Why Baltimore Multifamily Value-add Investments Are Hot

As American homeownership has fallen in recent years, rental demand has increased, showing no sign of slowing. According to the National Multifamily Housing Council, 35 percent of the U.S. population (112 million residents) rent vs own. By 2020, the Urban Institute projects new renter households will outnumber new owner households. The Baltimore multifamily market is no exception to this trend.

Many Baltimore neighborhoods provide compelling urban experiences with new restaurants, cultural attractions and green spaces. Millennials moving to the city continues to increase demand for more affordable housing. These factors point toward thriving multifamily investment opportunities with great potential for high returns. Multifamily developers and investors capitalize on Baltimore multifamily by satisfying demand for “renters by choice,” as well as “renters by necessity”.

Renters by choice can afford to own but have chosen to rent. This is typically a retired couple, single professional or millennial that has chosen the flexibility associated with renting over ownership. Renters by necessity may include millennials saddled with student loan debt or unable to afford a down payment. Other examples include someone with lower to middle income or subsidized housing.

Multifamily asset classification

The common multifamily assets, Class A, B and C, are typically assigned by characteristics such as age, tenant income levels, growth areas, appreciation, amenities, and rental rates. Certain asset classes cater to renters by choice, while others are better suited for renter by necessity. Renters by choice tend to seek out class A properties, while Class B and C properties are more affordable for renters by necessity.

Although there are no set rules for these letter grades, they are characterized by the following:

Class “A” is newer apartments built within the last 15 years. They have the most amenities, highest income earning tenants, and will typically demand the highest rents with no deferred maintenance. These buildings are usually owned by institutional investors. They demand the lowest capitalization rates (cap rates) and highest per unit prices.

Prime areas of Baltimore City such as Harbor East, Locust Point and Canton have a number of Class A multifamily properties. Many of the new recent multifamily developments fall into this category. Class A multifamily sells in the range of $200,000 - $300,000+ per unit and cap rates in the 5% - 6% range.

Class “B” is apartments built in the last 15-30 years with some amenities. Rents are typically  lower than Class A buildings with low deferred maintenance. They usually have appreciation potential with good cash flow on acquisition. There are numerous Class B apartment communities within Baltimore City including Mount Vernon, Federal Hill and suburbs including White Marsh, Owings Mills, Reisterstown and Cockeysville. Pricing ranges from $80,000 - $150,000 per unit and cap rate is in the 6.2% - 6.8% range. These properties cater to renters by choice or necessity depending on the rental price range.

Class “C” apartments are typically older properties, built 30+ years ago with much fewer amenities, and more deferred maintenance. These buildings are commonly owned by private investors and investment groups. They should provide for higher cash flow and cap rates, but will normally have lower appreciation. Baltimore City markets with Class C apartment communities may include certain areas of Fells Point, Bolton Hill, Station North and Park Heights. Dundalk, Middle River and Woodlawn have a number of Class C apartment buildings in Baltimore County. Prices range from $65,000 - $85,000 per unit and cap rates in the 7% -  9.5% range.

During times of economic uncertainty or economic downturn, Class B and C properties have an edge over their Class A counterparts. This is because older properties have proven themselves to be more or less recession-proof, whereas newer properties can easily become a liability under the same economic conditions.

Investment Strategies  

Buying and renovating older Class B and C apartment buildings has proved to be a good strategy for widening the renter demand pool. Savvy investors working value-add opportunities seek to improve older buildings. The strategy typically is to raise rents with certain improvements that attract residents who want more than a typical, aging Class B or C property but can’t afford to pay the type of rent currently being charged for new Class A apartments.

Value-add projects work best in neighborhoods where there is a wider difference between the average rental cost of a new Class A apartment compared to a Class B or C unit. You may see this in Baltimore’s Central Business District (CBD) where office buildings repurposed to multifamily are competing with ground up Class A apartments. Typically, there should be hundreds of dollars of difference between new Class A and existing Class B apartments. These projects do well in areas where employers are creating new jobs, with salaries large enough to pay higher “value-added” rents.

Class B and C properties also provide real estate investors with opportunities to enjoy a significant lift in NOI by making small property improvements. This may include communal clubhouses, adding dog parks, and hosting community events. Upgrades to B and C apartments can be relatively inexpensive to implement, yet can generate higher rents, leading to rapid ROI growth. For example, a redeveloper might plan to spend $5,000 to $8,000 per unit on such properties, adding new amenities, appliances, and upgrading bathrooms.
 

Summary

Class B and C multifamily rentals serve a market with insatiable tenant demand due to affordability. Value-add projects benefit from the strong demand for apartments overall, without having to compete with the thousands of more expensive luxury units now under construction.

Value-add multifamily opportunities offer the potential to invest in small one-time improvements that deliver big time payoffs. In changing economic climates, value-add properties tend to be more resilient. This continues to fuel broader buyer interest from Washington D.C., Philadelphia, New Jersey and New York chasing higher returns. 

Harbor Stone Advisors expects the appetite for Baltimore multifamily value-add opportunities to remain strong with occupancy across asset classes at its current 94.9% rate.