Commercial Real Estate Multifamily Classification

Brooklyn Bridge and Manhattan at night, New York City, USA.

A multifamily property houses more than one individual or family unit, such as in the case of duplexes, where people live in one and rent out the other or buy four to six units and manage them on their own. The commercial multifamily is different from residential multifamily and a small apartment, primarily regarding scale. For one, this is a property that can be managed by a property manager, because it is large enough to employ on-site staff that can and do receive middle of the night emergency calls. Additionally, the assets can be financed through non-recourse loans, so the bank does not pursue the owner in default. As such, commercial, multifamily assets are valued by income rather than comparable or replacement value.

Unlike the commercial multifamily asset, the residential multifamily is typically two to four units and can be financed through a residential mortgage, and its value is based on comparable properties. In the case of small apartments—which are between five to 70 units—they are usually managed by the owner or an off-site property manager. They can be financed through a commercial recourse loan, which means that banks would come after the owner if there is a default. Generally, institutional investors want more units to enter the market.

Multifamily properties are categorized based on the properties and quality materials they are made of:

Multifamily Property Classifications Overview

Class A Multifamily

This is a garden product that was built within the last decade, but its characteristics are over 10 years old and have been renovated to give it that fresh but historical appeal. The rent for this kind of property lands within the range of class A rents in the submarket. This is because it usually comes with landscaping, rental offices, or club buildings. There is also high-end exterior, and interior amenities and the construction materials are of the latest high-quality products on the market.

Class A assets typically command more interest from lenders, so they are one of the most highly sought assets on the market. Usually, pensions, agency lenders, conduits, and life companies pursue this multifamily class. As such, you should expect more financing options, lower rates, less requirements for debt service coverage, CAP rates between the 4% – 6% range, and longer fixed rate terms.

Class B Multifamily

This class includes products that were built within the last 20 years, with good quality construction and little maintenance. Both the exterior and interior amenity package is less than what is offered by high-end properties on the market.

Much like Class A, Class B commands more attention in the major markets. However, they lose some interest from institutional investors and borrowers who usually get financing from banks. As such, for Class B multifamily, you should expect fewer financing options, slightly higher rates than Class A, a fixed rate with balloon terms, CAP rates between the 6% – 8% range, 75% leverage, and a non-recourse for assets in major markets.

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Class C Multifamily

This product includes buildings that were built in the last 30 years, and its improvements show some of the aged and deferred maintenance. The majority of the appliances are considered to be original, even though they had to be replaced over the course of the three decades, giving limited interior and exterior amenity options. Rents for this type of property usually fall within the same range as the Class B multifamily.

Similar to Class B, the Class C multifamily attracts little interest from institutional investors, since borrowers can get financing from other places such as specific purpose REIT’s. You should expect less financing options or finance from local banks, fixed rates with resets, and higher financing rates or rates with little to no interest from secondary market lenders.

Class D Multifamily

Products such as these are well over 30 years old with visible worn characteristics and usually situated in outlying locations. The construction is marginal, and the condition is mediocre. There are no amenity packages offered, and the products are located on the lower side of the market.

This asset is usually financed by local banks with no interest from secondary market lenders. As such, there are limited financing options, shorter fixed rate terms, about a 65% leverage with no option for a secondary debt, and CAP rates well over 8%.

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