Matt Lester, founder and president of Bloomfield Hills, Mich.-based Princeton Enterprises, sees a lot of what he calls nice, solid C properties. They have 200 units, are fairly clean, and were built in the '70s. Lester would like to bid on them.
The problem is, while Lester is looking, right across the street, there’s a broken-down, barely functional apartment property that people also want to label a Class C asset, and he thinks that mislabeling can hurt the value of the stable C properties he targets.
“There’s an awful lot of junk out there that people are tying to put a C label on,” Lester says. “You could buy classic C assets on a price-per-pound basis. Now, you really have to do your homework. The percentage of stuff in this segment that constitutes junk might be 40 percent.”
Lester says the problem is exacerbated by special servicers and those trying to move these properties. “In most special servicers' minds, there is no such thing as a D class,” he says.
The reason why servicers are getting the brunt of the blame for this mislabeling is quite simple—they have large pools of properties at very disparate quality levels grouped together.
“When you have lots of properties taken over by lenders and servicers, they don’t have capacity to do an individual asset justice in terms of labeling,” said Hessam Nadji, managing director of Encino, Calif.-based Marcus & Millichap’s research division. “That’s why they’re relying on brokerage firms for broker opinions of value.”
This has created a situation where a lot of different people with a lot of different ways to define apartment classes creates even more confusion.
“Everyone’s classification difference is making people cuckoo,” says Bill Shippen, a principal in brokerage firm Apartment Realty Advisors’ (ARA) Atlanta office. “Servicers and people who underwrite those deals want an easier way to classify those deals [by having fewer classes]. I think that’s where the confusion is coming from.”
Dave Woodward, CEO of Greenwood Village, Colo.-based Laramar Group, manages a lot of properties for servicers. He says many of them really are of D quality (though things are improving), but no one will label them as that. “Some people don’t classify properties as a D, but they really are,” he says. “For the purposes of discussion, we call them C-minus-minus.”
An Ongoing Dilemna
Brokers don’t deny that they may try to dress up the more run-down properties out there, but they claim the practice has been going on forever. “If the brokers have a D property, they are hesitant to say it’s a D property,” says Carl Sims, a partner in the Las Vegas office of Hendricks and Partners “A D or D-plus property is often referred to as a C-minus property. They do get lumped together.”
But that doesn’t mean that brokers don’t question what a property’s true class is. “It’s something we argue all of the time,” Shippen says.
Shippen actually classifies a C property as something with obsolescence, a bunch of two-bedroom, one-bath units, and a lack of washer-dryer connections. As for a D property, Shippen says it’s not really livable.
“A D property is dysfunctional,” Shippen says. “Those are bombed out and are better off being demolished.”
Ultimately, Lester’s concern about the rundown C asset pulling down the value of a cleaner, better performing, yet older property can be blunted by one thing—performance.
“The performance of the asset is what matters,” Nadji says. “In marketing that property, it’s the performance over a long period as well as the past 12 months that makes the most difference.”