When I started investing in multifamily properties I worked with a property manager in Dallas who used to teach a course in real estate investment at SMU. He used a simple rule of thumb to differentiate between three types of multifamily investments: A, B & C properties.
An “A” property is an expensive multifamily property in a high-end area. Someone who invests in an A property is focusing more on significant long-term appreciation of the property over cashflow. Maybe the duplex is in a hot area with a great school district, or is on land that is very valuable and the investor expects that value to increase significantly. Because of higher property taxes, insurance and other expenses an A property may not even cash flow, and the owner may lose money each year while they own it. But that investor looks at the loss like they’re contributing to an investment that will pay off with a great ROI down the road.
A “B” property is a bread-and-butter duplex. These are what most investors are looking for. A “B” Property is usually a well-maintained duplex in an area that has average appreciation. The investor here is looking for a little cash flow and an increase in equity that has been paid for with other peoples’ money. An example would be a $250,000 duplex that generates $1000/month per side with around a 5-6% cap rate and 3% annual appreciation.
A “C” property is all about immediate cash flow. These are low-end properties that may very well be worth exactly what you paid for them 10 years from now, but they cashflow monthly and the investor has use of that money now. An example would be a $100,000 duplex that generates $500 per unit with a high cap rate. You have to be careful with C properties though because high turnover, repairs and evictions can eat away at that cashflow very quickly. A lot of beginners start with a C property because of the low price point which I think is a mistake. These are better for the seasoned investor who knows how to keep expenses low and deal with problem tenants. I recommend starting with a “B” property and build from there.
What’s your experience?
Do you agree with the “A, B, C” rule of thumb? It’s just a suggestion that I’ve found helpful through the years. Do you have any other tips for categorizing different kinds of investment properties? Please share them here if you do.