Class B apartments offer features coveted by renters across the U.S. They’re clean, modern, and most importantly affordable both to build and to rent. But because developers and investors have remained focused on more expensive Class A property, Class B multi-family property is in short supply.
This imbalance between supply and demand creates a unique opportunity for multi-family real estate development in the Rio Grande Valley. The region is one of the fastest-growing in the U.S., with HUD forecasting non-farm payrolls to increase 2% per year over the next few years.
In this article we’ll take an in-depth look at the numerous advantages of Class B apartments, and why this class of property is the sweet spot of multi-family investing.
Understanding the difference between classes
Real estate investors, lenders, and brokers use property class ratings to make it easier to compare the quality and rating of one property to another. Class rankings also represent different levels of risk and reward, making it a useful tool for an investor to determine how a specific property fits into the overall investment strategy.
Here are some of the general characteristics used to determine if a multi-family property is Class A, B, or C:
- Class A multi-family properties are those less than 10 years old – or that have been significantly renovated over the last 10 years. They’re located in very desirable areas, feature luxury amenities inside and out, and command the highest rental rates. They’re also the most expensive to build and to buy.
- Class B multi-family property is a little older than Class A but is still located in a desirable location. They offer amenities and furnishings that are attractive to tenants but that don’t fall into the luxury category. Because Class B multi-family property is often located near Class A, it can experience a similar growth in rents and tenant demand while avoiding the higher cost of Class A development.
- Class C property is usually more than 30 years old with dated exteriors and interiors and few amenities. While Class B multi-family property often is suited to a value-add investment strategy, Class C property is more opportunistic due to the high amount of capital needed to update, improve, and – if possible – reposition the property.
Class B multi-family is a favored real estate investment
A recent article in Forbes notes that Class B apartments are the bread-and-butter of multi-family real estate investment. There are three main reasons for this:
- More Stability – a balanced blend of conservative construction cost and attractive amenities creates a Class B property with stable tenants that rents as a Class A project. By value engineering the space and being selective with construction finish-out materials, the exterior is attractive yet simple creating a win-win situation for the tenant and the investor.
- Reduced Risk – Class B properties experience lower tenant turnover because residents are less prone to ‘amenity shopping’. Tenants normally know the market and know where they’re shopping. They understand there’s a slight tradeoff between high-end amenities and a competitive rent. For example, Class B multi-family developments might feature Formica countertops that are just as attractive to the tenant as marble and granite but are much more cost-effective for the developer.
- Greater Cash Flow – Class B multi-family apartments that are efficiently built and operated cost effectively will generate higher yields than will comparable Class A property. Once again, value engineering comes into play. Interior design concepts focusing on where washers and dryers are located can increase the amount of usable space. Choosing between stucco accents or painted concrete boards both make the exterior of the building very attractive but vary greatly in price.
Thriving in any economic environment
During times of economic uncertainty or economic downturn, Class B multi-family properties have an edge over Class A. The higher rents that luxury-grade Class A buildings command can become unaffordable to tenants when the economy slows down.
During times like these, NOIs on Class A properties decrease and vacancies rise as renters look for affordable alternatives. Class B multi-family projects offer residents more bang for the buck. They’re also attractive to a wider variety of demographic groups including working-class renters, millennials new to the housing market, and baby boomers looking to downsize while saving money to travel.
Demand for Class B multi-family keeps growing
Regardless of short-term economic cycles, the long-term increase in the demand for multi-family housing continues to grow.
A recent report by CBRE notes five factors creating a demand for Class B multi-family property, a product that is increasingly in short supply:
- Immigration continues to grow, particularly in regional border areas such as the Rio Grande Valley
- Population changes due to aging baby boomers and a rise in millennials
- Income disparity and slowing real wage growth
- Lack of affordable housing
- Cyclical shift toward a preference for renting rather than owning
These five major demographic forces are remaking the multi-family real estate market while creating an imbalance between demand and supply for Class B apartments. When demand exceeds supply rents, occupancy, and investors yields all rise. This provides an opportunity for multi-family investors to secure property that will provide stable returns year over year.
Three things to consider before investing in multi-family apartments
Prudent real estate investors don’t rely solely on demographic forces to generate net income. There are three things to consider before investing in multi-family property:
- Growth of the market. According to Pew Research Center, each year the percentage of people renting where they live continues to grow. It’s also important to invest in an area where the entire population is growing as well. With a current population of about 1.3 million people the Rio Grande Valley has quadrupled in size since 1969 and is admired as one of the fastest-growing regions in the United States.
- Developing a new multi-family project vs. buying an existing property. There are pros and cons to each approach. However, investors who pursue the opportunistic investment strategy by developing new Class B multi-family apartments can generate higher investment returns than those who purchase existing buildings.
- Leveraging lower up-front costs to create higher long-term yields. By value engineering Class B multi-family property, cost-effective improvements and upgrading can be made that attracts stable tenants and generates near-Class A rents without the high-cost of luxury Class A amenities.
High demand and low supply create investment opportunity for Class B apartments
Class B multi-family property is clean, modern, and affordable. When properly developed, improved, and updated they can generate rental income that comes very close to more expensive Class A projects without the corresponding increase in development cost.
Class B apartments also appeal to a wide variety of demographic groups. Working-class renters, millennials just entering the housing market, and retiring baby-booms tired of home ownership are all attracted to the value proposition of Class B multi-family property.
There is currently more demand for affordable housing by tenants than there is supply. This is creating an opportunity for Class B apartment development that will provide investors with solid, stable returns for years to come.
Feel free to contact us if you would like to hear about current opportunities in the Class B multi family sector in the Rio Grande Valley.