Part 2: Multi Family Asset Classification
By Al DiNicola, AIF®
Editor’s note- this is part two of a ten-part series on the various asset types of DST offerings.
May 10, 2022
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC
When multifamily asset class becomes a topic of discussion there is a lack of formal definition of the variations of multifamily assets.
Multifamily loosely defined would include apartment complexes. These are multi story buildings from two stories to multi story buildings as well as repurposed buildings. These may be in suburban locations, an urban location, or the edge of urban locations. The construction of the buildings may be purpose built or a conversion of an older building. The conversion of older buildings to multi-tenant dwellings are appearing in cities as property owners may be repurposing the asset.
For example, in cities like Philadelphia a warehouse along the waterfront may be converted into residential flats. In certain cities there may be special tax abatement or incentives to redevelop. Recently we placed an investor in a multifamily property that had a twenty-year tax incentive. Not all locations can be guaranteed this special situation.
The properties may also be separated into a classification or grading system from Class A (highest), Class B, C & D. The grading may be subjective in nature depending on who is making the evaluation. Sponsors of Delaware Statutory Trust (DST) will conduct due diligence into the various properties. It becomes very important to understand the underlying principles that create the risk / return profiles of the opportunities prior to acquisition. There may also be a fine line between the asset classification. Sponsors, Investment representatives as well as investors need to be objective in evaluating the criteria and offerings.
The Class A properties will normally have similar qualities. These qualities may be the physical locations with access to good schools, shopping, and other geographic assets. Normally these properties can generate the highest rents in the submarket. The construction may be more recent (built with the past 10 years) and there may be little deferred maintenance. The word luxury is used often (maybe too often). However, this may be draw for high-income tenants.
The Class B properties are still very functional and useful and a step down from Class A. The age may be older (built 10-30 years ago typically). The properties may be in need of maintenance and potentially have need of interior upgrades as well as exterior amenities. Because of these factors rents will be at mid-level. However, there may be upside potential for sponsors. The upside may be created as a result of interior finish packages being installed that may create rent increases.
The Class C properties may be an option for renters who rent out of necessity. The term work force housing occasionally comes up in this discussion. The properties tend to be older, build 30-50 years ago. With properties built that long ago there may be obsolescence either in the floor plans, HVAC, ceiling heights and other outdated physical aspects. The tenant base may also be lower income (paycheck to paycheck). These properties may be a great opportunity for value-add strategy. The caution would be the extend of additional capital required to elevate to class B. The physical location of the property may warrant a full investigation.
Class D properties once again are older and may include very low-income housing. Unfortunately, the location may be in higher crime areas. These areas also have additional requirements for security and increased maintenance. The vacancy rate and turnover may also be a concern for investors.
Each of the asset classes have a different risk profile. When DST sponsors are seeking properties for acquisition and ultimate packaging for individual investors the Class A and potentially Class B become the low hanging fruit so to speak.
Recent Activity
Recently there has been a compression of cap rates on the Multifamily asset. Prices of the properties have escalated over the past year as individual investors as well as institutional investors seek out properties to add to their portfolios. Multifamily properties have been the first choice of investment option for a variety of reasons. There are many reasons for the appeal of this asset class. Individual investor may be interested in smaller properties that contain less than 20 units. For an active ”hands-on” investor this may be manageable.
Typically, larger institutional investors look for projects that contain higher number of rental units. Projects that have over 200 units (an upwards of 400 units) are preferred. In addition, DST sponsors may package several complexes to offer assets that contain 800 units. The dynamics of multiple units all with different lease expiration dates enable the property managers to respond to market rate increases. The rental increases may only happen once per year on the renewal or on the turnover when a renter moves out. The property managers have the responsibility to minimize the down time and release the property. DST are passive investment that enable the individual investor to enjoy the benefits of ownership without dealing with property management, lease renewals, or capital improvements.
Each property may have unique features that may add to the overall appeal of the property.
The overall size of the property may be an advantage. Technology has increased the ability for property managers to handle larger numbers of units. When COVID occurred the management companies who embraced the electronic entry and digital lease and online application increased efficiencies. The product mix meaning the numbers of studios, one bedroom, two bedrooms and potentially three bedrooms may be different depending on the market. In urban areas the need for smaller units may be greater than suburban locations. When you look at a matrix of the DST offerings the majority of units are one and two bedrooms.
The community amenities could separate one asset from another. Here is an example from one closed DST offering. Please note this not to represent what all Multifamily properties contain. “Community amenities may include a designer clubhouse with complimentary gourmet coffee bar; a workspace with private, fully supplied offices, dedicated coffee bar and conference room; resort-style pool with sun shelf and poolside cabanas; a state-of-the-art 24-hour fitness and yoga/cross training center with fitness on-demand kiosk; weekly onsite fitness classes; community iMac and resident printer station; a 24-hour access-controlled package room; multiple outdoor grilling stations; Wi-Fi access throughout the clubhouse and common areas; a family hangout and kids play area; valet waste and recycling; a social room with poker table and shuffleboard; an outdoor pavilion with lounge seating and a ping pong table; a fenced pet park; a pet spa with multiple wash stations and a grooming table; car charging stations; outdoor courtyard with hammocks and firepit; controlled access gated community; 24-hour onsite community market; private garages and storage; and elevator access”.
The physical location of the property may be another important feature.
Many potential tenants want to know how close the shopping is, restaurants, employment opportunities, school quality and proximity, and other external amenities.
There may also be regional features such as a highly educated population of residents within a certain radius on the property. Having an educated workforce may assist companies looking to relocate which in turn could bring an increase of jobs which benefits the overall community.
One of the metrics some real estate professionals use what is known as the Yardi Matrix© which identifies long term occupancy in the property’s submarket. This is not the only element of evaluation but may indicate stability in the marketplace.
The sponsor’s experience may also be a competitive advantage. The overall question regarding the sponsor may be do they specialize in acquisition development, management and reposition if real estate investment assets.
We will expand on other asset classes in future sections of the Educational Series B DST Asset Classifications. The next topic of discussion will be Student Housing. This is similar in many ways to Multifamily and at one time was a subsection of Multifamily.
DSTs are not for all investors. The acquisition of a DST is for accredited investors only. Contact your investment adviser for additional details on how a DST may be a solution to your 1031 Exchange and suited for your investment future. For more information on how to properly set up an IRC 1031Tax Deferred Exchange or if you are an accredited investor and would like additional information on a DST contact Al DiNicola at 239-691-8098 or email adinicola@namcoa.com.
This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission).
Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 410 Peachtree Parkway Suite 4245, Cumming, GA 30041. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.
Thank you.
NAMCOA® – Naples Asset Management Company®, LLC