5 Things Investors Should Know About Multifamily Real Estate
Institutions have long recognized the economic value that multifamily properties offer the strategic investor. According to the most recent Census, about 37% of U.S. households are rented, with shifts in demographics and consumer tastes predicting continued growth in the multifamily rental market. If you’re considering investing in apartments, here are five questions you should ask.
1. What qualifies as multifamily housing?
Imposing glass towers certainly qualify as multifamily properties, but smaller dwellings do, too – including two- and three-family homes that line quieter suburban streets. “Multifamily” is defined as two or more adjacent housing units that share physical systems such as roofing or heating. It can also mean townhome-style residences that share amenities such as a pool, gym or common area.
Multifamily properties can be either low-, mid- or high-rise construction. Low-rise properties, sometimes called “garden-style” apartments, are up to four stories high and are most common in suburban locations. Mid-rise buildings range from five to nine stories and are often found in dense suburban and “close-to-urban” locations, while high-rise properties are ten stories or higher and are mostly built in major cities where land is expensive and scarce.
2. How do investors evaluate apartment quality?
Just as multifamily properties come in all shapes and sizes, quality can vary widely across assets and markets. To help investors and renters evaluate a property’s relative attractiveness and condition, industry-wide classification “grades” are applied. Classes A, B and C are the most common grades.
What is Class A Real Estate? Class A multifamily properties feature high-end finishes and amenities such as luxury kitchens, on-site pools and attractive common spaces. They are well-located and maintained, with high ceilings (9 feet or more), and modern systems and technologies that may include the latest in environmentally sensitive design or concierge service. Class A properties command the highest rents and are often, but not always, recent construction.
What is Class B Real Estate? Class B multifamily properties are one step below Class A in terms of overall quality. Class B units may lack the prime location, highest-end finishes and luxurious amenities of their Class A counterparts, but highly-desirable older buildings with charming features albeit outdated systems often fall into this category. While Class B apartments typically command lower rents than Class A, they can still fall above the market average. Units in Class B buildings generally appeal to the broadest pool of renters.
What is Class C Real Estate? Suboptimal locations, poor maintenance and aged systems are the hallmarks of Class C real estate. These properties may be at (or near) the end of their useful life with unfixable features such as 8-foot ceilings or dated layouts. Class C buildings may also require significant investment to repair, and therefore rents are comparatively low.
Investors should keep in mind that a property’s classification can change over time. For example, following renovation, a Class C property could be reclassified as Class B. Similarly, a Class A or B property that is not well maintained could slip in grade. Changes in tenant quality and neighborhood infrastructure can also influence classification.
3. What market trends affect multifamily investing?
Numerous economic trends affect the multifamily investment market on macro and micro levels. Generational shifts, global and local economies, and affordability are just a few factors to consider when investing in the commercial residential real estate market.
For example, as Baby Boomers retire – about 250,000 people turn 65 every month, according to the U.S. Census Bureau – they tend to seek smaller homes that require less expense and effort to maintain, and are closer to cultural attractions. Millennials agree – factors such as delaying marriage, student loan debt, and a preference for urban living fuel this desire. Urban and suburban multifamily properties appeal to these generations, and those that offer city or town amenities within walking or biking distance are generally the most desirable.
When it comes to affordability, there is strong demand for accessible housing in primary and secondary urban markets. Affordability – defined as annual rent payment divided by annual income – can be used as a proxy for quality of life in a particular market. Employers may evaluate a market’s average affordability when they’re deciding to relocate or create new office space.
However, urban areas with walkable amenities and plentiful job opportunities aren’t always affordable for the “workforce” population. As a result, there is a strong need for mid-quality, affordable units in urban centers. Often referred to as Class C, this product is generally well-occupied despite superior product nearby. This means that properties in secondary markets that offer amenities plus a higher quality of life at a lower cost are in the highest demand.
Macro and microeconomic concerns drive demand for multifamily unit rentals, but location-specific amenities drive demand for specific properties – both Boomers and Millennials expect conveniences such as high-speed internet and easy access to public transit. In addition, features that were once “nice-to-haves” such as bicycle parking, an in-unit washer and dryer, and a rooftop deck are quickly becoming must-haves as the urbanization trend continues and competition for renters intensifies.
4. What drives success in multifamily commercial residential real estate?
To determine the fair price of a property, investors typically review historical net operating income (NOI), projected NOI (adjusting for new real estate taxes, expense savings, better sales, etc.) and cap rate on both historical and future NOI. Meanwhile, renters consider factors such as cost, location, amenities, the condition of the unit, and building management when comparing one multifamily unit to another.
A right-priced, well-located, upgraded unit garners the most demand, which often translates into the most profitable investments. When evaluating multifamily opportunities, investors must be sure that any identifiable issues are fixable – unlike location and ceiling height which are not.
Remember, however, that classification does not correlate to profitability. For investors, Class B apartments that appeal to a large market of qualified, responsible renters may return stronger NOI than Class A buildings with a smaller pool of qualified renters and significantly higher operating expenses.
5. How do I invest in multifamily real estate?
If you’re interested in investing in apartments, Cadre provides accredited investors with access to institutional quality private real estate. To learn more about building your real estate portfolio or to become an investor, please request access to the Cadre platform.