Working Class Apartments Provide Safe and Steady Returns during Recession

There are several different asset classes when talking specifically about commercial multifamily apartment investments. One asset class is proven to outperform others during a recession, and that is what is called B-grade (or working class) multifamily apartments. This is due to the fact that the tenant base is affected differently during a recession. We will look at historical data from the 2008-2012 recession and draw comparisons to the current COVID recession. During this article, I will explain why investing in B-grade apartments is a great way to diversify your portfolio, and will add cash-flow into your bank account during a recession. First I will quickly dive into each asset class.

Unemployment rates during the 2008 - 2012 economic recession

Tenant base matters when deciding on investment properties to own and when deciding on how much risk you are willing to take. As the above graph shows, not all demographic populations were affected the same during the last recession. The economic effect on unemployment is greatly predisposed to education levels and jobs. As the graph shows those with higher education levels were the LEAST affected during the last recession, never going above 5 percent unemployment. Conversely, those with the lowest levels of education were the MOST affected by unemployment.

Why is this important when choosing an asset class to invest in? Those demographic factors play a significant role in the tenant base of your multifamily asset. There are four basic levels of apartments: A, B, C, and D; with A-grade being the newest and most expensive, and D-grade being the oldest and cheapest.

Example of a new A-grade apartment complex with a focus on amenities

A-grade luxury apartments are usually built in the last 10 years and provide wealthy tenants with a plethora of amenities. These renters are normally seasoned white-collar workers who do not want the burden of homeownership. They have disposable income and want all the benefits of having amenities at their fingertips even if they never use them. People live in these complexes because they WANT to, and they have the disposable income to be able to afford this luxury living. However, during a recession some of these tenants might be furloughed, have reduced incomes, or become unemployed. A-grade assets usually see a dip in occupancy and rent collections because the tenant base is tightening their belt and being much more conservative with their money. During a recession, white-collar workers will tend to be more modest with the rents they are willing to pay and will choose to live in a slightly older asset that is more affordable but is still safe, close to their job centers, and has comfortable amenities rather than lavish ones.

Example of modest B-grade, working-class, apartment with simple but desirable amenities

B-grade, or working-class, apartments tend to be built from 1980-2010 and provide a safe location that is close to white-collar job centers and blue-collar industrial centers. These apartments have modest amenities such as pools, dog parks, playgrounds, outdoor barbecues, modest fitness centers, and easily accessible business centers. Since the amenities and other niceties are more modest the rents are also more modest. The location is still close to job centers and is safe for raising a family when looking at crime statistics for the area. Additionally, these assets tend to be close to good schools to provide new white-collar families and seasoned blue-collar families the ability to have their kids in great schools while they work. During a recession, the tenant base that makes up working-class apartments is the least likely to be affected by unemployment which keeps occupancy high and rent collections high.

C-grade apartments are older and house service industry and hourly workers

C-grade apartments are generally built before 1980 and have minimal amenities. They most likely will not have a pool, playground, business center, or fitness center. Some C-grade apartments have a coin-laundry facility that is shared between the tenants. This class of apartments primarily houses service industry personnel and hourly workers. These older properties usually have high-levels of deferred maintenance and require capital expenditures to replace old roofs, old air conditioning units, and cracked pavement parking areas. Crime tends to be higher in these areas, and schools are lower-rated. These assets tend to be further away from job centers, schools, and desirable retail outlets. During a recession, this asset class is hit hard as the hourly worker is laid off and will likely not be able to afford rent. Occupancy and rent collections will start to suffer.

Example of a D-grade apartment building

D-grade apartments are the most affected by a recession. Large portions of the tenant base will be unemployed and living on government subsidies. There will be high levels of non-payment and high levels of vacancy. There will even be high levels of non-payment but the tenants refuse to move, causing large expenses in evictions. This asset class doesn't boast any amenities besides basic utilities and is not close to prime job locations. These areas can have higher than normal violent crime rates, and schools have lower than state average test scores. The apartments themselves older and have high capital expenditure costs that have been deferred for extended amounts of time.

B-grade working-class apartments performed well during the last recession and have been performing well into the 2020 COVID recession. Since A-grade renters are becoming more frugal, they will likely move out of A-grade assets and into safer B-grade assets. C/D - grade assets will be the hardest hit by unemployment and will suffer high vacancy and low rent collections. For these reasons adding B-grade multifamily assets to your portfolio will hedge your exposure to unemployment and volatility during a recession

If you would like to find out more about how to add B-grade, working-class, assets to your portfolio contact [email protected] or visit www.thegrowthvue.com to find out more.

-Brad Penley

Mr. Penley is an apartment investment expert with a multimillion-dollar portfolio of personal multifamily assets. He is the lead for Investor Relations and Broker Relations for Growth VUE Properties.