Apartment building Classifications

Chicago Construction - Apartment building Classifications

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Apartment building Classifications

Lender Ratings of Residential venture Properties

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Chicago Construction

Lenders have advanced general classifications of apartment buildings so that they can present amongst themselves and other members of the industry with some level of uniformity. The classifications are Class A, Class B, Class C, and Class D.

Grade 1. Class A.....Newer, Institutional
Grade 2. Class B.....Older, Institutional
Grade 3. Class C..... Older, Declining Area
Grade 4. Class D......Older, Declining Area, Poor Condition

Class A Apartments - Institutional buyers like new, larger apartments in prime locations because of low deferred maintenance. These properties are typically occupied by white collar workers and have amenities such as garages, in-unit washer/dryers, pools, spas, rehearsal gyms, the newest technology, etc. They are typically in the middle of 1-10 years old. Typically they are in the path of strengthen and as of this writing (July 2008) can be bought at cap rates of 7%. They will likely have less cash flow than properties with higher cap rates but will have greater appreciation potential.

Class B Apartments - Class B buildings are in good areas with many of the same amenities as Class A properties, but Class B buildings are 10-20 years old and occupied by both white and blue collar workers. Class B properties are often owned by venture groups, such as small partnerships and small liability companies. As of this writing (July 2008) they can typically be bought at cap rates of 8% - 9%. These properties will have decent cash flow and decent appreciation potential.

Class C Apartments - These apartments are older properties built within the last 21-30 years in working class areas typically occupied by blue collar workers and even some Section 8 tenants(please see my article on Section 8). The properties may be in declining areas but not necessarily hazardous areas. The units in Class C buildings are smaller than those in Class A and B buildings and the projects have fewer amenities. The occupancy rates are typically higher than Class A 0r B because they are more affordable. Individuals usually own Class C properties, which as of this writing (July 2008) can be bought at cap rates of 10%. These properties will have decent cash flow but small opportunity for appreciation.

Class D Apartments - These buildings are older, in declining and even hazardous areas and as a ensue may have high vacancy rates, deferred maintenance, functional obsolescence and inquire a high level of hands-on supervision from their individual owners. As of this writing, they can typically be purchased for cap rates of 12% but may create less earnings than other properties despite their higher cap rates because of higher maintenance and supervision demands.

Rules of Thumb:

1. Class A & Class B properties are purchased for appreciation potential.
2. Class B & Class C properties are purchased for cash flow
3. Unless you are an experienced investor, don't buy Class D properties.

The goal is to buy a singular class of property in the same area class. In other words, buy a Class B property in a class B area. Alternatively, buy a lower class property in a higher class area. In other words, buy a Class C property in a class A area or one in the path of progress. The reasoning is so that you can perhaps convert the Class B property bought at higher cap rates (lower in price) into a Class A property which can be sold for lower cap rates (higher prices). This "infill opportunity" is typically only inherent if the area is good than the property. For a good comprehension of cap rates, please read my numerous other articles which give detailed data on the subject.

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