Class B multifamily properties are solid and stable real estate investment properties including apartment complexes and condos. While Class B multifamily properties are not the luxury high-rise buildings you might see on a cityscape, the apartments are in good condition, are well maintained, and the buildings are often attractive places to live. How exactly do you classify a Class B multifamily property, and are they a good real estate investment?
This guide breaks down the characteristics of a Class B multifamily property and covers the advantages and potential drawbacks of investing in this asset class.
Multifamily properties — and commercial real estate in general — are evaluated on a Class A, B or C scale. While Class A properties are top of the line, and Class C properties are generally more than 20 years old, need renovation and are usually located in undesirable areas, Class B properties fall somewhere in between.
Multifamily real estate — which is a commercial property with five or more residential units — is considered one of the safest real estate asset classes for CRE investors. After all, people will always need a place to live.
Because Class B multifamily properties are typically in good condition, they can often be upgraded with light renovations, as opposed to Class C properties that require more extensive — and costly — renovations. “Real estate investors typically buy Class B properties with the intent to renovate the property and increase the rental rates. The strategy, if successful, allows the buyer to own a building at a relative discount to newly constructed buildings while being able to renovate the property at similar finishes to Class A properties,” Adil Hasan, Director of Real Estate at Yieldstreet, told lev.co.
The property class of a multifamily building is based on an informal set of characteristics real estate investors and lenders use to assess a property. There isn’t a strict formula, but the class is determined according to a set of characteristics. “You can tell the difference between classes A, B, and C by examining factors such as the age, location, growth prospects, appreciation, amenities, rental income, and tenant income levels of a property,” said Tomas Sulichin, President of Commercial Division at RelatedISG Realty.
Here’s what you can typically expect from a Class B property:
Check out our interview with Tomas!
Property class will vary according to each specific real estate market. “The best way to illustrate what Class B looks like in any given market is often to define the characteristics of the best and worst multifamily properties,” John Todd, CFO and Head of Real Estate Investment Banking at LEX, told lev.co. “Class B always sits in between. A mix of variables including property age, number of amenities, quality of location, rent levels, and tenant incomes — they all play a role in mapping the hierarchy.”
For example, if a Class A multifamily property is a high-rise with a concierge and a gym and the latest amenities in the best part of town, a Class B multifamily property might be one that’s still located in an attractive area, a well-kept building in good condition with relatively new amenities (but not the latest ones).
227 NW 13th Ave is a 10-unit Class B apartment complex in Miami, Florida. This neighborhood has historically had some of the lower rents in Miami, but has seen an increase of renters in the past few years. The complex is located a short walk from many restaurants and stores, and a nine minute drive from the commuter rail. The market cap rate for this unit is 4.4%.
This 16-unit mixed-use building is centrally located and has recently been updated. Apart from the residential units, there are two retail tenants in the building — a Starbucks and a restaurant. The building, which has an average occupancy of 100%, is across the street from public transportation and restaurants and retail shops. The cap rate for this unit is 5.75%.
Located in Gramercy Park, one of the most central locations in Manhattan, this 22-unit apartment building is in solid condition. Built in the 1800s, the building is six-stories and contains an elevator and is located a few minutes from the major transit lines in the city. The cap rate for this property is 4.3%.
Check out our coverage about how LEX is democratizing investing in multifamily buildings.
Here are some of the criteria you can typically expect from Class A and Class C multifamily properties:
Class B multifamily properties offer a stable source of income with the potential to yield a higher return on investment for buyers who renovate the property.
Here are some of the main benefits a Class B multifamily investment property offers:
One of the biggest benefits of investing in Class B multifamily properties is the ability to improve them and increase their value long-term. “While a Class B property has the potential to become a Class A if some updates are done to the building, it will take more time and requires more budget to put a Class C up to the same standards,” Sulichin explained.
People will always need a place to live. While Class A multifamily properties are considered safe investments, they come at a premium. Class B multifamily properties are still stable investments without the high price tag of Class A properties.
Class B multifamily properties attract a wide range of prospective tenants, which increases the likelihood of high tenant occupancy long-term. “Class B sits in a strata of value that can be tapped by Class A and C tenants alike depending on their circumstances,” Todd said.
Because Class B properties are considered riskier than Class A, you can usually acquire these properties at a higher cap rate, Sulichin explained. While cap rates vary depending on the market and region, Todd shared that the lower end could merit 4%.
According to a CBRE market report, in 2021, average cap rates for multifamily units in the U.S. ranged from 4.14% to 5.96%, depending on the region (though these numbers were not specific to property class). However, a higher cap usually comes hand in hand with more risk, which isn’t a benefit for all investors. A lower cap rate, while not yielding as high of a return on investment, is typically a safer investment.
Investing in Class B multifamily properties comes with its own set of drawbacks to consider.
“The biggest drawback is uncertainty around renovation and maintenance costs which are generally higher in Class B properties,” Hasan explained. Older properties might make it harder to gauge potential maintenance issues and the associated price tag that comes with fixing them.
An asset’s risk profile is an essential factor to consider for any CRE investment. Class B properties are defined by higher risk profiles than Class A due to higher need for maintenance and repair and increased likelihood of tenant turnover. “Given the lower rents compared to Class A, the tenants base is less affluent and more susceptible to adverse economic conditions,” Hasan said.
Class B multifamily properties offer investors stability and steady income. “Investors looking for a steady cash flow are usually drawn by this option, which is also more affordable than a Class A. Many of them are often looking for Class B properties, as they are more liquid than the other options, which means it’s easier to sell them,” Sulichin said. Class B properties are riskier than Class A properties and will generally yield higher cap rates. However, if the plan is value-add, investors will need to allocate funds for renovation.
“Generating value-add returns, however, requires capital to execute the business plan. Some amount of capital saved by buying on the cheap relative to the cost of Class A should be committed after the purchase in order to put the property in an attractive position relative to its competition,” Todd added. In the end, Todd explained that there are a few factors investors in multifamily assets must assess: their access to capital, their track record against similar strategies, and, most importantly, their appetite for risk.
Class B multifamily properties are stable assets that suit a wide range of investors. Many investors consider Class B multifamily properties an ideal value-add investment opportunity, given the potential to upgrade a property to Class A with light renovation.
However, renovations come with another set of costs, some of which can be unexpected. Overall, given that people will always need a place to live, Class B multifamily properties are one of the most stable real estate assets for CRE investors in the long term.
