Class C multifamily property in Phoenix

[Diane G.]

I have been reading about investing in Class C multifamily in Phoenix lately... When I google what is out there on the Phoenix market, not looking good to me?? The properties all look very run down in poor locations.... Any one has real experience and success with Phoenix?

[Account Closed]

Hi Diane,

Please allow me to throw in my 2 cents. You have to view it from the seller's perspective. If you own a building in an A or B neighborhood and it's producing 8% - 12% CoCR almost trouble free, what would make you want to sell it? Nothing. There's no motivation to sell.

As you already have seen, higher cap rates come in crappier neighborhoods, and that is true across the whole country. There is no unicorn. If you want higher yield, you'd have to take higher risk and earn that yield.

Let's take a look at an example. You're a value investor. You buy an under performing building for $1MM. You put $500k into rehab, and it's worth $2MM. You now have the option of doing a cash-out refinance at 75% LTV and takes out your initial investment. If the building is producing 10% CoCR after the cash-out refinance, would you sell or would you keep it?

Since you got all of your money back, the CoCR is actually infinity. Say if you get 10% ROE, that's $50k/year. If you can rinse and repeat 5 times, you're home free. However, if someone comes along and offer you $2.5MM, would you sell it? At $2.5MM price, your ROE is only 5%. Well, not so fast.

Let’s throw in a curve ball and say your market appreciates at an average 5% annually like our Bay Area market, and history has shown that in the last 45+ years. That's $125k/year in appreciation for a $2.5MM asset that you only get 5% ROE, would you still sell it? 

Sometimes, we're too short-sighted for our own good and only look at the yield NOW. Stay away from C class assets. It's not what it seems.

Have fun researching and investigating!