Apartment Buildings - Lender's Classifications & Characteristics

Lender Ratings of Residential Investment Properties

Lenders have developed general classifications of apartment buildings so that they can communicate amongst themselves and other members of the industry with some level of uniformity. The classifications are Class A, Class B, Class C, and Class D.

 

Grade 1. Class A.....Newer, Institutional
Grade 2. Class B.....Older, Institutional
Grade 3. Class C..... Older, Declining Area
Grade 4. Class D......Older, Declining Area, Poor Condition

 

Class A Apartments - Institutional buyers like new, larger apartments in prime locations because of low deferred maintenance. These properties are typically occupied by white collar workers and have amenities such as garages, in-unit washer/dryers, pools, spas, exercise gyms, the latest technology, etc. They are typically between 1-10 years old. Typically they are in the path of progress and as of this writing (July 2008) can be bought at cap rates of 7%. They will likely have less cash flow than properties with higher cap rates but will have greater appreciation potential.

 

Class B Apartments - Class B buildings are in good areas with many of the same amenities as Class A properties, but Class B buildings are 10-20 years old and occupied by both white and blue collar workers. Class B properties are often owned by investment groups, such as limited partnerships and limited liability companies. As of this writing (July 2008) they can typically be bought at cap rates of 8% - 9%. These properties will have decent cash flow and decent appreciation potential. Class C Apartments - These apartments are older properties built within the last 21-30 years in working class areas typically occupied by blue collar workers and even some Section 8 tenants(please see my article on Section 8). The properties may be in declining areas but not necessarily dangerous areas. The units in Class C buildings are smaller than those in Class A and B buildings and the projects have fewer amenities. The occupancy rates are typically higher than Class A 0r B because they are more affordable. Individuals usually own Class C properties, which as of this writing (July 2008) can be bought at cap rates of 10%. These properties will have decent cash flow but little opportunity for appreciation.

 

Class D Apartments - These buildings are older, in declining and even dangerous areas and as a result may have high vacancy rates, deferred maintenance, functional obsolescence and demand a high level of hands-on management from their individual owners. As of this writing, they can typically be purchased for cap rates of 12% but may generate less income than other properties despite their higher cap rates because of higher maintenance and management demands.

 

Rules of Thumb:

1. Class A & Class B properties are purchased for appreciation potential. 2. Class B & Class C properties are purchased for cash flow 3. Unless you are an experienced investor, don't buy Class D properties.

 

The goal is to buy a particular class of property in the same area class. In other words, buy a Class B property in a class B area. Alternatively, buy a lower class property in a higher class area. In other words, buy a Class C property in a class A area or one in the path of progress. The reasoning is so that you can possibly change the Class B property bought at higher cap rates (lower in price) into a Class A property which can be sold for lower cap rates (higher prices). This "infill opportunity" is typically only possible if the area is better than the property. For a better understanding of cap rates, please read my numerous other articles which give detailed information on the subject.

 

Kerri Hamilton is a commercial broker, CCIM Candidate, instructor and Founder of the Commercial Investment Education Institute, LLC which teaches commercial real estate investment to both novice and seasoned investors in a friendly and easy to understand manner. As an investor like you, she understands your concerns and your needs. Invest bigger! Invest better! Take a FREE online course now and learn that CRE doesn't require a lot of money, is not complicated, is easier to finance than residential property and should be your investment of choice! Get on the road to bigger profits now! http://www.cieinst.com