Young Adults, Boomers and Families Drive Rise of Class B Apartments

February 7, 2019

Cash-strapped Millennials, retiring Baby Boomers and middle-income families are driving demand in less expensive Class B multifamily apartments.

Class B multifamily apartments tend to be older buildings with fewer amenities and less expensive finishes than their Class A counterparts that command much higher rents.

The rise of Class B apartments is also a response to the affordable housing crisis in America, which is making it harder for people to stretch their paychecks far enough to cover basic needs such as rent and groceries, according to a recent study by the Urban Institute.

“The social safety net faces a period of transition as policymakers seek significant changes to an array of programs that help low-income families pay for food, health care, housing and other basic needs,” the Urban Institute wrote.

There’s not a single state in America where minimum wage for a 40-hour work week covers the cost of a 2-bedroom rental home, according to the National Low Income Housing Coalition. In Georgia, one must make $17.53 per hour to afford a 2-bedroom rental home or work a 97-hour work week at minimum wage.

At the same time, young adults entering the workforce have more student loan debt than ever before, which siphons away funds that previous generations could spend on rent or a mortgage.

Upon graduation, the average amount of student loans is $32,731, which is more than double the amount a decade and a half ago, according to the U.S. Federal Reserve Bank. That’s equivalent to making a 10 percent down payment on a $327,000 home.

Retiring Baby Boomers living on fixed incomes are another large demographic driving demand for affordable apartments.

Investor Interest is Piqued

Investors are taking notice, pouring billions of dollars in foreign and domestic capital into Class B affordable housing in recent years.

“All factors point toward Class B and C housing becoming the darling of the U.S. real estate investment sphere,” Yuen Yung, CEO of multifamily private equity investment firm Casoro Capital, wrote in trade publication Multifamily Executive. “Key market indicators such as the increased need for affordable housing by Millennials and an increase in foreign investment in multifamily housing underscore the veracity of this prediction.”

Vacancies for Class B units were just 5.8 percent nationwide in early 2018, according to the Federal National Mortgage Association, the provider of financing also known as Fannie Mae.

Class B units are generally $440 to $700 per month cheaper than Class A in the Atlanta area, according to real estate investment services firm Marcus & Millichap. Still, the average rent for Class B apartments was $1,152 nationally last year, up 2.9 percent, CoStar data show.

Quartz Countertops & Hardwood Floors

Investors are wooed by Class B apartments because valuations and rents can often be pushed higher after relatively inexpensive renovations and other technological or cosmetic touches that boost curb appeal.

“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,” Mitch Paskover, managing partner at real estate private equity firm Trion Properties, wrote in an April guest column in Multifamily Executive.

“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.”

At one property, Trion spent $2.6 million on quartz countertops, stainless steel appliances, cabinets, smart thermostats, new hardwood floors, exterior paint and high-speed internet throughout the complex and doubled the value of the asset in 18 months, to $19.4 million from $9.6 million previously, he wrote.

“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,” Paskover said in the article.

Foreign investors are particularly bullish on affordable housing, as evidenced by a $550 million joint venture created in early 2018 by Singapore’s sovereign fund GIC, Canada Pension Plan Investment Board and Cortland Partners to purchase and renovate as many as 10,000 Class B apartments in markets including Denver; Raleigh, North Carolina; and Austin, Texas.

“This venture will pursue a value-add strategy to capture the strong demand and resilient return profile of the U.S. multifamily sector,” Lee Kok Sun, chief investment officer for GIC Real Estate, said in a January statement announcing the formation of the affordable housing joint venture.

Trump Tax Reform Incentive

Another draw for Class B investors is the newly created “Opportunity Zones” program in President Donald Trump’s Tax Cuts and Jobs Act (TCJA).

Under Trump’s tax reform law, investors can roll capital gains into special purpose funds that invest in thousands of designated low-income areas in exchange for deferred recognition of capital gains for tax purposes.

Investors who keep money in the funds for a full 10 years still pay taxes on the original amount of deferred gains, but post-investment appreciation that is held for at least 10 years is exempt from tax.

Class B and C housing is a prime target for such funds.

In June, Phoenix-based private equity real estate firm Virtua Partners said it was launching an Opportunity Fund with a $200 million target to invest in affordable apartments and other businesses in approved Opportunity Zones in Sunbelt markets including Atlanta, Orlando and Dallas.

“This is a unique opportunity to capture a generous break on capital-gains taxes, while investing in real estate that stands to benefit from a broader government mandate for growth,” Derek Uldricks, president of Virtua Capital Management, said in a news release. “At the same time, investors can also make an impact by supporting the improvement of local communities and economies with their Opportunity Zone-directed investments.”

In Summary

Millennials, retiring Baby Boomers and low- and moderate-income families are driving demand for less expensive Class B apartments.

Investors are confident that demand will continue to rise and that modest upgrades such as new countertops and hardwood floors will help them increase rents and boost valuations when they sell the properties.

Another draw for investors is the newly created Qualified Opportunity Zones that were part of Trump’s tax reform law, which can defer and potentially reduce capital gains taxes on investments in affordable housing projects such as Class B apartments.