When investing in real estate, there are multiple avenues you can pursue to help your money work harder. Generally, the options include single-family homes, commercial real estate, or multifamily properties.
Each real estate category has its ups and downs, but generally, multifamily properties can be one of the best and safest choices, particularly in an area with a high number of renters.
That said, not all multifamily properties are equal, and they fall into one of three different classes. Knowing these classes and their pros and cons can help you make the best decision for your portfolio. In fact, knowing the difference between class A vs class B vs class C can provide you with valuable insight for potentially better long-term gains.
What are the Different Types of Multi-Family Property Classes?
Technically, multifamily properties come in one of four distinct classes, but class D properties are the highest risk and require additional time, resources, and capital, so investors often neglect them. Here’s a quick rundown of each class and what it offers:
- Class A – Nicest properties that are often in high-demand areas. Few renovations or upgrades are required, and the tenants tend to be more financially stable.
- Class B – Not as nice as class A properties, but still cash flow positive and may appreciate in a rising real estate market.
- Class C – Older buildings that may require renovations or building code upgrades. Typically, these properties are cheap, but rental rates are often below market value.
- Class D – Old properties in high-crime and low-income areas. Investors have to worry about property damage, vacant units, squatters, and other issues.
What is the Difference Between a Class A and Class B Property?
Even if you’re a seasoned real estate investor, you’ll likely want to avoid class C multifamily homes. While some of these properties can be highly valuable in the right situation, they often require too much time, money, and resources to be a good deal for most investors.
Instead, you’ll want to look at class A or class B properties. Here’s a more detailed breakdown of how these investments compare in different areas.
- Cap Rate – The cap rate refers to how valuable (and financially safe) a property is. Generally, the lower the rate, the safer your investment. Class A buildings tend to have the lowest cap rates because they’re more expensive. Class B properties have a higher cap rate because they’re cheaper and have positive cash flow.
- Age – Class A multifamily properties are typically newer, meaning they were built within the last 10 years. By comparison, most class B properties are between 10 and 30 years old. However, what matters most is the condition of the property. Some historical buildings have been brought up to modern building codes, so they’re classified as A properties even when they’re 50 or 100+ years old.
- Demand – Almost all class A properties are in a primary market, meaning there’s a lot of demand from renters. For class B properties, demand may still be high, but not as much as with a class A building. Less demand means it can be harder to raise rents to improve the cap rate.
- Appreciation – Because class A properties are in prime condition in high-demand locations, they will appreciate over time. However, many investors buy class B properties because they’ll appreciate more, leading to a higher return in the long run. The best option is to buy a class B property in an up-and-coming market and turn it into a class A.
- Cash Flow – Class B properties are almost always cash flow positive. For class A buildings, the value may be in the property itself and its location, not necessarily its operating income. In hot real estate markets, class A properties may have relatively low vacancy rates, but they’re still highly valuable investments.
- Maintenance and Operating Costs – Because class B properties are older, they tend to have more maintenance issues (which will only get worse over time). As an investor, it’s crucial to determine how those costs will increase year after year and affect your earnings potential. With class A properties, you typically don’t have to worry about rising maintenance expenses.
- Amenities – Class A properties often have the most on-site amenities, including dog parks, fitness centers, swimming pools, and more. Class B properties have fewer amenities, or those provided are in relatively poor condition.
Other Factors to Consider When Looking at Multifamily Homes
While the property class matters a lot when investing in multifamily buildings, it’s only one factor to consider when building your portfolio. Also, remember that it’s possible to turn a class B property into a class A with the right renovations or upgrades. Here are some other points to think about when determining which class is best for your situation.
- Building Type – Everything from duplexes to high-rise apartment buildings fall into the multifamily category. As a rule, more units means more income but also higher costs associated with property management and maintenance. If you’re going to use a property management company, you may have more options with the types of buildings you can invest in.
- Owner-Occupied – New investors looking to get into multifamily homes will often occupy one unit while renting out the rest. While you can do this with a duplex, investing in a four- or five-unit property is often best. However, you must weigh the pros and cons of earning more rental income compared to managing more tenants.
- Rising Markets – If a particular market is rising, now may be the best time to invest in a class B property. Because the building will appreciate as demand increases, you can leverage that equity to buy a better property or reinvest into upgrades to turn the class B into a class A building.
Understanding multifamily real estate classes can help you make the most informed decision when closing the deal on a new property. Overall, the more research and due diligence you do beforehand, the more likely you can increase your returns over time.