As housing is a human necessity, renters will typically choose the highest quality apartment unit they can afford as close to where they work or go to school as possible. Thus, the dynamic between Class A and Class B/C apartments is as meaningful as any sub-class set in real estate. Class A apartments are averaging asking rents of $1,424 per unit per month versus $999 for Class B/C, both amounts representing all-time record highs, according to REIS®. The premium for Class A, 42.5% over Class B/C, is also a record high indicating the strength of the upper-end apartment market.
This spread is so wide because Class A has been growing its rents meaningfully faster than Class B/C, 4.8% versus 3.4% in 2015. Class B/C is always slightly constrained in its ability to grow rents as the incomes of those who occupy the units tend to grow slower than the incomes of those who rent Class A units. However, in 2016 and beyond, it is quite plausible that the growth rate in A will slow relative to B/C as almost all new supply is Class A and thus more prone to oversupply.
In fact, the rate of new supply has moved vacancy rates in Class A properties up to 6.1% in 2015, up from 5.5% in 2014. Class B/C, on the other hand, fell to 3.1% from 3.4%. The very low vacancy rate in B/C means that this sub-sector is likely to see faster-growing rents due to undersupply. This is already occurring in many cities where lack of affordable/workforce housing is being considered a crisis by public officials. Since new supply is effectively zero in Class B/C and net absorption is significantly positive, this situation will only get worse in 2016.
Investors looking to acquire multifamily properties in 2016 may find better returns and yields in Class B/C properties than Class A as they are much more relatively undersupplied. Further, the Class B/C landlord has the ability (with limitations) to make capital expenditures to make the units more competitive with Class A properties and of course faces substantially less risk from new supply. The downside is that rent growth and thus NOI growth in Class B/C can- not exceed less-than-median income affordability; wages in these sectors are not likely to grow substantially in 2016 and beyond.