025: Stay Classy: The Grading Scale of Apartments
We don’t know about you guys, but man has it been a doozy of a year already. 😖😖 We think a lot of people are feeling a certain kind of way, whether it’s processing feelings, educating ourselves on this world, or just being plain exhausted by a news cycle, you’re not alone.
We want to be sensitive to the state of our world and where our readers and followers are coming from.
This is a tough time. Between the height of wars, inflation at an all-time high, and navigating what we hope is the tail end of a pandemic, we totally get if you’re asking yourselves some hard questions. So consider us right there with you.
We wanted to start today’s post in a simple state of acknowledgment about where the world is at and tell you that it’s completely okay if you’re not okay.
While everything around us seems like it’s out of control, we’re here on a simple mission to remind you that you can still take control of your financial life.
Even if 🍓 strawberries are $5 each and the gas prices are making you question if you really need to leave your house today.
But even while the news is cycling in the background, apartment syndication and investing to grow your passive income empire are still realities that can come true for you this year.
Today we’re talking through the ABC’s of class to consider in your apartment investing journey. Like we’ve mentioned before, apartment syndication comes with its own lingo and lessons.
When you’re in a room with investors, it’s common to hear phrases like:
“I only buy A class properties.”
“I focus on investing in B or C class properties.”
And sometimes, you’ll even hear them grading neighborhoods, too.
“That’s a C class property in a B neighborhood.”
If you’re thinking, “Hey, uh this suspiciously sounds like a report card.” Then you’re on the right track. 🤓🤓 These investors are grading buildings and neighborhoods. And if you’re anything like us– you’re only gonna want the top notch grades. And don’t forget to ask about extra credit!
So, what properties do you want to own? What is going to fit your portfolio best? We’ll break down the property and neighborhood grading system real estate investors often use to classify the properties they buy.
And, bonus! We also will explain why we are such huge fans of A/B class properties. You’re going to want to stick around until the end. The reason may not be what you think!
What are the ABCD’s?
Alright, we’re gonna be honest with you guys– we actually aren’t that huge fans of the ABCD grading of buildings and neighborhoods that most investors use. But, as anyone who has fought their way into anything, sometimes you gotta learn the internal language to fit in. You’ll want to learn to establish your internal investment criteria.
There is another important reason to understand the classification system—it gives you a sense of who will be living in a particular apartment complex. This helps you evaluate the risk and return.
And before we move on any further, there’s one last thing we want to make abundantly clear: Ethics. We always believe in doing the right thing, and it’s valuable to discuss the reasoning for ethics behind classifying properties and neighborhoods.
Neighborhood Ethics & History
As we mentioned earlier, these are some trying times. This is why it’s no secret that the ethics behind classifying neighborhoods does come with some unfortunate circumstances around it.
We can discuss this topic more in-depth for hours, but there are so many resources out there that can also educate you on the topic of redlining from Black people and minority groups who have experienced this first hand. We encourage you to do your due diligence and educate yourself on the history of racism and classism in this country while investing. And you can set an example for other investors on how you treat your tenants.
Part of what we do, and what we take pride in, is try to improve our properties and make them a safe, clean, well-kept place for our tenants to live in. We aim to treat all of our tenants with respect.
We can all do with a little more kindness in this world, anyways.
The Grading Scale AKA Property Characteristics
Okay, so, how are these properties graded? What qualifies a ‘good’ score? 👀 For most investors, this goes back to simple property characteristics and age.
Never ask a woman– or an apartment building– their age. 😜😝😝
Again, we’re not huge fans of the system simply because there’s no objective way each of these classes are defined. Different investors include different characteristics and value them differently within their grading system.
So everyone is different with their grading scale? That’s a nightmare.
Exactly, but here are some commonly included building characteristics that are based off of that scale.
- The quality of the building
- Amenities provided
- Tenant income levels
- Growth prospects
- Expected market appreciation
- Livibility of the property
- Need for upgrades/rehab
- Location, although some investors separate location out and grade it independently.
- And rental income return.
Whew! A lot! 😗😗
But you know us, and we don’t really play by everyone else’s rules. So here’s a quick rundown of how we give buildings their grades.
Class A properties are quality, newer buildings that were built within the last 10-20 years. They have all the amenities tenants are looking for, like gyms and front desk concierge services. They also have Pinterest-worthy countertops made from quartz or granite and stainless steel appliances.
These properties are typically located in downtown or nicer single-family neighborhoods. The neighborhoods surrounding the apartment are owned, not rented, and attract high-income professionals.
You get the idea– Class A properties are seen by many investors as investments for the long-run. They are looking for legacy investments, they don’t need the monthly/quarterly cash-flow, they just want to invest in apartment complexes that are often seen as having a higher potential for market appreciation. So.
👉 If you’re someone who has the personality to ‘go big or go home’….
👉 If your friends describe you as a little bougie…
👉 If you’re always buying the latest and greatest phone on the market….
✔️ Then Class A apartment investing might be for you.
Next up, Class B. Class B properties are older builds, often 20-30 years old, with higher-grade rental finishes. They may have wood floors, granite countertops, and luxury vinyl planking and white/black appliances.
Which, let’s not forget, were at the height of luxury back in the day.
Plus, they don’t often have a lot of amenities. Some larger apartment buildings might have a pool or a front desk whereas Class B apartments will just have an office for leasing. Location-wise, they are often outside of downtown, and perhaps in a neighborhood with more townhouses or other multifamily apartments.
These properties can cash flow really well and have low vacancy rates. They also have the potential for market appreciation, since they may be fairly close to desirable neighborhoods. Class B properties could also be the path of progress in terms of city growth.
Which is a big deal because that’s what you want, to improve neighborhoods.
For example, often investors will buy C-class properties and improve finishes, landscaping and the external appearance to force appreciation and make them more of a B-type property.
In other words, people buy C properties to give them that B glows up. Suddenly, everyone’s into the quote/unquote ‘new’ building. 👌
👉 So if you’re someone who hates picking up a hammer…
👉 Thinks Goldilocks from the 3 Bears was noble for being “just right”…
👉 And people describe you as high maintenance even though you’re totally not…
✔️ Class B is for you. Investors who invest in class B love the idea of less deferred maintenance. They want to invest where the median household income is $60K or above, increasing rent without doing major renovations is achievable (less expense, more income = higher NOI), meaning more money in the pocket to investors.
Onto Class C. Class C properties are usually those built 30-40 years ago, with pure rental grade finishes. They have cheaper, non-stainless steel appliances, laminate countertops, and rare, often older, amenities. Tenants are largely working-class. They are usually located in neighborhoods composed of mostly multifamily properties and they may be somewhat worn down compared to other apartments.
Class C properties generally cash flow well. Investors can force appreciation by upgrading them to be more type B properties.
Ya know, putting in more upgraded appliances and repaving the parking spaces and such. Management costs could also be higher, as could vacancy and turnover.
Our first Dallas-Fort worth property was a Class C apartment. 🌟 It was located in a not-so-ideal neighborhood, but it performed so well. 1.50x equity multiple in 20 months‼️💋 Even though now we tend to look more towards Class A or B apartments due to less deferred maintenance, every once in a while a Class C catches our eye. We’re opportunists!
👉 Class C investors are always looking at the glass half full…
👉 They’re into the classics with a modern twist…
👉 And they’re always creating their own versions of trends.
✔️ Then Class C apartment investing might be for you.
Last up, D. Class D properties are older, often run-down and in need of major repair. They may be located in areas of high crime in neighborhoods that are declining in populations and businesses. They have the risk of high vacancy and frequent evictions. On paper, class D properties appear to cash flow well, but when you take into account how high the vacancy rates are, it is often not the case.
Due to the higher risk, we’ll tell you guys straight up: We highly encourage all passive real estate investors to stay away from Class D apartments. If your sponsorship team wants you to invest in any Class D ask them if there’s something that you don’t know.
Some questions you might want to start with are: What is their business plan? Is there data to back up their underwritings? And what returns are they presenting to you?
Even though you might have heard us preach “high risk, high reward,” some risks simply aren’t worth it.
On top of all of this, remember what we said earlier in this podcast. Do your work on ethics and learn why the neighborhood is the way that it is– go above and beyond and learn for yourself. The answer might surprise and educate you. 🧐🧐
Risk and Return by Class
So if you’re sitting there, thinking Class A is the way to go because you’re a risk-avoidant person, think again. Each building class difference also comes with the understanding of the inherent risks that also go with each class.
Most investors see Type A properties as low risk. For example, due to the tenant base, there’s a low risk of evictions. Also, there’s the possibility for market appreciation, which attracts a lot of investors.
In comparison, Type D properties are seen as a higher risk and more effort. This is due to the number of vacancies and evictions that happen in these properties on the regular. There’s also a very little possibility for market appreciation unless you buy in a neighborhood that becomes “gentrified” down the road. If you’re unfamiliar with the practices of gentrification, we highly encourage you to read up about it.
Leaders are learners and we know we have some of the best leaders following us! Back to the conversation about each class and their risks, we see risk a little differently.
👉 We’re actually not ones drawn to Class A properties. We think B/C properties hold way less risk.
New asset classes like Class A likely mean less vacancy, less deferred maintenance and more items to write off for depreciation. You know we are all about paying as little taxes as possible, right?
Legally and ethically of course‼️
In newer asset classes, we experienced less push back from tenants to increase rents and higher renewal rates This means cost savings when preparing to get the units ready to move in. This simultaneously lowers your turnover and vacancy costs.
Our portfolio is mainly made up of B/A classes renting from $1700-$2300 a month. We believe this lowers our risk and maximizes our returns over the long term.
If you want more insight into this topic, we’ll refer you to one of our earlier episodes, EP015, Don’t Get Caught in These 6 Investing No-No’s on why we like class A and B asset class the best.
Last But Not Least…
Educate yourself! 💻 You should familiarize yourself with the A/B/C/D property classification system. Investors and members of your team will use it often. And you don’t want to be the one on that webinar or team meeting asking where everyone else is getting these report card grades. So what does our portfolio say about us?
We think it’s all about specialization. We took the time to learn, see what class investments worked for us and from there we built up expertise. We don’t think we would have been able to deep dive into all of this without a greater understanding of what the class properties meant and how we play a part in making them even better.
Now it’s up to you! Defining your own internal investment criteria from the beginning avoids any possible mistakes you can make. We like to poke fun at stereotypes, but in all seriousness, you know what works for you, your schedule, and your finances. So go forth and become top of the class. After all, you have the grades to prove it.
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