Do you work with A class properties?

Question

Hi everyone,

I'm curious to hear people's thoughts on A class assets. I hear a lot of syndicators targeting B and C class assets in order to reposition and safegaurd against market fluctuations. But there are plenty of A class assets out there. What happens with those? Are they only new construction, are they bought and managed only by institutions? I heard somewhere they're excellent cashflow assets, but only if you're willing to wait quite a while. Do you have any insights on how A class assets factor in to the business?

Erik W. · Answer

@Shafi Noss, I looked into Class A awhile back, and here's what I learned:

1) They are good for big dollar deals with institutional investors who care less about total return and more about steady return.  Think insurance companies that offer annuity payments.  They need to make 4% every year, good or bad, to pay out their contracts.  So a 3-5 CAP property may work.  They need zero hassles.  Class A in a prime, steady location fits that perfectly.

2) The main upside is in appreciation, not cash flow.  Due to the high cost of keeping properties in tip top shape, they often don't return a lot of cash, but 10-15 years later they can be sold for a large profit.

3) Lenders like them because if they have to foreclose, they're getting an excellent piece of collateral vs. a dump.

4) Tenants expect the best service as well as amenities such as high speed internet, pools, gyms, and professional landscaping.  When they have a maintenance problem, it needs to be fixed today or at latest tomorrow by a skilled, clean-cut, courteous service person at a time convenient for them.  The typical Ma and Pa land lord is not equipped to provide this level of management and should hire a professional.

In my town, 1-2 bed apartment complexes are being built for around $120,000 - $175,000 per unit.  They rent between $1,000 - $1,500 per month.  The only reason they cash flow is they amortize the loans over 30-40 years using institutional, non-recourse financing and have almost zero repairs for the first decade.  Or they are built by hedge-funds that have scandalous amounts of free cash and need to park it somewhere, so they build for cash and don't carry any debt.  Of course that will cash flow.

I would be interested to hear more about where you heard they were excellent cash flow assets.  My study of them says the opposite, but I'm here to learn.

Evan Polaski · Answer

@Shafi Noss, to tag onto what @Erik Whiting mentioned, Class A is for the "big boys".  On the retail real estate side, part of my past life, my company looked for Class A assets when they began raising capital through non-traded REIT formation.  They promised a 6% return, paid monthly and no upside on any exit.  But, they also became a fee machine.

In multifamily, it is the same idea, your hedge funds, sovereign wealth funds, insurance companies, etc. that have more cash than they know what to do with, and need to make more than a money market can provide, without taking on much more risk.

Michael Ealy · Answer

The answers you've received so far are GENERALIZATIONS and per every general statement others have made, I can cite examples from my and other syndicators' experiences that will contradict those generalizations.

"A" apartments in "A" locations are bought for a premium because they are newer (20 years old or less), have lower (and more predictable) repairs & maintenance (with little to no capex for the next 1-5 years) and therefore gives a more predictable yield on investor capital. Because the risk is small, investors are more than willing to pay low cap rates (and their CoC return is low as well).

Having said that, I bought 2 apartment complexes last year in "A" areas of Cincinnati. One is in Wyoming and another in Mariemont. They BOTH cashflow nicely - comparable to "C" properties.

How come?

It all comes down to the deal.

In both situations, the previous owners did NOT increase the rents as they should have done. We can increase the rents by $100-$200/month even if we don't do anything. However, we decided to improve the apartments as they become vacant and by doing so, we are able to increase the rents by more than $300. In fact, in both cases, we can increase the rents by as much as $500/month and we plan to do that over the next 2 years or so.

We also look at other ways to look at these "A" deals to ensure we're getting the highest and best use of them. For instance, in our Mariemont deal, we're exploring condo conversion since the units are townhouse in style and there's also an extra lot to build more apartments. Just the condo conversion alone will result in us being able to sell the condos for $24-$28M (our purchase price was $10.3M and renovation is about $4M).

So although we did pay a good price for it (we paid 6% cap), the right deals in A areas can:

1) cashflow; and

2) produce a great return on investment

Gregory H. · Answer

We buy class A townhomes & condos in the $200-350K range, put 30% down, 15 year fixed loans, 5 caps. They don't cashflow terribly well, but the principal pay down & appreciation build long term wealth. Additionally, if more of your return comes from higher appreciation on lower cap rate investments, you have an extremely minimal tax consequence. They're also very easy to manage because typically the people who can afford them are college educated, white collar employees making $80-100K+.

Greg Dickerson · Answer

Class A are assets are not new construction only. They are and can be defined by any or all the following, area, age, type of construction and finishes. You can build a brand new B or C level building in an A,B,C or D area. You can buy a C or D property thats 100 years old in an A area and renovate it bringing it to A status. Whats hard to do is build an A property in a C or D area and get the same premium but you can build it as an A asset.

Shafi Noss · Answer

Thanks for the input everyone.

@Erik Whiting, Your analysis makes sense to me. I get the sense they are appropriate for institutions since they can take advantage of the long time frame and focus on low risk to realize the profit.

I don't remember exactly what I read. It's possible I misremembered and the author said they were excellent for long term profit but not short term cashflow, like you and  @Evan Polaski, are suggesting. Sounds like @Gregory Hiban's SF works the same way too.

@Greg Dickerson, So B and C class can do well in any area but Class A buildings, renovation or new construction, are only solid in an A area, and then it's usually best to sell them to institutions like others have suggested. Fits in with the picture the others have painted, thanks everyone for the insights.

Do you work with A class properties?

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