When to move on up to Class B

Question

Hi BP fam,

Currently, I am working in all Class C properties (duplex/tri/quad, and soon to be 24 unit MF property, also Class C).

I hear horror stories online about people talking down Class C and saying that cap rates are gonna go up and delinquencies are going to also increase, however, we are batting 0% on bad renters and payments from our tenants.

Other investors that I follow (albeit more advanced and well heeled that me at my stage) indicate they would ONLY buy Class B and would not touch Class C, for the above reasons.

I make most of my money buying Class C with value add (have done well - now at 63 units), and am interested in Class B, however - I'm interested to know what the BP Family think about "when" to do that.

My initial plan was to accumulate 100+ units of Class C, add the value, and then liquidate/consolidate into a better asset class.  But should I get out now? even when all my tenants are paying well?

Love to hear some thoughts on this.

Thanks!

Mark Cruse · Answer

What I have learned about being here several years is that there are so many varying perspectives which in most instances ties to experiences, personal biases and ability. There are several people in here that will tell you class C property on down cannot work or make money which is why they only do B and up. Then you can directly talk to someone who has consistently made them work for decades where they have created tons of wealth. To me its an individual take. I have done class D for over a decade and now want to reposition to C or B. If not B, Id do a play to add value similar to what you are doing. D has worked but its also a lot of work to maintain so as I mature in the business and have more capital, I want to reduce some of the time it takes to stay on top of them. For you, if class Cs are all working and you can transition them into something else, what is the desire to move to something else? It sounds like you are only considering this because of what others have told you. If that's the case and you are basing your own perspectives on it, please get diverse perspectives. If I move to all C-B and they all work well, make tons of money and reduces constant involvement, there will be no logical or intelligent reason for me to do anything else.

Justin Moy · Answer

I think the reason you're hearing this argument more now from other investors is because of income to rent levels in certain communities. In hot markets the C class renter is getting squeezed very hard. Some studies have shown up to 41% of their income is going to rent to stay in these areas, so investor confidence in how much those rents can continue to rise is low right now.

the A or B class renter is paying closer to the benchmark of 30% of their income in rents in these hot markets, meaning there is still a bit of room for investors to feel confident that incomes can continue to support rent increases.

It doesn't mean there's a time to "switch" your strategy, but just know what your investor base can pay and how hard the current market you're in is pushing them.

Ryan Howell · Answer

@Glenn Barlow - Wow...we are in very similar positions.  I have a similar portfolio of C class properties and I'm having the same debate.  I've always had the mindset that C is a great class to own because as times get difficult, A class tenants will go down to B and so on so rents will get squeezed more in A class, but I don't think that's the case we are going to see in the next few years. I think we will see A and B class continue to keep pace with inflation, but I feel that C class is going to struggle due to high inflation and wages not keeping pace.  I see this causing rent growth to slow relative to A/B and delinquencies rise.  That said, I'm not opposed to C class, but I watch very closely how the rents compare to the wages for a given market and I'm looking to add B class to my portfolio to diversify.  My $0.02.

Taylor L. · Answer

I'm all for upgrading. Valuation spreads in terms of cash flow multiples have narrowed in recent years compared to 5-7 years ago. Newer properties tend to have fewer major deferred maintenance issues and gremlins waiting to cause big bills.

Chris Collins · Answer

@Glenn Barlow Here's my quick take: Class C properties are trading closer and closer to Class B properties (both price-wise and cap rate-wise), so many savvy investors opt for the newer properties for not that much more cost.

The longer version...

Check with your brokers on price/door they're seeing trading in the markets you're in.  Oftentimes today, that Class C property that traded for $60k/door is now trading for $120k/door.  The class B property may now be trading at $150k/door.  It's not THAT much more, and will come with way less deferred maintenance, and less headaches, and (arguably) be more desirable to incoming residents. That's why a lot of investors are choosing to invest in newer properties.  "The cat is out of the bag" on class C properties, pushing cap rates DOWN on C class properties, but B class properties cap rates can only go so low before it stops making sense.

So, to answer your question, do the research in your market.  If you can get a nicer/newer/lower hassle property for 'not that much more' then why wouldn't you?

Best of luck in your decision and attack strategy!

Sergey A. Petrov · Answer

Many years ago, I knew a guy who invested in sub C- properties only. He owned a few dozen, was really good at it, and was making a killing surpassing any "expected" returns. If you are good at it, stick to it. If you are ready to take a more passive approach, interview some property managers and either turn over your existing portfolio or upgrade B class before you turn it over. It takes a special skill in each class and I know that finding quality managers is easier in Class B+... So, if you want to keep doing what you do best, stick to it. If you want to get out and enjoy life more consider hiring a manager. Self managing and having properties managed are different beasts so decide where you want to go next with your personal life and proceed from there!

Marcus Auerbach · Answer

Your question is OR and my answer would be AND when it comes to neighborhoods. Keep what you have AND grow into a higher class. Generally going up in asset value will reduce cash flow and increase equity. You are playing with bigger chips. More rent revenue per unit, more principal pay down every month, more equity gain forced or natural, more tax depreciation.

Once you generate enough cash flow to meet your personal and strategic goals you can start shifting to a more equity weighted strategy. I am wrestling with a similar question. Our market here in Milwaukee has a ton of properties from the 1920s and the 1960s, most of our portfolio is 1960 with all it's pro's and cons. I am contemplating building new construction MF and that points me to lower class A, otherwise you can't make the numbers work.

Luc Boiron · Answer

IMO moving from Class C to B is more of a personal investing philosophy than it required for the growth of an investor. Other investors might start with Class A properties and eventually move to C because they find their strengths are better suited for that type of asset.You can change you investing preferences over time, but you don't need to. If your strengths play better into investing in Class C, then keep buying Class C and be the best at it. If you think B will be better for you, then do that.As a side note though, "Even when all my tenants are paying well" might actually be the best time to sell.

Bjorn Ahlblad · Answer

@Glenn Barlow I say stick with what is working for you and making money. The letter definitions are very squishy at best. Who is to say if it is a C+ or a B- anyway. Congrats on your success!!

Jim Pellerin · Answer

I think what you are referring to is Class C neighborhoods and not Class C properties. Class C properties can still be good investment properties catering to certain income groups.

When to move on up to Class B

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