hard and fast rules, there are several key indicators that help distinguish between the different classifications. Factors that go into multifamily property classifications include things such as age, the income of tenants, area growth, appreciation, rent rates, amenities, and construction quality.
Class “A” Multifamily Properties
Class A properties generally have been built within the last 10-15 years and will be in top condition with no deferred maintenance. The tenant grade will include higher income earners and will demand higher rents. The landscaping, rental office, club building and other amenities will be above that offered in all other classifications. The cost per unit will be the highest in the area and the property will have a low Capitalization Rate (CAP Rate). They are often owned by Institutional investors. Class A properties generally won’t cash flow very well starting out but will have a high appreciation potential.
Class “B” Multifamily Properties
Class B properties typically have been built within the last 15-30 years. They will have rents lower than what is found in Class A properties with a mix of white collar and skilled blue collar workers as tenants. Often there is found a low amount of deferred maintenance and a more moderate amenity package – both of which can provide opportunities for improvement projects. Their cash flow potential is usually better than Class A properties, they will still have appreciation potential, and will typically include a higher cap rate. Class B properties are often owned by Institutional investors, high net worth individuals, or private investment groups such as Master Multifamily.
Class “C” Multifamily Properties
Class C properties usually were built 30+ years ago. They will have dated exteriors and interiors with limited to no amenity packages. Rents will be lower than that found in Class B properties. Class C properties will have some deferred maintenance and lower occupancy rate. Tenants may include mostly blue collar workers and could include government-subsidized tenants. These properties will often be owned by private investors and private investment groups. Class C provides higher cash flow and CAP rates but will have lower appreciation potential.
Class “D” Multifamily Properties
Class D properties are older buildings in mediocre locations with potentially dangerous neighborhoods. They will have a high amount of deferred maintenance with no amenity package. The construction is typically poor quality. The various system components will often be at the end of their lives. Tenants will include low income earners and generally government-subsidized individuals. Due to the tenant mix, Class D properties can have challenging tenant and management issues. The rents will be on the lower end of the market and will be subject to higher turnovers. These properties will usually have high CAP rates without much appreciation potential. Though they will have a high amount of cash flow, these are often diminished by repairs and other tenant related expenses.
The various classifications can be generally stated as follows:
A – newer growth areas
B – older, stable areas
C – older, declining, or stable areas
D – older, declining, potentially rapidly declining areas
Master Multifamily targets to acquire multifamily apartments with significant appreciation potential that are attractive to renters. Appreciation potential directly relates to increasing revenues or lowering operating costs because multifamily apartment values are a function of net operating income. The sweet spot for favorable economic characteristics is apartments fitting within the C+ to A- quality range.
Having owned both single-family and multifamily investment properties, we have found several advantages of multifamily investing. While money can be made with both property types, one of the main advantages of multifamily is the time saved. Instead of spending limited time on several single-family deals, multifamily properties allow investors to make more efficient use of their time. Multifamily assets also have healthy liquidity upon disposition (good exit options) due to a steady supply of inventory matched by a constant demand.
Additional advantages include reduced transaction costs, a concentration of units within each asset, gains in efficiency for management and maintenance, and easier tax and record keeping. This article examines each of these advantages in detail.
Acquisition Time and Efficiency
We all are limited in the amount of time we have. By consolidating the purchase of multiple units into fewer transactions, a lot of time can be saved. This is exactly what takes place through multifamily investing. Instead of purchasing each investment one unit at a time, all the units may be acquired in a single transaction.
Imagine you want to purchase 24 units within a year. In order to do that with single-family properties, you would need to purchase an average of 2 units per month. For this to work, you likely would need to review more than 10 units for every one purchased. If this were the case, you would be reviewing around 20 units per month and more than 240 for the year. For most people, the time required to evaluate all these properties simply isn’t feasible. Even if such reviews are possible, it wouldn’t be a good use of your time because it would pull you away from other high value goals.
Instead of purchasing 24 units as single-family properties, consider what it would take to purchase 24 multifamily units. You could purchase units in a variety of ways by purchasing them all at once in a 24 unit complex or by mixing two 12-unit assets, several 8-unit buildings, multiple fourplexes, etc. Let’s say you end up locating one 12-unit building, and three fourplexes over the course of the year. Under the same circumstances as before, you would be reviewing around 40 properties instead of 240. If you chose to focus on one 24-unit property and spent the year locating and acquiring it, you would still be saving a lot of time in your effort.
There is a big difference between the number of multifamily vs. single-family properties that will be available at any given time. The number can be influenced by many different factors including population, economic factors, current supply and demand, etc. No matter the circumstances, the number of single-family units available will far exceed multifamily investment properties.
This may seem like a disadvantage at first. However, the larger supply of single family properties is also paired with a larger demand. There will be thousands of people looking for a place to live as well as investors trying to find places to rent. Competition exists for multifamily investments, but can be more favorable because fewer people have the resources and expertise to acquire and manage multifamily properties.
Reduced Transaction Costs
With each property closing, there are transaction costs such as lender and attorney fees, appraisals, surveys, inspections, title fees, environmental surveys, engineering inspections, etc. By investing in multifamily properties, you incur these expenses more efficiently. Consider the example above: if you were to purchase 24 single-family units, you would have a separate closing on each of the 24 units. Each closing would have its own set of time deadlines, financing applications, legal documents, and acquisition expenses. Imagine the time and expense it would take to prepare and review all the loan documents, inspections, and other reports.
With multifamily investing, the costs may be higher in some cases because fees often are based on the value of the loan or property. This can work in your favor since those involved in putting together the deal will tend to need to be more competitive to secure the higher value business – helping you get the best price.
Early on in our investment careers, we sat down with a commercial banker to discuss buying several single-family properties under one loan. He told us that it would be as much work for him to put together this small deal as it would be for a big deal. We learned an important lesson that day and our focus shifted to multifamily.
Unit Concentration Fosters Management Efficiency
It’s much easier to visit all of your units if they are under the same roof or on the same plot of land. Imagine the effort in visiting all 24 of the single family units from the example before. Most likely they would be spread out all over town. You would find yourself constantly going back and forth through traffic and possibly bad weather. Instead of using your time on the important task of growing your portfolio, you would be spending it on visiting your units.
By putting a larger number of units within one asset, you can much more efficiently manage your time. Even if you have two apartment complexes on opposite ends of town, you will still only be visiting two properties instead of 24. Another great benefit is that the larger assets often tend to have their own set of on-site staff to help you manage the property.
Even if you elect to have a property manager do the work for you, with smaller properties you will be faced with the disadvantages of negotiating management agreements with several parties, seeking to manage your properties through third parties, and will be unable to ensure consistent quality in the management of your units.
The Benefits of Efficient Management and Maintenance Labor
With a larger unit count, you are able to make better use of property management and any additional part-time or full-time staff. At a lower unit count, it is harder to justify the costs of on site labor resources. It is a classical economies of scale situation in which a larger unit count generally results in bigger profits per unit, which makes the labor and management proportionally more affordable.
Multifamily labor and management are not only more affordable but they are more efficient because the units are physically concentrated. In medium to large apartment complexes the staff will often be on-site and dedicated to each property. If you have several properties within one area, this same staff can be shared between the properties as efficiency demands.
Improved Tax and Record Keeping
It is easier to keep records for one 24 unit property than for 24 single-family houses. It can be very time consuming to prepare and file all the necessary paperwork required by the IRS and the states for each property. Banking time is more extensive with the small property approach, With 24 single-family houses, you will need to keep track of everything separately for each property including expenses, depreciation, interest expenses, etc. With a large multifamily property, the record keeping becomes less tedious because the preparation is done for a smaller number of properties. Better quality software and record keeping becomes justifiable.
Divestiture of the Property
When it comes time to sell your properties, there are advantages and disadvantages to both single-family and multifamily investment properties. Single-family units can be more flexible in that you don’t have to sell the entire portfolio at once. You can choose to sell off a few houses at a time and also choose which ones would be best to sell at any given time. However, there will be additional effort to divest the properties due to the extra paperwork and time.
Multifamily investments on the other hand can be easier to sell. There usually is a good supply of buyers interested in purchasing. Instead of working through multiple transactions, you can sell much of your portfolio properties at once, including dispositions through Section 1031 exchange transactions.
Considering all the benefits of multifamily real estate investing, we hope you see why we have chosen it over single-family property ownership. A limiting factor for new investors may be the amount of capital required to invest in multifamily properties. To help people overcome these barriers, we team up with investors and other partners to make multifamily investing in reach of a wider audience. We look forward to working with you on our next project.