Multifamily developers are continuing to target supply-constrained urban core markets. As land availability tightens and construction prices skyrocket, the bulk of new development in these areas has been Class A product with luxury features.
While sustained high demand for housing has led many investors to view the development of Class A in core markets as a safe bet, we’ve begun to see some instances of flattening rent growth in the sector over the past several months.
In response to this risk of oversupply, many investors are seeking alternatives. One strategy focuses on Class B properties that offer strong upside with light to moderate renovations while still giving residents a value alternative to new construction.
Class B multifamily assets can offer residents the look of luxury without the cost while optimizing returns to investors and providing more opportunity for rent growth.
Based on more than a decade of experience owning, renovating, and managing multifamily communities along the West Coast, my firm, Trion Properties, has devised three chief strategies for multifamily investors looking to Class B assets:
Target Assets in Emerging Submarkets
Opportunities to acquire existing product are highly competitive, especially in high-density areas such as San Francisco and downtown Los Angeles. With rent growth softening, these locales may no longer be the best option for investors.
Further, many up-and-coming professionals are being priced out of these markets. Instead of spending the bulk of their income on rent, or settling for small, no-frills spaces in the urban core (if available), they’re drawn to more-spacious options with high-grade amenities at locations that still offer quick and easy commutes to jobs and social destinations.
For example, we’ve been bullish on the East Bay submarkets outside of San Francisco, due to their proximity to the urban core and other factors driving demand for housing. Not only do locations there, including Fremont and San Leandro, offer convenient access via freeways and the BART public transit system, but the cities themselves are seeing an influx of employers and development, including Fremont’s expanding Tesla campus. These submarkets are thriving and evolving to meet the needs of the modern workforce, rendering multifamily a strong long-term investment.
Choose Cost-Effective Upgrades
According to a recent Marcus & Millichap report, Class A multifamily vacancy rates are expected to rise to 6.8% this year, with Class B and C vacancies averaging approximately 200 basis points less and climbing at lower rates. The report projects that rent growth will taper as well, particularly in Class A assets.
Given this, investors should consider strategically targeting underutilized and mismanaged properties that provide tremendous upside and rent growth through the implementation of minor to moderate upgrades while still offering a value alternative to newer Class A construction.
Many available Class B multifamily assets were built or last upgraded upward of a decade ago and, thus, present an opportunity for a relatively inexpensive refresh. Light renovations, such as updated kitchen appliances, bathroom fixtures, countertops, and flooring, can greatly increase the appeal of the units and the property as a whole.
Today’s residents, of all generations, also continue to value high-tech amenities that contribute to the “luxury” feel of a community and increase convenience in their day-to-day lives. These amenities include USB charging stations, smart locks and thermostats, and a strong Wi-Fi connection throughout the property.
At one of our properties, we installed quartz countertops, stainless steel appliances, smart thermostats, new cabinetry in each unit, and new hardwood floors; painted the exterior; and arranged bulk high-speed internet for use throughout the community.
Ultimately, by investing $2.6 million in a combination of interior, exterior, and tech-related upgrades, we increased the value of the asset from approximately $9.6 million to $19.4 million within 18 months.
Investors who target distressed assets with significant upside and implement strategic renovations and amenities can open up a variety of opportunities in markets experiencing strong and sustained demand.
Attract and Retain Residents Using Creative Strategies
While demand remains relatively high, multifamily owners and investors are finding it increasingly important to stand out from the crowd amid rising vacancies and slowing rent growth.
When acquiring older Class B assets, a rebrand and name change alone can greatly increase the appeal of and modernize a community. Further, creative exterior upgrades such as a new color scheme will help differentiate the property, especially in dense urban areas and submarkets whose populations heavily consist of young professionals or students.
Small touches that can also drive leasing include providing residents with yoga mats and other gym-related items to use in a property’s fitness rooms, as well as seasonal tenant events, which can be a strong way to build a sense of community.
Lastly, establishing a strong local presence is important to driving leasing, referrals, and retention.
There are still ample opportunities for investors to acquire value-add Class B multifamily product in some of the most in-demand urban markets and submarkets across the country. As more renters are priced out of urban cores, the submarkets just outside these areas will continue to grow, and value alternatives to new Class A construction will continue to be sought out.
By implementing a range of cost-efficient upgrades and amenities, investors can maintain a strong upside while contributing to thriving communities and serving resident needs.